Derivative Actions

September 28, 2021Taek Soo Shin

A “derivative action” is a lawsuit that is commenced by a “complainant”, usually a minority shareholder, on behalf of a corporation for harms done to the corporation. This is in contrast with the typical securities class action, which is initiated against the corporation for damages suffered by its shareholders.

Generally speaking, a shareholder is unable to directly sue wrongdoers for harms done to the corporation. This is because a corporation is a separate legal entity from its shareholders. Hence, if and when corporate management is unwilling to rectify a harm done to the corporation—often because the management is directly involved in the harm or wrongdoing done to the corporation—shareholders end up suffering the consequences. This is especially true for minority shareholders who have little to no control over the corporation’s business or affairs.

A derivative action is a vehicle designed to protect shareholders in such circumstances. Under section 239 of the Canada Business Corporation Act[i] and the various provincial corporate statues,[ii] a shareholder has a statutory right to seek “leave” (i.e., permission) of the relevant Court to commence a derivative action on behalf of a corporation for the purpose of prosecuting, defending or discontinuing the action on behalf of the body corporate.[iii] Stated differently, with leave of a Court, the shareholder can directly act as the corporation’s representative and file legal claims for the corporation, circumventing the corporate management who is unwilling to act.

In a derivative action, the complainant is not suing for damages personally suffered, but for corporate relief (i.e., to recover for harms done to the corporation).[iv] As such, monetary awards from a successful derivative action would go to the corporation, not the individual complainant (although the Court could order that the corporation pay reasonable legal fees incurred by the complainant in connection with the derivative action).[v] Nonetheless, the complainant and other shareholders would benefit because the corporation’s share price—and consequently the value of the shareholders’ investments—very well could rise as a result of the successful derivative action and the recovery achieved therefrom.

Procedural Requirements

Prior to commencing a derivative action, a complainant must first make reasonable efforts to cause the directors of the company themselves to prosecute or defend the proposed legal proceeding, provide to the corporation’s directors a reasonable amount of time (often at least 14-days) to respond as to whether they will do so, and give notice of the complainant’s intention to file a derivative action if management is unwilling or unable to act. This is to provide the corporation an opportunity to investigate and pursue the complainant’s proposed claims on its own behalf, which could eliminate the need for a derivative action. If the corporation declines to act or fails to respond, then the complainant may apply for leave of the relevant Court by showing:

  • the complainant has made reasonable efforts to cause the directors of the company to prosecute or defend the legal proceeding;
  • notice of the application for leave has been given to the company and to any other person the Court may order;
  • the complainant is acting in good faith; and
  • it is in the best interests of the company for the legal proceeding to be prosecuted or defended.[vi]

Once leave is obtained, the complainant can commence the proposed legal proceeding in the name and on behalf of the corporation against the alleged wrongdoers.

Conclusion

Since a derivative action is a two-step process with the added layer of a leave application or motion, pursuing a derivative action can sometimes take a significant amount of time. However, a derivative action may be the only and most effective remedy in matters such as a breach of directors’ duties of loyalty and care, wherein none of the alleged wrongdoings were committed by the corporation, but rather against it.

I think I may have a case - How do I know if my issue is suitable for a derivative action?

TThe lawyers at KND Complex Litigation have extensive experience in assessing the suitability of a particular issue to be brought as a derivative action. If you believe that you have suffered a loss or been harmed by wrongful conduct committed against a corporation in which you have invested, reach out to KND Complex Litigation at [email protected] and one of our lawyers will respond to your inquiry within one day. You can also call our firm at +1 416 537 3529 and ask to speak with Eli Karp.

How to Reach Us

If you have a pressing legal issue, our lawyers can help:

Toronto1186 Eglinton Ave W.M6C 2E3