Opinion ID: 2156030
Heading Depth: 1
Heading Rank: 7

Heading: The Maryland Response

Text: In Kamen v. Kemper Fin. Servs., Inc., 939 F.2d 458 (7th Cir.1991), the Court of Appeals for the Seventh Circuit, on remand from the Supreme Court ( see Kamen v. Kemper Fin. Servs., Inc., supra, 500 U.S. 90, 111 S.Ct. 1711, 114 L.Ed.2d 152), attempted to predict how Maryland would react to these developments. Citing Waller, Eisler, and Parish, the court noted that Maryland requires demand as a norm but excuses it when the request would be futile, but that it had done little to develop the scope of its futility exception. Id. at 460. The plaintiff posited six reasons why a pre-suit demand on the directors would have been futile, including (1) the seven independent directors on the 10 person board received aggregate remuneration of $300,000/year for their services as directors, (2) the directors voted to circulate the proxy statement complained of, (3) they opposed her lawsuit on both procedural and substantive grounds, (4) a demand would have been tantamount to a request that the directors sue themselves, and (5) the directors were under the control of Kemper. The court did not read Parish as excusing demand on any of those grounds. If remuneration or a general allegation of control were sufficient, the court noted, the demand rule would be negatedfor almost all directors receive fees, and independent directors come to a board after being slated by corporate insiders. Id. In the particular case, the plaintiff was not seeking damages against the directors personally, so the third reason offered had no relevance. In dealing with the assertions that all of the directors approved the proxy statement and opposed her lawsuit, the court noted that whether the directors' involvement in the transaction complained of excuses a demand depends on the function of the demand rule. If demand serves only to alert the directors to a grievance, then their involvement would excuse a demand, because they already know what they have done. Id. at 461. If, however, demand either recognizes the allocation of powers within the corporation ... or serves a screening role (a form of alternative dispute resolution helping to weed out weak cases), then the fact that the directors participated in the transaction is not enough. Id. Maryland, the court held, had not spoken clearly to the function demand serves, although Waller treats demand as a useful screen for the courts, and Parish says that application must be made unless the directors are `wrongdoers.' Id. Participants who are not wrongdoers, the court continued, may evaluate their acts and change their minds. Id. Although noting cases that appeared to support Kamen's approach, the Seventh Circuit court observed that [t]he tide is running against this approach. Id. Citing the ALI Principles and the Delaware view, the court determined that [t]he prevailing contemporary view is that demand is necessary if the directors are disinterested-and because of the business judgment rule directors may be financially disinterested even if they took part in the acts of which the plaintiff complains. Id. The court concluded: In resolving doubt about the scope of its demand requirement, Maryland could well be influenced by the recommendations of the American Law Institute and the American Bar Association, both of which believe that the futility exception to the demand requirement should be eliminated rather than expanded [citations omitted]. So, too, Maryland might be influenced by the burgeoning research casting doubt on the value of derivative litigation for investors [extensive citations omitted]. State legislatures have begun to adopt universaldemand requirements. There is no counter movement toward enlarging the futility exception. We think it likely, then, that if Maryland does not abolish the futility exception it will cast its lot with the states that require demand on directors who face no substantial risk of personal liability. Id. at 461-62. See also Grill v. Hoblitzell, 771 F.Supp. 709 (D.Md.1991). There is much to be said for the ABA/ALI approach, but, unlike the Pennsylvania court, we are not prepared, at this point, to engraft it as part of our common law. It is not just § 7.42 (or § 7 .03 of the Principles ) that is involved. That section is part of a larger scheme laid out in other sections of the Model Code and Principles, and careful attention needs to be given to the provisions in those sections as well. See MBCA § 7.41 (standing requirements), § 7.43 (stay of proceedings pending corporate inquiry), § 7.44 (circumstances under which court may dismiss action on motion of corporation), § 7.45 (discontinuance or settlement), § 7.46 (payment of expenses), and § 7.47 (applicability to foreign corporations), and Principles §§ 7.01 through 7.17. The approach taken by the ABA and ALI constitutes a radical departure from our current common law, and, although it is certainly within our power to make such modifications, this is a matter that should be subjected to legislative hearings, at which all interested groups, and not just the litigants in one case, can present their views. We therefore decline, at this point, to adopt the ABA/ALI approach of eliminating altogether the futility exception. Nor are we disposed, at this point, to adopt in full the Delaware approach. Although, due to the respect properly accorded Delaware decisions on corporate law, the Delaware approach is often mentioned and the business judgment rule is generally regarded as applicable in a demand futility analysis, few, if any, States have abandoned their existing law in favor of that approach, and some of the criticism of it needs to be taken into account. We agree with much of what the Seventh Circuit court said in Kamen, however, and are not willing to excuse the failure to make demand simply because a majority of the directors approved or participated in some way in the challenged transaction or decision, or on the basis of generalized or speculative allegations that they are conflicted or are controlled by other conflicted persons, or because they are paid well for their services as directors, were chosen as directors at the behest of controlling stockholders, or would be hostile to the action. The demand requirement is important. Directors are presumed to act properly and in the best interest of the corporation. They enjoy the benefit and protection of the business judgment rule, and their control of corporate affairs should not be impinged based on non-specific or speculative allegations of wrongdoing. Nor should they, or the corporation, be put unnecessarily at risk by minority shareholders bent simply on mischief, who file derivative actions not to correct abuse as much to coerce nuisance settlements. [11] We agree, moreover, with the ABA/ALI that, in most cases, a pre-suit demand on the directors is not an onerous requirement. As the Seventh Circuit court noted, it gives the directorseven interested, non-independent directorsan opportunity to consider, or reconsider, the issue in dispute. It may be their first knowledge that a decision or transaction they made or approved is being questioned, and they may choose to seek the advice of a special litigation committee of independent directors, which has become a common practice, [12] or they may decide, as a business matter, to accede to the demand rather than risk embarrassing litigation. The futility exception essentially eliminates any chance at meaningful pre-litigation alternative dispute resolution. It also virtually assures extensive and expensive judicial wrangling over a peripheral issue that may result in preliminary determinations regarding director culpability that, after trial on the merits, turn out to be unsupportable. If a demand is made and refused, that decision, and the basis for it, can be reviewed by a court under the business judgment rule standard. We adhere, for the time being, to the futility exception, but, consistent with what appears to be the prevailing philosophy throughout the country, regard it as a very limited exception, to be applied only when the allegations or evidence clearly demonstrate, in a very particular manner, either that (1) a demand, or a delay in awaiting a response to a demand, would cause irreparable harm to the corporation, or (2) a majority of the directors are so personally and directly conflicted or committed to the decision in dispute that they cannot reasonably be expected to respond to a demand in good faith and within the ambit of the business judgment rule. That focuses the court's attention on the real, limited, issuethe futility of a pre-suit demandand avoids injecting into a preliminary proceeding issues that go more to the merits of the complaintwhether there was, in fact, self-dealing, corporate waste, or a lack of business judgment with respect to the decision or transaction under attack. It does not preclude, however, appropriate judicial review, under the business judgment rule, of the response (or non-response) to a demand. See Harhen v. Brown, 431 Mass. 838, 730 N.E.2d 859 (2000).