Court Opinion

ID: 8967867
Source: CourtListenerOpinion
Date Created: 2022-11-27 10:19:30.443185+00
Date Added: 2024-06-11T17:10:22.802393
License: Public Domain

ESCHBACH, Senior Circuit Judge.
This appeal challenges the district court’s dismissal with prejudice of the appellant’s third amended and consolidated complaint.1 In essence, this is a shareholder derivative and class action suit asserting that the directors and officers of First Chicago Corporation (“FCC”) and First National Bank of Chicago (“FNBC”) have egregiously mismanaged the affairs of the corporations. The appellant raises two contentions on appeal. First, she argues that the district court erred in ruling that she was not a proper party plaintiff under Fed.R.Civ.P. 23.1. Second, the appellant contends that the district court erred in ruling that she should have made a demand upon the directors to bring this suit prior to the filing *1169of this complaint. For the reasons stated below, we affirm the district court’s dismissal with prejudice of the third amended and consolidated complaint for failure to make a demand upon the directors or to allege with particularity facts sufficient to excuse such a demand as futile. Because the appellant’s failure to make a demand or allege specific facts excusing a demand prohibits her from maintaining this derivative suit, we do not need to reach the issue of whether she was a proper party plaintiff under Fed.R.Civ.P. 23.1.
I
On July 16, 1985, Joel Starrels, a shareholder of FCC, filed a derivative and class action suit in the Circuit Court of Cook County, Illinois. He sued the appellees, FCC, FNBC (a wholly-owned subsidiary of FCC), their officers and directors, and Arthur Andersen & Co. (accountants for FCC and FNBC), for negligence, mismanagement, malfeasance, bad faith, abuse of discretion, breach of fiduciary duty, and waste of corporate assets. Two days later, Star-rels sued the appellees in federal district court for RICO violations.
After the appellees had the state court suit removed to the federal district court, they filed motions for dismissal based on various grounds, including that Starrels had failed to comply with the requirements of Fed.R.Civ.P. 23.1 and Delaware corporate law because he did not make a demand upon the directors to bring this suit or allege with particularity why such demand would be futile. Instead of responding to the motion to dismiss, on December 6, 1985, Starrels filed an amended and consolidated complaint. The defendants again filed motions to dismiss arguing in part that Starrels did not allege with particularity why demand upon the directors would be futile.
On January 30, 1986, Starrels died. Pursuant to the terms of his will, the executor assigned some of his stock in FCC to Patricia Starrels Bernstein, the appellant. On June 24, 1986, Bernstein filed a second amended and consolidated complaint naming herself as the substitute derivative plaintiff. Once again, the appellees responded by filing motions to dismiss for failing to allege with particularity why demand would be futile and by opposing the substitution of Bernstein as plaintiff.
On December 15, 1986, the district court dismissed without prejudice Bernstein’s second amended and consolidated complaint for failing to comply with Fed.R.Civ.P. 23.-1. First, the court found that under Rule 23.1 and Delaware law the plaintiff should have made a demand upon the directors to bring this suit. Second, the court found that Bernstein did not receive her stock in FCC “by operation of law” as required by Rule 23.1, therefore, she was not a proper party plaintiff. On February 18, 1987, Bernstein moved for leave to file a third amended and consolidated complaint. One year later, the district court dismissed her third amended and consolidated complaint with prejudice.2
II
The appellant contends that the district court erred in ruling that under Fed.R. Civ.P. 23.1 she should have made a demand on the directors to bring this suit. Bernstein does not claim that she had made such a demand upon the directors. Rather, she argues that a demand was excused because it would have been futile.3 Wheth*1170er the appellant was required to make a demand before bringing this suit is an issue left to the discretion of the district court. Therefore, assuming no error of law has been made, we review its determination under an abuse-of-discretion standard. Nussbacher v. Continental Ill. Nat’l Bank & Trust Co., 518 F.2d 873, 878 (7th Cir.1975), cert. denied, 424 U.S. 928, 96 S.Ct. 1142, 47 L.Ed.2d 338 (1976); Fields v. Fidelity Gen. Ins. Co., 454 F.2d 682, 684-85 (7th Cir.1972); accord Gaubert v. Federal Home Loan Bank Bd., 863 F.2d 59, 68 n. 10 (D.C.Cir.1988); Kaster v. Modification Sys., 731 F.2d 1014, 1018 (2d Cir.1984); Lewis v. Graves, 701 F.2d 245, 248 (2d Cir.1983); Greenspun v. Del E. Webb Corp., 634 F.2d 1204, 1208 (9th Cir.1980).
