Futility of Demand on Board of Directors in Derivative Suit

The U.S. District Court for the Eastern District of Tennessee recently rejected an argument that might have given shareholders an end run around the demand requirements for derivative suits. See Lay v. Burley Stabilization Corp, 2010 WL 2639931 (E.D. Tenn. Jun. 28, 2010). In Tennessee, plaintiffs in a derivative action must “allege with particularity the demand made, if any, to obtain action by the directors and either why the plaintiffs could not obtain the action or why they did not make the demand.” Tenn. Code Ann. §48-56-401(c). The demand requirement is typically excused if the plaintiff establishes that demand would be futile. However, to establish futility, plaintiffs must demonstrate that: (1) that the board is interested and not independent and (2) that the challenged transaction is not protected by the business judgment rule.

In Lay, the shareholders presented a novel argument — they contended that demand was futile given the defenses asserted and positions taken by the corporation in prior lawsuits brought against it by the shareholders. This case was the eighth in a four-year series of substantially similar suits brought against the corporation (an agricultural cooperative) by its shareholders (tobacco farmers). The shareholders sought to require the corporation to distribute funds collected through a government price support program. Essentially, their argument was that it would be futile to ask a director, though technically disinterested and acting within the business judgment rule, to suddenly take a position contrary to the one he took in seven prior lawsuits involving the same facts. The argument makes some sense.

However, the Court immediately recognized the flaw in this approach: a derivative plaintiff could effectively bypass the demand requirement simply by filing multiple lawsuits to which a corporation would be forced to respond. It would effectively nullify Tennessee’s long-standing demand requirement. Wisely forsaking the trees for the forest, the Court rejected the shareholders’ argument and dismissed the case.


Related content

  1. Litigation Privilege Applies to Claims of Inducement to Breach
  2. The Rule of Nullification - Exceptions for Unlicensed Brokers
  3. Liberal Interventions—Not What You Think

Comments

Cheyanne MahoneyJoe KellyDan LinsGriffin DunhamBob MendesWill Helou