Derivative Actions Explained: When Shareholders Can Sue On Behalf Of The Company

You’re a shareholder in a company. The directors are stealing money, making terrible deals that benefit themselves, or running the business into the ground. 

The company should sue them, but the directors control the company and refuse to take action against themselves.

What can you do? 

This is where a derivative action comes in: a powerful legal tool that lets shareholders sue on behalf of the company when those in control won’t act.

A derivative action is a lawsuit where a shareholder sues on behalf of the corporation, not for themselves personally.

Here’s how it works:

• The company has been harmed (by directors, officers, or others)
• The company should sue but won’t (usually because wrongdoers control it)
• A shareholder steps in and sues in the company’s name
• Any money recovered goes to the company, not the individual shareholder

Think of it like this: You’re acting as the company’s champion when the company can’t or won’t defend itself.

Key difference from regular lawsuits: In a normal lawsuit, you sue for harm done to you. In a derivative action, you’re suing for harm done to the company — you just happen to be the one bringing the lawsuit.

You can bring a derivative action when:

The company itself must have suffered harm, such as:

• Directors stealing corporate funds or assets
• Self-dealing transactions that harm the company
• Directors taking corporate opportunities for themselves
• Fraud or breach of fiduciary duties
• Negligent management causing significant losses

The harm is to the company, not just to you as a shareholder. 

Typically because:

• The wrongdoers control the board and won’t sue themselves
• Directors are protecting each other
• The company is controlled by the people who caused the harm

This is the whole point of derivative actions — you’re stepping in because those in control won’t police themselves.

You must show that:

• The lawsuit is in the company’s best interests
• There’s a reasonable chance of success
• You’re acting in good faith (not for personal revenge or harassment)

Yes. You must get court approval before you can proceed.

This is a critical requirement under Ontario’s Business Corporations Act. You can’t just file a derivative action lawsuit: you must first apply to the court for permission.

Stage 1: Apply for Leave (Permission)

• You ask the court for permission to bring the derivative action
• You explain what happened and why the company should sue
• The court decides whether to allow you to proceed

Stage 2: The Actual Lawsuit (only if you get permission)

• You proceed with the lawsuit on behalf of the company
• Normal litigation process follows

The court will only give you permission if you prove:

1. You’re acting in good faith

• Your motives are legitimate
• You’re not doing this for harassment or personal gain
• You genuinely believe the company was wronged

2. It’s in the company’s best interests

• The lawsuit would benefit the company
• Potential recovery outweighs costs and disruption
• The claim has merit

3. The company itself won’t bring the action

• Those in control refuse to sue
• You’ve given notice and they declined to act (usually required)
• It’s clear the company won’t pursue the claim on its own

Here’s the step-by-step process:

• Identify the harm to the company
• Gather evidence (documents, financial records, communications)
• Ensure the wrongdoing is serious enough to justify legal action

• In most cases, you must notify the directors in writing
• Demand that the company take action itself
• Give them a reasonable time to respond (14-30 days is typical)
• Document their refusal or failure to act

• File a motion seeking leave to bring a derivative action
• Provide evidence of:
  • The harm to the company
  • Why the company won’t sue
  • That you’re acting in good faith
  • That it’s in the company’s interests
• Attend a court hearing

• File the main lawsuit in the company’s name
• Follow normal litigation procedures
• The company becomes the plaintiff (with you as the person driving it)

• Discovery (exchange documents and information)
• Possible settlement negotiations
• Trial if no settlement reached
• Any recovery goes to the company

Yes. Any shareholder can bring a derivative action, regardless of how many shares they own. You don’t need:

• A majority stake
• A certain percentage of shares
• Permission from other shareholders

One share is technically enough, though courts will consider your stake when deciding whether to grant leave.

Derivative actions are specifically designed to protect minority shareholders who:

• Can’t control board decisions
• Are outvoted by majority shareholders
• See the company being harmed but are powerless to stop it

This levels the playing field and gives minority shareholders a way to hold directors and majority shareholders accountable.

You’re more credible if:

• Your shareholding is meaningful (even if not majority)
• You can show genuine concern for the company
• You’ve tried other avenues first
• Other shareholders support you (though not required)

Courts are sympathetic to minority shareholders who are trying to protect the company from wrongdoing by those in control.

Consider it when:

• Directors are clearly breaching their duties
• The company is suffering significant harm
• Those in control refuse to address the problem
• The potential recovery justifies the cost
• You have solid evidence of wrongdoing
• Other remedies (negotiation, oppression action) won’t work

Our Toronto derivative action litigation Lawyers have experience with corporate disputes and shareholder rights. Contact us to discuss whether a derivative action is right for your situation – 416.901.9984 or info@pintoshekib.ca.