Rule 23.1 provides in pertinent part:
In a derivative action brought by one or more shareholders ... [t]he complaint shall also allege with particularity the efforts, if any, made by the plaintiff to obtain the action he desires from the directors ... and the reasons for his failure to obtain the action or for not making the effort.
Fed.R.Civ.P. 23.1 (emphasis added). This rule does not always require a shareholder to make a demand upon the directors in order to bring a derivative suit. If the shareholder does not make such a demand, he need only state with particularity why such a demand would have been futile. Nussbacher, 518 F.2d at 877; see Lewis, 701 F.2d at 248; Cramer v. General Tel. & Elecs. Corp., 582 F.2d 259, 276 (3d Cir.1978), cert. denied, 439 U.S. 1129, 99 S.Ct. 1048, 59 L.Ed.2d 90 (1979). It is not enough for the shareholder “to state in conclusory terms that he made no demand because it would have been futile.” 7C C. Wright, A. Miller & M. Kane, Federal Practice and Procedure § 1831, at 117 (1986).
Rule 23.1 “concerns itself solely with the adequacy of the pleadings; it creates no substantive rights.” Daily Income Fund, Inc. v. Fox, 464 U.S. 523, 544, 104 S.Ct. 831, 842, 78 L.Ed.2d 645 (1984) (Stevens, J., concurring). Any substantive rights that directors of a corporation may have in a demand requirement revolves around state law. See Burks v. Lasker, 441 U.S. 471, 477-78, 99 S.Ct. 1831, 1837, 60 L.Ed.2d 404 (1979) (“As we have said in the past, the first place one must look to determine the powers of corporate directors is in the relevant State’s corporation law.” (citations omitted)); Lewis v. Curtis, 671 F.2d 779, 785 (3d Cir.1982) (noting that a plaintiffs allegations must show under state law that the directors lacked disinterestedness).4 Therefore, we must look to the law of Delaware, the state of incorporation of FCC, to determine the substantive rights of the appellees. The issue, then, is whether the appellant’s third amended and consolidated complaint states with particularity (federal procedural requirement under Rule 23.1) facts which would excuse a demand upon the directors as futile under Delaware corporate law (substantive state law). See *1171Cottle v. Hilton Hotels Corp., 635 F.Supp. 1094, 1097 (N.D.Ill.1986).
Under Delaware law, the rule that a shareholder must make a demand upon a corporation’s directors before initiating a derivative suit, unless such demand would be futile, is more than a mere pleading requirement; it is a substantive right. Ar-onson v. Lewis, 473 A.2d 805, 809 (Del. 1984); Haber v. Bell, 465 A.2d 353, 357 (Del.Ch.1983). The standard for determining whether a complaint adequately alleges demand futility is: “whether taking the well-pleaded facts as true, the allegations raise a reasonable doubt as to (i) director disinterest or independence or (ii) whether the directors exercised proper business judgment in approving the challenged transaction.” Grobow v. Perot, 539 A.2d 180, 186 (Del.1988); accord Pogostin v. Rice, 480 A.2d 619, 624 (Del.1984); Aronson, 473 A.2d at 814; Good v. Getty Oil Co., 514 A.2d 1104, 1107 (Del.Ch.1986). Moreover, conclusory allegations of fact or law contained in the complaint need not be considered true in determining demand futility unless they are supported by specific facts. Grobow, 539 A.2d at 187; Kaufman v. Belmont, 479 A.2d 282, 285 (Del.Ch.1984).
In the case before us, the appellant does not claim that the directors were in any way interested in the transactions of which she complains. Rather, Bernstein asserts that the directors’ actions were not the product of proper business judgment. Therefore, we need to examine Bernstein’s third amended and consolidated complaint only to see if it raises a reasonable doubt that the directors exercised proper business judgment. Under Delaware law, this requires us to look at both the substantive due care (substance of the transaction) as well as the procedural due care (an informed decision) used by the directors. See Grobow, 539 A.2d at 189.
