Opinion ID: 2071197
Heading Depth: 1
Heading Rank: 2

Heading: the viability of flocco's derivative action

Text: On appeal, Flocco asserts essentially that he has complied with all prerequisites to the institution of his action, that any defects could readily have been cured by amendment of his pleading, and that the trial judge erred in dismissing the action. The defendants respond that Flocco was not entitled to maintain this derivative action because, assuming that such a suit may be brought by a policyholder at all, [2] Flocco has failed to comply with two essential procedural prerequisites. First, the defendants claim that Flocco was required, as a precondition to maintaining a derivative action, to make a demand for remedial action on the directors both of State Farm Mutual and of State Farm Fire. The defendants assert that Flocco failed to make the requisite demand on either company before instituting his action; that although Flocco alleged in his complaint that a demand on State Farm Mutual would have been futile, this allegation was insufficient as a matter of law; that, in any event, Flocco waived his claim of futility, after the entry of the trial court's order, by making demands both on State Farm Fire and on State Farm Mutual; and that for all of these reasons, the suit cannot be maintained. Second, the defendants contend that State Farm Fire was an indispensable party to Flocco's action, that Flocco failed to join State Farm Fire as a defendant, and that the case therefore cannot proceed. We address these contentions in turn.
Both State Farm Mutual and State Farm Fire are companies organized under the laws of the State of Illinois. The trial judge held, and we agree, that under the District's choice-of-law rules, the viability of Flocco's derivative action must therefore be determined by application of Illinois law. See Labovitz v. The Washington Times Corp., 900 F.Supp. 500, 503 (D.D.C. 1995), aff'd, 335 U.S.App.D.C. 296, 172 F.3d 897 (1999); cf. Cohen v. Beneficial Indus. Loan Corp., 337 U.S. 541, 548-49, 69 S.Ct. 1221, 93 L.Ed. 1528 (1949) (in derivative actions, the question whether a stockholder has standing to sue on behalf of the corporation is controlled by the law of the state of organization).
The directors of a corporation and not its shareholders [3] manage the business and affairs of the corporation. Levine v. Smith, 591 A.2d 194, 200 (Del.1991). In a derivative action, the shareholder seeks to assert, on behalf of the corporation, a claim belonging not to him but to the corporation. Id. The right of a stockholder to file a bill to litigate corporate rights is, therefore, solely for the purpose of preventing injustice where it is apparent that material corporate rights would not otherwise be protected. Zapata Corp. v. Maldonado, 430 A.2d 779, 784 (Del.1981) (quoting Sohland v. Baker, 141 A. 277, 282 (Del.1927)). The decision to bring a law suit or to refrain from litigating a claim on behalf of a corporation is a decision concerning the management of the corporation. Levine, supra, 591 A.2d at 200 (quoting Spiegel v. Buntrock, 571 A.2d 767, 773 (Del.Super.Ct.1990)). Accordingly, [b]efore a stockholder should be permitted to bring suit ... he should show to the satisfaction of the court that he has exhausted all of the means within his reach to obtain within the corporation itself the redress of his grievances or action in conformity [with] his wishes. Scalzo v. Commercial Trust & Sav. Bank, 239 Ill.App. 330, 338 (1925). Specifically, the stockholder must either 1. allege that he has made a demand upon the directors of the corporation requesting that they seek the relief that he proposes to obtain through his derivative action, and that the directors have wrongfully refused his demand; or 2. allege facts showing that such a demand would be futile because the directors are not disinterested or did not validly exercise their business judgment. See 805 ILL. COMP. STAT. 5/7.80 (b) (2000) [4] ; Miller v. Thomas, 275 Ill.App.3d 779, 211 Ill.Dec. 897, 656 N.E.2d 89, 93-96 (1995); Powell v. Gant, 199 Ill.App.3d 259, 145 Ill.Dec. 339, 556 N.E.2d 1241, 1244-45, appeal denied, 135 Ill.2d 566, 151 Ill.Dec. 392, 564 N.E.2d 847 (1990); cf. Super. Ct. Civ. R. 23.1. [5] To permit the shareholder to represent the corporation without making a demand or showing futility would eviscerate the right of the corporate directory to corporate control. Delaware & Hudson Co. v. Albany & Susquehanna R.R. Co., 213 U.S. 435, 446-47, 29 S.Ct. 540, 53 L.Ed. 862 (1909). In the present case, it is undisputed that prior to the institution of his action, Flocco failed to make a demand on the board of directors either of State Farm Mutual or of State Farm Fire regarding the possible institution of proceedings by either company to secure the return of moneys paid to President Clinton or to his attorney in connection with the Jones litigation. Flocco alleged in his complaint, however, that such a demand upon State Farm Mutual would have been futile, because, inter alia, State Farm Mutual had issued a press release in which it had characterized Flocco's claim as absurd and as wholly lacking in merit. State Farm Mutual challenged the sufficiency of this allegation, and the trial judge held that Flocco had not satisfied the applicable requirements of Illinois law. [6] On appeal, Flocco asks us to hold as a matter of law that a demand would have been futile and that the complaint against State Farm Mutual, which the trial judge dismissed without prejudice, should be reinstated. But whatever merit, if any, Flocco's claim of futility may have had at the time Flocco initially asserted it, Flocco has undermined his own position and inadvertently scuttled his own claim by his actions since the entry of the trial judge's order. Specifically, in his brief on appeal, Flocco's attorney advised the court that Flocco subsequently made a demand to State Farm Mutual and State Farm Fire and that demand was rejected. [7] This representation is fatal as a matter of law to Flocco's position in the trial court and on appeal. By making his post-order demands on the boards of directors of State Farm Mutual and State Farm Fire, Flocco substantially altered the legal landscape, [8] conceded the independence of a majority of the board of directors of each corporation, Levine, supra, 591 A.2d at 212, and waived his claim of futility. Under the law of Delaware and the States that follow its lead, a shareholder who makes demand may not later assert that demand was in fact excused as futile. Miller, supra, 211 Ill.Dec. 897, 656 N.E.2d at 96-97 (quoting Kamen v. Kemper Fin. Servs., Inc., 500 U.S. 90, 103, 111 S.Ct. 1711, 114 L.Ed.2d 152 (1991)); see also Spiegel, supra, 571 A.2d at 775. In Miller, the Illinois Court of Appeals went on to state: We see no reason to deviate from Delaware's standard, as this rule makes a great deal of sense from an efficiency standpoint. It would be a waste of time and resources to allow a shareholder to make a demand and have the claim investigated by the company, only to allow the shareholder to declare the investigation meaningless when unhappy with the results. 656 N.E.2d at 97. Having grounded his derivative action on an allegation that a demand would have been futile, and having subsequently taken post-order actions by which he waived this claim by operation of law, Flocco has effectively conceded that he cannot prove an indispensable element of his derivative action. See, e.g., Bazata v. National Ins. Co. of Washington, 400 A.2d 313, 316 (D.C. 1979) (holding that, for purposes of Super. Ct. Civ. R. 41(b), demand is not jurisdictional, but is an element of the shareholder's claim). This defect is fatal to his complaint as written and requires dismissal of the action against all defendants. [9]