Opinion ID: 2320147
Heading Depth: 2
Heading Rank: 1

Heading: Demand Excused/Demand Wrongfully Refused

Text: Under Rule 23.1, a shareholder bringing a derivative action must plead either (1) that he has made a demand for action upon the corporations directors which the directors wrongfully refused, or (2) that a demand would have been futile because, for example, the majority of directors is not independent or failed to validly exercise their business judgment. See Flocco, supra, 752 A.2d at 151 (citations omitted) (applying Illinois law); Beam Ex Rel. M. Stewart Living v. Stewart, 845 A.2d 1040, 1048 (Del.2004) (citation omitted) (setting forth alternative presuit demand or wrongful refusal requirements for derivative suits by shareholders). Appellant argues that he satisfied these requirements for the first of these alternative theories by alleging that he made a demand and the dates and manner in which he made the demands. He also contends that he provided the reasons for his inability to obtain the required action from the corporation, i.e., that Mr. Dashtara was the sole director, who controlled the Board, and rejected the demand that the Corporation sue himself. In fact, appellant made these allegations as he claims, as reflected in the portions of the second amended complaint set forth in the margin of this opinion. [9] Appellees concede that appellants allegations are sufficient to constitute a presuit demand under Rule 23.1. [10] Appellees argue, however, that appellants concession that he made a presuit demand has certain legal consequences pertinent to the determination of the adequacy of his complaint. Specifically, they contend that, having made a presuit demand, appellant cannot later use the boards alleged lack of independence as a basis for arguing that the Boards refusal to take action was wrongful. Appellees further challenge the adequacy of the complaint on the grounds that it does not explain with particularity the reasons the refusal was not a valid exercise of the Boards business judgment. Appellant responds that the question is whether the demand was wrongfully refused, and the facts alleged are such that appellees are not entitled to the presumption of the business judgment rule. We examine the parties respective arguments in light of the applicable legal principles. This court has recognized that demand excused and demand refused are separate concepts that present different legal issues. Flocco, supra, 752 A.2d at 153 & n. 8 (citing Miller v. Thomas, 275 Ill.App.3d 779, 211 Ill.Dec. 897, 656 N.E.2d 89, 96-97 (1995)) (applying Illinois and Delaware law). In determining presuit demand futility, the focus is upon whether, under the particularized facts alleged, a reasonable doubt is created that: (1) the directors are disinterested and independent and (2) the challenged transaction was otherwise the product of a valid exercise of business judgment. Aronson v. Lewis, 473 A.2d 805, 814 (Del.1984). If the Court determines that the pleaded facts create a reasonable doubt that a majority of the board could have acted independently in responding to the demand, the presumption is rebutted for pleading purposes and demand will be excused as futile. Beam, supra, 845 A.2d at 1049; Grimes, supra, 673 A.2d at 1216 (noting that one ground for alleging demand futility is a reasonable doubt as to the boards ability to make an independent decision). When a demand is refused by a corporate board, it is entitled to the presumption of the business judgment rule unless the stockholder can allege facts with particularity creating a reasonable doubt that the board is entitled to the presumption. Spiegel v. Buntrock, 571 A.2d 767, 777 (Del.1990). In Spiegel, the court stated that when considering the propriety of a boards action or inaction, the issues before the Court are independence, the reasonableness of its investigation and good faith. Id. It went on to state that by making a demand, a shareholder plaintiff tacitly concedes the independence of a majority of the board to respond, thereby leaving for consideration only the issues of good faith and reasonableness of the boards investigation. Id. However, under Delaware law, by making a demand, the stockholder does not waive the right to claim that the demand was wrongfully refused. Grimes, supra, 673 A.2d at 1219. If there is reason to doubt that the board acted independently or with due care in responding to the demand, the stockholder may have the basis ex post to claim wrongful refusal. The stockholder then has the right to bring the underlying action with the same standing which the stockholder would have had, ex ante, if demand had been excused as futile. Id. (citing Stepak v. Addison, 20 F.3d 398 (11th Cir.1994) (other citations omitted)). In the present case, appellant alleged in the complaint that he had made a presuit demand, which was wrongfully rejected because of Dashtaras majority control, self interest and lack of independence. Appellees concede that appellants efforts, as alleged in the complaint, were sufficient to constitute a presuit demand under the pleading standard of Rule 23.1. They contend, however, that a shareholder who has made a prior demand on the board may not assert thereafter as a grounds for the boards wrongful refusal of the demand that the board lacks independence or is motivated by self interest. Relying on this courts decision in Flocco, supra, appellees contend that it is improper for a shareholder to bifurcate his claim in this manner. In Flocco, this court held that a shareholder, who had grounded his derivative action on demand futility, had by making a demand on the corporate defendants after the trial court entered its order dismissing the complaint, waived his claim of demand futility and conceded the independence of a majority of the boards directors. 