The appellant makes several allegations challenging the substantive due care used by the directors. In her third amended and consolidated complaint, Bernstein lists numerous transactions which she claims were not the product of proper business judgment. First, she alleges that FNBC and FCC, acting under the domination, direction, or control of the officers and directors, entered into a series of loans and a contract with companies affiliated with Nelson Bunker Hunt and W. Herbert Hunt, which resulted in losses totaling more than one hundred million dollars. She particularly complains that FNBC did not require collateral for some of these loans. See Plaintiff's Third Amended and Consolidated Complaint, Rec. 77, at 9-12 [hereinafter Complaint]. Nowhere in her complaint, however, does Bernstein allege specific facts showing that these loans were “devoid of a legitimate corporate purpose.” See Pogostin, 480 A.2d at 626. At most, her allegations merely show with hindsight that these loans were a mistake.
Bernstein’s third amended and consolidated complaint also criticizes FCC’s decision to purchase a 44.5% interest in a Brazilian bank and to guarantee the Brazilian bank’s deposits. This investment resulted is significant losses to FCC. Her complaint, however, also notes that the investment was purportedly made in order to facilitate lending to multinational corporations in local currency. See Complaint, at 12-14. Clearly, this is a valid reason to invest in a foreign bank. Moreover, the complaint fails to allege with particularity any improper motive or conflict of interest on the part of the directors and officers in deciding to make this investment. Therefore, this transaction can hardly be considered “so egregious on its face that [it] cannot meet the test of business judgment.” Aronson, 473 A.2d at 815.
The third amended and consolidated complaint further alleges impropriety in the awarding of $1.5 million in bonuses to top management. See Complaint, at 15-16. The complaint, however, is void of any specific allegations of fact showing why these bonuses were improper; for example, the complaint lacks facts which would support a claim that these bonuses amounted to a waste of corporate assets. Indeed, we note that Delaware corporate law gives directors broad powers to provide suitable compensation for a corporation’s officers. See DEL.CODE ANN. tit. 8, § 122(5). *1172Thus, the appellant has failed to create a reasonable doubt about whether these bonuses were the product of the directors’ business judgment.5
Bernstein’s third amended and consolidated complaint also criticizes the directors’ procedural due care in entering into the challenged transactions. She alleges that many of these transactions were “made without regard for adequate approval, or review auditing procedures.” Complaint, at 17. She further alleges that, in deciding to invest in the Brazilian bank, the directors “failed to take steps to fully comprehend the financial situation” of the Brazilian bank and did not “adequately study the situation.” Id. at 13. Notably absent from her complaint, however, are specific facts describing what steps the directors did not take in informing themselves or how they could have better informed themselves before entering into the challenged transactions. Thus, these bare conclusory allegations are not enough to cast a doubt on whether these transactions were the products of the directors’ business judgment.
Contrary to the appellant’s claim, her third amended and consolidated complaint does not allege with particularity facts which would have excused her from making a demand upon the directors.6 Therefore, we cannot say that the district court abused its discretion in determining that this was a demand-required case and in dismissing with prejudice Bernstein’s third amended and consolidated complaint for failure to make a demand or to allege with particularity why such a demand would be futile. Because Bernstein’s failure to make a demand prohibits her from maintaining this derivative suit, we do not need to decide whether she was a proper party plaintiff under Fed.R.Civ.P. 23.1.
Ill
For all the foregoing reasons, the judgment of the district court is
AFFIRMED.

