Derivative Actions

A derivative action may be necessary if a company suffers loss or damage at the hands of its own directors and officers. Cleary, if the wrongdoers control the company, they will not bring an action against themselves. This is exactly the situation contemplated by sections 246 and 247 of the Business Corporations Act, R.S.O. 1990, c. B.16 (the “Act”). Under those sections, certain stakeholders, such as a shareholder, can apply to the Court to bring an action in the name of the company. The derivative action is a remedy for a wrong committed against the company, itself, which may ultimately affect the shareholders’ value.

By contrast, the oppression remedy relates to a wrong to the individual shareholders in their capacity as shareholders. For information about the oppression remedy, see the Oppression Remedies section in this website. There is an overlap. In some circumstances, the conduct of the company’s directors may justify both an oppression claim as well as a derivative action.

Under s. 246 of the Act, a shareholder (which includes beneficial shareholders), a director, or any other person whom the court considers appropriate, may bring apply to the Court to allow that person to bring a lawsuit in the name of and on behalf of a company. Bringing an action on behalf of the company is called a “derivative action”. An application can also be brought for the same individuals to defend a legal proceeding brought against the company, although this situation does not arise as often.

Before bringing the application, the complainant needs to make reasonable efforts to cause the directors to either bring or defend the lawsuit. In most circumstances, the complainant must notify the company of the complaint’s intent to bring the application. The complainant must be acting in good faith and it must appear to the Court that it is in the best interest of the company to either bring or defend the legal proceeding. The right to bring a derivative action in the name of the company does not necessarily mean the company will have to pay the legal expenses related to the action, as that is left to the discretion of the Court and will depend on the circumstances.

A cost-benefit analysis ought to be done before bringing an application for the right to file a derivative action. The complainant has to be serious about pursuing the derivative action. The complainant may be required to give security for costs, or may be ordered to indemnify the company or its directors and officers for expenses, including legal costs, that are incurred as a result of the legal proceeding. Further, the legal proceeding cannot be settled without court approval, so the complainant must be prepared to go back to court once the matter is resolved.

Lawsuits brought by shareholders can be struck on the grounds that their claim is derivative to the company. In other words, the wrong was really done to the company and not the shareholder as an individual. In these circumstances, the shareholders’ only recourse is to bring a derivative action. Sometimes, both an oppression claim and a derivative action are appropriate. Therefore, it is best to consult a legal about whether it is appropriate to bring a derivative action, an oppression claim, or both, depending on the circumstances.