To Demand or Not Demand, “Futility” is the Question
November 09, 2017
Under Delaware law, the decision to commence litigation on behalf of a corporation is, of course, a fundamental exercise of business judgment, which decision rests with the Board of Directors. A shareholder, therefore, cannot bring a derivative action without pleading that a demand on the corporation to do so had been made, or that such demand would have been “futile.” The shareholder, therefore, has an initial decision to make: make the demand, or plead futility.
Recently, in Reese v. Andreotti, Justice O. Peter Sherwood dismissed a derivative action brought by a shareholder who made the demand, which was rejected by the Board. Relying on Delaware law, the court noted that the mere making of a demand is a tacit acknowledgment by the shareholder that there is an absence of facts that would support a “futility” argument (citing Spiegel v. Buntrock). Mere disagreement with the Board’s conclusion is simply not sufficient to raise doubts about the Board’s good faith and whether it acted on an informed basis. Similarly, the court held that by making a demand, a shareholder is effectively conceding that his demand can be fairly assessed and thereby waives any later claim that the Board members were conflicted.
How about the availability of discovery to determine the reasonableness of the Board’s rejection of the demand? “No” says the court, relying on both Delaware law and New York law, which come to the same conclusion: plaintiffs are not entitled to discovery to assess the reasonableness of the Board’s rejection.
Making a demand or pleading futility becomes an important, strategic first step in any derivative action. There are presumptions and ramifications that must be considered before the chosen course is charted and demand is made.