Brief Fact Summary.
The trial court dismissed this derivative suit for failure to meet the prerequisite of making a demand on the board of directors to bring the suit.
Synopsis of Rule of Law.
A prior demand can only be excused where facts are alleged with particularity that creates a reasonable doubt that action by the director was entitled to the business judgment rule’s protections.
The mere threat of personal liability for approving a questioned transaction, standing alone, is insufficient to challenge either the independence or disinterestedness of directors, although in rare cases a transaction may be so egregious on its face that board approval cannot meet the test of business judgment, and a substantial likelihood of director liability therefore exists.View Full Point of Law
Aronson (Plaintiff) and others brought a shareholder’s derivative action contesting a corporation’s employment contract granted to a longtime employee.Â Large lifetime compensation and other benefits were provided by the contract.Â The board approved the contract, most of which were controlled by the principal actors in executing the contract.Â No prior demand was made on the board to bring the suit on the basis of impartiality.Â The trial court dismissed the suit, and the appellate court reversed, holding there was a reasonable inference that the business judgment rule did not protect the actions.Â Plaintiff appealed.
Will a prior demand be excused where it appears the actions are not protected by the business judgment rule?
(Moore, J.)Â No.Â A prior demand can only be excused where facts are alleged with particularity that creates a reasonable doubt that action by the director was entitled to the business judgment rule’s protections.Â Here, no such facts were claimed.Â Simply alleging the prior loyalties of the individual board members does not indicate the business judgment rule may not apply.Â Consequently, the case was properly dismissed.Â Reversed and remanded.
To excuse prior demand, the facts called for which must be alleged include conflict of interest or taking action contrary to the corporate interest.Â Because derivative suits are brought on behalf of the corporate entity, the corporation should be made aware of facts giving rise to a cause of action.Â Through its board of directors, the corporation will then decide whether it will bring suit.Â If it declines to do so, the shareholders may then sue.