Intro[]
The lynch pin of the modern strike suit reforms is the demand requirement.
Rules of civil procedure commonly provide that "[t]he complaint shall also allege with particularity the efforts, if any, made by the plaintiffs to obtain the action the plaintiff desires from the directors or comparable authority.
Demand is not merely a pleading requirement. Substantive state corporation laws require that plaintiffs make such a demand. The United States Supreme Court has held that the demand requirement is a device whereby state corporate law has made an important substantive allocation of power among shareholders, directors, and the corporation .
Demand is the means whereby the board of directors has an opportunity to managed litigation in the corporation's name or on its behalf. Demand also presents an opporutnity for intra-corporate dispute resolution. By receiving and acting upon a demand, the board may save the corporation great expense. Demand may also filter out abusive strike suits.
A shareholder generally makes demand by letter to the board of directors, a senior manager, such as the CEO, or the corporation's counsel. In the letter the shareholder sets out the grievance. No format or specific level of certainty or content is required. The demand should eventually end up in the hands of the board of directors.
Demand Refused[]
The board "rejects" the demand after due deliberation, preceded by investigation of the facts. Demand may be refused either because:
- 1) the board has concluded that the law has not been violated, or
- 2) because pursuing the corporations rights would not be in the corporation's best interests.
The corporation then notifies the shareholder-plantiff or opposing counsel that the demand has been rejected. Sometimes the affair ends there and other times the shareholder files a lawsuit.
In such a lawsuit the corporation would likely move to dismiss or move for summary judgment in its favor on the grounds that the
- board has considered and refused the demand
- the law charges boards and not courts with management of the corporation's business and affairs, and
- the business judgment rule shields from judicial scrutiny the board's decision that the proposed litigation should not ensure.
The demand refused scenario is thus not favorable for plaintiffs it presents two uphill battles.
- First, at the intra-corporate state
- Second, after an action is filed in court.
- The demand refused scenarios is made even more unpalatable by the Delaware decision in Speigel v. Buntrock in which the Supreme Court of Delaware held that "[b]y making a demand, a stockholder tacitly acknowledges the absence of facts to support a finding of futility," that is, concedes the ability of the board to deal impartially with the demand. The difficulty is that Speigel creates a discincentive to explore alternative dispute resolution. A plaintiff who conduct preliminary dicsussion with the corporation or its counsel may have made a demand thereby conceding the ability of the baord, and given up any realistic alternative to court proceedings later on if the intra-corporate approach fails to yield fruit.
Demand Accepted[]
In the demand accepted scenario the board of directors notifies the shareholder that the board intends to take action on the demand. The corporation may hire special counsel or conduct an investigation. After investigating the plaintiff's claims, the corporation may either go ahead with the action or settle. Settlement may occur with or without the filing of an action against the alleged wrongdoers.
Settlement may pose probems. The sharheolder may fear that via the board of dictors, the corporation will accept demand and then administer a slap on the wrist or enter into a sweetheart settlement with the alleged wrongdoers. The settlement and the feckless prosecution scnarios give pause ot plaintiffs.
Once the board accepts demand, the shareholder no longer has any rights to the litigation: the shareholder's name is dropped from the complaint in the realignment of the parties, she will not be entitled to participate in discovery or settlement discussions and she will not even be entitled to be copied on pleadings or other court papers. She will have no window on the litigation at all.
Another feature of the demand accepted landscape is the nature of the settlement. Federal Rule of Civil Procedure 23.1 provides that "a derivative action shall not be dismissed or compromsied without the approval of the court and notice of the proposed dismisal or compromsie shall be given to shareholders or members in such as manner as the court directs." Two types of settlement are possible: a possible settlement with the alleged wrongdore - a director or direcotrs or senior executive - on the underlying claim, and a settlement with the shareholder-plaintiff in the dervative action itself.
In Wolf v. Barkes, the SEcond Circuit held that Rule 23.1 does not require judicial approval of the settlement the corporation reacehs with the "true" defendants. That feature of the landscape enlarges the potential field of play for a sweethear settlement.
Frequently, corporations do proffer the settlement for court approval in order to gain protection aginst suit over the same facts by other shareholders. The corporation then has res judicata as a shield in subsequent litigation. However, the prevailing law follows Wolf v. Barkes. Thus, the corporation may accept demand, commence an action , and then quicly settle. The complaining sharheolder is entiteld to neitehr ntoice of hte settlement nore a window of opporutnity to examine or challenge the settlement.
Demand Excused[]
Because "demand refused" and "demand accepted" conjure up unpalatable scenarios, experienced shareholder rights attorneys turn first to the "demand excused" branch of the common law of demand. Alleging that the law "excuses" demand, the attorney proceeds directly to court, filing a summons and complaint and causing the corporation and the individual defendants to be served with process.
The common law excuses demand in several sets of circustmances such as:
- When the corporation is threatened with irreparable harm
- When it is a closely held corporation
- When the corporation has taken an extraordinarily long period of time and still has not responded
- When demand has been made and the corporation takes no position on the issues
- When demand is excused as futile.