Article: The Power Struggle Between Shareholders and Directors: The Demand Requirement in Derivative Suits (original) (raw)

This article examines the demand shareholders must make on a corporation's board of directors prior to bringing a derivative suit. ... Presented with the question of whether the court would give effect to a decision of a committee of disinterested directors to terminate a shareholder derivative suit alleging directors' breach of fiduciary duties, the court ruled that even if the special committee was truly disinterested and independent, "[t]he Court should determine, applying its own independent business judgment, whether the [corporation's] motion [to dismiss the derivative action] should be granted." ... A derivative suit is one of the means for conducting a thorough investigation of corporate management. ... THE DEMAND REQUIREMENT AND SECTION 36 OF THE INVESTMENT COMPANY ACT ... The majority's statement implies that, consistent with federal policies, a court may terminate a derivative suit based on the ICA if this standard is not met. ... TEXT: This article examines the demand shareholders must make on a corporation's board of directors prior to bringing a derivative suit. The article is divided into two parts. The first part analyzes the nature of the demand requirement and its implications generally. The second part evaluates the demand requirement in a narrow federal statutory context: section 36(b) of the Investment Company Act of 1940. n1 We chose this topic and its specific application for two reasons. First, the subject involves important issues relating to corporate power structure. Second, judicial analysis, especially in the federal appellate courts, has been consistent only in its persistent confusion. Consequently, cases are conflicting and provide little guidance for practitioners and the courts alike. Specifically, this article evaluates judicial decisions on the demand requirement and offers a clearer approach to the subject. Part I of this article, concerning demand generally, is divided into four sections. Section A describes rules of procedure and substance regarding demand and analyzes their effects. Section B examines the diverse and conflicting outcomes of applicable cases. Section C specifies the issues raised by the demand requirement and demonstrates how Page 2 12 Hofstra L. Rev. 39 the cases differ depending on the issues chosen. Section D proposes general principales which should guide the development of the law in the demand area. Part II of this article examines the demand requirement in connection with claims under section 36(b) of the Investment Company Act. I. THE DEMAND REQUIREMENT A. Demand: Procedure and Substance Rule 23.1 of the Federal Rules of Civil Procedure n2 and many state procedural rules n3 require that a shareholder plaintiff suing derivatively allege with particularity: (1) the efforts, if any, which he made to obtain the action he desired from the corporate directors, and (2) the reasons for his failure to obtain the action he desired, or the reasons for not making the effort. These rules are not purely procedural. Clearly, rule 23.1 n4 has been given a substantive component, presumably in accordance with the applicable state law or federal law. n5 The courts have insisted that the plaintiff not only describe his efforts-or reasons chosen for not making such efforts-to obtain a specific action from the directors, but have further prescribed the legal sufficiency required in these efforts and the basis on which the courts then determine whether the plaintiff may proceed to litigate. n6 The effect of these procedural rules is to make it mandatory for the plaintiff to bring before the court the issues of his standing to sue derivatively and the directors' power to prevent him from pursuing the litigation. Because of the nebulous distinction between simple pleading requirements and substantive law, the exact issues posed by the pleadings have varied with different cases. The issues seem to stem from related sources which are difficult to isolate. This difficulty is compounded by the different approaches which courts have taken when confronted with a derivative suit. Some courts apply the "business judgment rule," n7 while others evaluate the underlying corporate claim on the merits. n8 Still other courts consider the benefits accruing to the corporation from the derivative suit. n9 As a result of these foregoing considerations, confusion reigns. B. Judicial Decisions and Issues The decisions regarding the demand requirement will be treated briefly since so much has already been written about them. n10 We have chosen to describe recent cases by listing some of the issues as the various courts have posed them and the divergent results which these courts have reached.