. The plaintiff originally filed two separate causes of action, one in Illinois state court and the other in federal district court. The state court suit was removed to federal court on the basis of 12 U.S.C. § 632, which gives the district courts jurisdiction over actions arising out of international banking. The federal district court then allowed the plaintiff to file an amended complaint which consolidated the two separate causes of action.

. It is unclear from the record whether the district court granted the appellant’s motion for leave to file a third amended and consolidated complaint. Therefore, we consider his dismissal with prejudice to be a dismissal of both the second and third amended and consolidated complaints. Although in our opinion we refer to the third amended and consolidated complaint in disposing of this appeal, our analysis and result would be the same for the second amended and consolidated complaint. Moreover, although the district court dismissed this action with prejudice in a two-sentence order, we assume that it was dismissed for the same reasons contained in the court's order dismissing the second amended and consolidated complaint. See District Court’s Memorandum and Order, Rec. 74 (dismissing the plaintiffs second amended and consolidated complaint).

. The appellant’s third amended and consolidated complaint states:
A demand on the Chairman, Board of Directors or officers would be purely ministe*1170rial, a useless formality and a futile act, in light of the allegations above. This conduct by the Chairman and the members of the Board of Directors of the First National Bank and of First Chicago, and by the officers of FNBC and FCC named, each of whom acted together without dissent and in a unified manner. The challenged transactions, which inter alia violated bank procedures, rules and representations to holders, cast a reasonable doubt that the directors and officers acted in good faith, absent a gross abuse of discretion, and that such actions were not the product of a valid exercise of business judgment. As such, those transactions sterilized the directors’ ability to properly conduct this litigation. In addition, as the conduct of these defendants was known to them but not to plaintiff, a demand seeking to cease such conduct was not possible, and the actions complained of each was a fait accompli. Demand would permit merely the Board to delay action to the detriment of the Corporation, plaintiff and the other shareholders.
Plaintiffs Third Amended and Consolidated Complaint, Rec. 77, at 20-21.

. Although we consider the demand requirement to be an issue of state law, we note that other courts apparently assume that federal law controls both the pleading requirement as well as the underlying demand requirement. See Kaster v. Modification Sys., 731 F.2d 1014, 1017-18 (2d Cir.1984); Greenspun v. Del E. Webb Corp., 634 F.2d 1204, 1208-10 (9th Cir.1980); see also 7C C. Wright, A. Miller & M. Kane, Federal Practice and Procedure § 1831, at 100 (“Federal law governs the issue whether plaintiff has made a sufficient demand on the directors.").

. In her third amended and consolidated complaint, Bernstein also complains of other transactions which resulted in monetary losses to FCC and FNBC. Similar to the allegations discussed in this opinion, Bernstein fails to allege with particularity facts to support her broad, conclusory statements. Therefore, these allegations also fail to cast a reasonable doubt on whether these transactions were the products of the directors’ business judgment.

. The appellant argues that her third amended and consolidated complaint sufficiently alleges facts which excuse a demand, especially in light of the fact that she was not allowed to undertake discovery. The district court entered a stay of discovery in October and again in November of 1985. See Rec. 16; Rec. 18. The record, however, contains no evidence that the appellant tried to lift the stay until approximately ten months later when she filed a motion for discovery. See Plaintiffs Motion for Discovery with Supporting Authorities, Rec. 52. Moreover, on appeal the appellant does not challenge the district court’s refusal to allow her to conduct discovery. Under these circumstances, the appellant cannot now excuse the lack of specific allegations in her third amended and consolidated complaint on the ground that she was not allowed to conduct discovery.