Opinion ID: 2629374
Heading Depth: 2
Heading Rank: 4

Heading: the district court properly dismissed plaintiffs' derivative claims because demand on the company was required

Text: ¶18 Although the trial court dismissed their individual claims, Plaintiffs were granted leave to refile them as derivative claims on behalf of the Company. However, the district court turned back the refiled derivative claims because Plaintiffs failed to make proper demand on the Company to correct their alleged misdeeds before filing suit, a condition precedent to bringing a derivative claim. ¶19 Both the Utah Rules of Civil Procedure and the Revised Nonprofit Corporation Act require that a derivative action must allege with particularity that demand was made on the directors and why the directors failed to act or why demand was not made. Utah Code Ann. § 16-6a-612(3) (2001); Utah R. Civ. P. 23.1. We note that a literal reading of the text of these provisions imposes a heightened degree of attention to detail in the pleading of demands upon a corporation. The language implies that to satisfy the statute, a demand must be sufficiently comprehensive in articulating the shareholder grievance and pointed in its expectation for corrective corporate action to be capable of being particularized. Both the rule and the statute include, albeit by implication, substantive requirements for shareholder demands. The district court found that Plaintiffs' demands did not meet these requirements, and we agree. ¶20 The second amended complaint, where Plaintiffs first brought their derivative claims, does not allege that any demand was made or that the demand requirement was waived. In their briefs to this court, Plaintiffs now claim that, notwithstanding the deficiencies in their pleadings, they in fact made adequate demand or, in the alternative, demand was not required. We disagree.
¶21 This court has articulated the requirement that a party make a demand on the corporation. The stockholder must show. . . that a demand upon the board of directors or other managing body, to have an action brought and prosecuted in the name of the corporation to redress the grievances complained of, has been made and refused. Tripp v. Dist. Ct., 56 P.2d 1355, 1359 (Utah 1936). Plaintiffs list several interactions between themselves and the Company which they claim satisfy this requirement. The questions before us are, then, what are the essential characteristics of a demand and are they present in Plaintiffs' communications with the Company? ¶22 Plaintiffs claim that our case law offers ambiguous direction concerning the necessary features of a demand. We disagree. To the contrary, Tripp is quite explicit on this point. As noted, the demand must be to have an action brought and prosecuted in the name of the corporation to redress the grievances complained of. Id. Therefore, the demand must not merely remonstrate against a certain corporate policy. Rather, the communication must articulate legal claims that the corporation holds and insist that the corporation pursue them. ¶23 None of the communications from Plaintiffs to the Company meet these standards. Several of them voice opposition to the proposed asset transfer, communicated both orally at Company meetings and in letters demanding certain analyses of corporate assets be undertaken prior to the transfer. Such expressions of disagreement fall short of the demand requirement because none of them insist that the corporation seek legal remedies. The interaction that comes closest to meeting the requirement occurred prior to the transfer of assets at a meeting of the board of directors at which Plaintiffs informed Company directors that they would pursue legal action if the corporation followed through with the asset transfer. However, this communication was inadequate for two reasons. First, it did not demand that the corporation pursue legal action. Second, it failed to outline the specific legal claims that Plaintiffs wanted rectified.
¶24 Both the Revised Nonprofit Corporation Act and the Utah Rules of Civil Procedure allow the demand requirement to be waived if a plaintiff alleges with particularity why demand was not made. Utah Code Ann. § 16-6a-612(3)(a)(ii) (2001); Utah R. Civ. P. 23.1. This court has held that for that exception to be satisfied, the circumstances [must be] such that such a demand would be futile and unavailing. Tripp, 56 P.2d at 1359. Therefore, we must examine first whether Plaintiffs did allege with particularity why demand would be futile and whether that allegation establishes that demand would have been futile and unavailing. ¶25 Before us, Plaintiffs allege that the continued antagonistic relationship between Plaintiffs and Herriman, as evidenced by this litigation, demonstrates that a perfectly crafted demand would have been futile. However, this is the first instance where they present such a claim. The second amended complaint, in which Plaintiffs brought their derivative claims, makes no mention of the futility exception and fails to address why demand would have been futile. This fact alone would be a sufficient basis for turning away Plaintiffs' futility claims; however, even had Plaintiffs properly preserved their futility claims, a close analysis shows that they are insufficient to satisfy the exception and waive the demand requirement. ¶26 It is axiomatic that the right to seek the redress of corporate grievances belongs to the corporation to be exercised by corporate management. See, e.g., In re Kauffman Mut. Fund Actions, 479 F.2d 257 (1st Cir. 1973). Utah Rule of Civil Procedure 23.1 provides an exception to this general rule by allowing members or shareholders to bring derivative actions, but this exception must be carefully applied in order to protect the right of corporations to govern their own affairs. In re Kauffman, 479 F.2d at 263-64. Therefore, we must exercise considerable caution before using futility to relieve a shareholder of his obligation to make the statutorily-required demand. ¶27 This presumption is further strengthened by the relative ease with which demand can be made. A potential litigant would, of necessity, have prepared and outlined the legal claims upon which his lawsuit will be based. The marginal cost for presenting these claims to corporate management and demanding that they take them up is so insignificant that to strip the corporation of its rights based solely on conjecture or a post hoc judicial determination would be unreasonable in most instances. Courts must not leave such determinations of futility to the subjective determination of the party upon which the law requires action; to do so unnecessarily risks stripping the corporation of its rights. In fact, it will generally require less effort for the plaintiff to make a demand on the corporation than to satisfy rule 23.1's stringent pleading requirements. For this reason, application of rule 23.1's futility exception requires close scrutiny. ¶28 We can conceive of two instances in which the futility exception would be met. For the first, we borrow logic from Jenkins v. Equipment Center, Inc., 869 P.2d 1000 (Utah Ct. App. 1994), a case dealing with a futility exception to the requirement that an obligor tender payment as a condition to being excused from performance. In Jenkins, we stated that tender is excused where the lienor states that he or she does not intend to accept payment. Id. at 1003. Likewise, in the corporate setting, demand would be futile if the corporation had specifically and explicitly stated that it would not pursue the claims brought in the derivative action. The futility exception could also excuse a shareholder from making a demand when doing so would be substantively detrimental. Such a circumstance could arise if the demand would risk further injury to the corporation by, for example, permitting the alleged perpetrator to cover up his misdeeds or to cause further harm to the corporation because he had been alerted that his unlawful conduct had been uncovered. ¶29 Neither instance is applicable in this case. The Company never explicitly stated that it would not pursue the specific claims raised in this derivative action. Nor would there have been a detriment to Plaintiffs in making a demand. Herriman already knew that it was embroiled in litigation and presumably acted accordingly. Therefore, a demand prior to the filing of Plaintiffs' second amended complaint would not have affected the Company's behavior to Plaintiffs' detriment.