Opinion ID: 2308645
Heading Depth: 1
Heading Rank: 3

Heading: the standards for determining whether demand is excused in this derivative suit

Text: The stockholder derivative suit is an important and unique feature of corporate governance. In such a suit, a stockholder asserts a cause of action belonging to the corporation. Aronson, 473 A.2d at 811; Levine v. Smith, Del.Supr., 591 A.2d 194, 200 (1991). In a double derivative suit, such as the present case, a stockholder of a parent corporation seeks recovery for a cause of action belonging to a subsidiary corporation. See Sternberg v. O'Neil, Del.Supr., 550 A.2d 1105, 1123-24 (1988). Because directors are empowered to manage, or direct the management of, the business and affairs of the corporation, 8 Del.C. § 141(a), the right of a stockholder to prosecute a derivative suit is limited to situations where the stockholder has demanded that the directors pursue the corporate claim and they have wrongfully refused to do so or where demand is excused because the directors are incapable of making an impartial decision regarding such litigation. Levine, 591 A.2d at 200. Fed. R.Civ.P. 23.1, like Chancery Court Rule 23.1, constitutes the procedural embodiment of this substantive principle of corporation law. [7] Derivative suits have been used most frequently as a means of redressing harm to a corporation allegedly resulting from misconduct by its directors. As we observed in Aronson: [A] stockholder is not powerless to challenge director action which results in harm to the corporation. The machinery of corporate democracy and the derivative suit are potent tools to redress the conduct of a torpid and unfaithful management. 473 A.2d at 811. In such instances, stockholders often do not make a demand on the board of directors, and instead file suit claiming that demand is excused. Because such derivative suits challenge the propriety of decisions made by directors pursuant to their managerial authority, we have repeatedly held that the stockholder plaintiffs must overcome the powerful presumptions of the business judgment rule before they will be permitted to pursue the derivative claim. Aronson, 473 A.2d at 814; Grobow, 539 A.2d at 186; Levine, 591 A.2d at 200, 205-6; Pogostin v. Rice, Del.Supr., 480 A.2d 619, 624 (1984). Our decision in Aronson enunciated the test for determining a derivative plaintiff's compliance with this fundamental threshold obligation: whether, under the particularized facts alleged, a reasonable doubt is created that: (1) the directors are disinterested and independent [or] (2) the challenged transaction was otherwise the product of a valid exercise of business judgment. 473 A.2d at 814. Although these standards are well-established, they cannot be applied in a vacuum. Not all derivative suits fall into the paradigm addressed by Aronson and its progeny. The essential predicate for the Aronson test is the fact that a decision of the board of directors is being challenged in the derivative suit. Our discussion of the Aronson test in Pogostin v. Rice makes this clear: Directorial interest exists whenever divided loyalties are present, or a director has received, or is entitled to receive, a personal financial benefit from the challenged transaction which is not equally shared by the stockholders. The question of independence flows from an analysis of the factual allegations pertaining to the influences upon the directors' performance of their duties generally, and more specifically in respect to the challenged transaction. The second, or business judgment inquiry of Aronson, focuses on the substantive nature of the challenged transaction and the board's approval thereof. 480 A.2d at 624 (emphasis added) (citations omitted). See also III Ernest L. Folk, III, Rodman Ward, Jr., and Edward P. Welch, Folk on the Delaware General Corporation Law § 327.4.1.1 (1992) (Demand is excused under this step only if a reasonable doubt is raised concerning the disinterestedness or independence of the board majority approving the challenged transaction. (Emphasis added)). Under the unique circumstances of this case, an analysis of the Board's ability to consider a demand requires a departure here from the standards set forth in Aronson. The Board did not approve the transaction which is being challenged by Blasband in this action. In fact, the Danaher directors have made no decision relating to the subject of this derivative suit. Where there is no conscious decision by directors to act or refrain from acting, the business judgment rule has no application. Aronson, 473 A.2d at 813. The absence of board action, therefore, makes it impossible to perform the essential inquiry contemplated by Aronson  whether the directors have acted in conformity with the business judgment rule in approving the challenged transaction. See Pogostin, 480 A.2d at 624. Consistent with the context and rationale of the Aronson decision, a court should not apply the Aronson test for demand futility where the board that would be considering the demand did not make a business decision which is being challenged in the derivative suit. This situation would arise in three principal scenarios: (1) where a business decision was made by the board of a company, but a majority of the directors making the decision have been replaced; [8] (2) where the subject of the derivative suit is not a business decision of the board; [9] and (3) where, as here, the decision being challenged was made by the board of a different corporation. Instead, it is appropriate in these situations to examine whether the board that would be addressing the demand can impartially consider its merits without being influenced by improper considerations. Thus, a court must determine whether or not the particularized factual allegations of a derivative stockholder complaint create a reasonable doubt that, as of the time the complaint is filed, the board of directors could have properly exercised its independent and disinterested business judgment in responding to a demand. If the derivative plaintiff satisfies this burden, then demand will be excused as futile. In so holding, we reject the defendants' proposal that, for purposes of this derivative suit and future similar suits, we adopt either a universal demand requirement or a requirement that a plaintiff must demonstrate a reasonable probability of success on the merits. The defendants seek to justify these stringent tests on the need to discourage strike suits in situations like the present one. This concern is unfounded. A plaintiff in a double derivative suit is still required to satisfy the Aronson test in order to establish that demand on the subsidiary's board is futile. The Aronson test was designed, in part, with the objective of preventing strike suits by requiring derivative plaintiffs to make a threshold showing, through the allegation of particularized facts, that their claims have some merit. Aronson, 473 A.2d at 811-12. Moreover, defendants' proposal of requiring demand on the parent board in all double derivative cases, even where a board of directors is interested, is not the appropriate protection against strike suits. While defendants' alternative suggestion of requiring a plaintiff to demonstrate a reasonable probability of success is more closely related to the prevention of strike suits, it is an extremely onerous burden to meet at the pleading stage without the benefit of discovery. [10] Because a plaintiff must satisfy the Aronson test in order to show that demand is excused on the subsidiary board, there is no need to create an unduly onerous test for determining demand futility on the parent board simply to protect against strike suits.