752 A.2d at 153. In Flocco, under choice of law principles, this court applied Illinois law. 752 A.2d at 151 (holding that the viability of the derivative action is determined by law of Illinois, the state of incorporation). Again, applying Illinois law, this court stated that a shareholder who makes demand may not later assert that demand was in fact excused as futile. Id. at 153 (quoting Miller, supra, 211 Ill.Dec. at 905, 656 N.E.2d at 96-97) (in turn quoting Kamen, supra, 500 U.S. at 103, 111 S.Ct. 1711). In Miller, the Illinois court stated that it was following Delawares standard and agreed with its rationale that it would waste time and resources to permit a shareholder to make a demand, have his claim investigated and then claim that it was meaningless after learning the results. Flocco, 752 A.2d at 153 (citing Miller, 211 Ill.Dec. at 905, 656 N.E.2d at 97). Flocco is distinguishable on the law and the facts. In Flocco, the shareholder made no presuit demand, as appellant did here; he claimed futility as a matter of law. Only after his complaint was dismissed did he make a demand on the corporation, which this court held operated to defeat his claim of demand futility under Illinois law. [11] Id. at 152-53. Moreover, there is no indication that the shareholder in Flocco sought to claim that his post-order demand was wrongfully refused as appellant does in this case. [12] See Grimes, supra, 673 A.2d at 1219 (sanctioning challenge to the boards independence for wrongful refusal claims). Therefore, Flocco cannot be read to preclude a shareholder in a derivative suit against a District of Columbia corporation from alleging demand futility, or alternatively, wrongful refusal of the demand, supported by allegations challenging the boards independence. See Grimes, 673 A.2d at 1219. This court has not been presented squarely with that issue in the context of the facts of this case. In this case, appellant does not allege demand futility. He alleges that he made a presuit demand and claims that the corporation wrongfully refused to act on it. Appellees agree that, under Delaware law, after making a demand on the board, a shareholder may attack the self-interestedness of a director in support of the claim that the board did not act reasonably or in good faith in its decision not to pursue the corporations claims. See Scattered Corp. v. Chicago Stock Exch., 701 A.2d 70, 74-75 (Del.1997) (noting that [i]t is not correct that a demand concedes independence `conclusively and in futuro for all purposes relevant to the demand.); see also Grimes, supra, 673 A.2d at 1219. [13] Failure of an otherwise independent-appearing board . . . to act independently is a failure to carry out its fiduciary duties in good faith or to conduct a reasonable investigation [, and] [s]uch failure could constitute wrongful refusal. Id. (citing Grimes, 673 A.2d at 1218-19). It is eminently logical and reasonable to permit ex post challenges to the boards independence. Allegations that the board was biased, lacked independence, or failed to conduct a reasonable investigation, . . . [can] create[] a reasonable doubt that demand was properly refused. Scattered Corp., supra, 701 A.2d at 75. Adoption of this approach is consistent with a principal purpose of the demand rule, which is to give the directors of the corporation, who are responsible for corporate governance including litigation decisions, the opportunity to redress the wrong before a shareholder resorts to litigation. Kamen, supra, 500 U.S. at 101, 111 S.Ct. 1711; Allison, supra, 604 F.Supp. at 1117. It is also consistent with the goal of promoting judicial economy, since the board may take corrective action that obviates the need for litigation. See Stoner v. Walsh, 772 F.Supp. 790, 796 (S.D.N.Y. 1991) (citations omitted); see also, Gaubert, supra, 274 U.S.App. D.C. at 164, 863 F.2d at 69 (The demand requirement is designed to require a shareholder to exhaust intracorporate remedies before bringing a corporate cause of action to the courts.). However, a rule that a demand concedes for all purposes any claim of bias or lack of independence in the boards action thereafter might discourage presuit demands and work against the goal of promoting judicial economy. Given the logic and benefits of Delawares approach on this issue as enunciated in Scattered Corp., supra, and Grimes, supra, we are persuaded to follow that approach. Therefore, we conclude that appellant-shareholder did not lose his right to allege directors bias and lack of independence in its action on his demand simply by filing a presuit demand. He retains the right to show, if he can, that the boards bias, lack of independence or failure to conduct a reasonable investigation creates a reasonable doubt that the demand was properly refused. See Scattered Corp., 701 A.2d at 75. Therefore, we turn to consideration of appellants second amended complaint to determine whether the allegations therein are sufficient to state this claim.