Shareholder Derivative Actions (Part III): “Demand Futility” Doctrine

As we discussed in Part I of this series, shareholders of San Diego corporations can bring lawsuits on behalf of the corporation against other shareholders and against members of the board of directors. These are called shareholder derivative actions. As we discussed previously, before a shareholder can bring a derivative action, the shareholder must make a “demand” on the board of directors that they can correct the alleged wrongful conduct. See Cal. Corp. Code, § 800. However, under some circumstances, a demand by a shareholder on the board of directors can be excused under the doctrine of “demand futility.” We discuss that concept in this article (part III of this series).

San Diego Corporate Law: What is “Demand Futility?”

Essentially, the doctrine of “demand futility” governs when a demand would be clearly rejected by the board of directors or be pointless because the board is corrupt or otherwise involved in the alleged wrongful conduct.

The question of demand futility is answered based on the time when the complaint or the amended complaint is filed and asks whether the board of directors could have properly exercised its independent and disinterested business judgment in responding to the demand. The focus is on each director, the number of directors, and who controls the board. Facts that might support demand futility would include:

• Corruption or wrongful conduct by individual directors, such as self-dealing
• Past refusal to address issues raised by shareholders
• Whether individual directors are “independent” or “disinterested” or “controlled” by dominant shareholders
• Overlapping board memberships or relationships or responsibilities — facts with respect to board members being independent and disinterested
• Whether alleged actions or non-actions create material benefits for certain directors
• Whether corporate actions or non-actions benefit dominant shareholders more than minority shareholders

The recent case of Apple Inc. v. Superior Court, 18 Cal. App. 5th 222 (Cal. App. 6th Dist. 2017) provides a good example. In that case, several Apple, Inc. shareholders filed a derivative action with respect to Apple’s use of anticompetitive agreements with other Silicon Valley tech companies. In the lawsuit, the minority shareholders alleged that various current and former members of Apple’s board of directors were aware of or tacitly approved of Apple’s practices of agreeing to not try and hire away each other’s employees. The plaintiffs alleged that the directors breached their fiduciary duties by enabling or permitting these illegal agreements over many years. For their second amended complaint, the plaintiffs attempted to plead demand futility.

However, the pleading was deemed deficient by the trial court and by the Court of Appeals. The court focused on individual members of the board of directors and noted that nothing was pleaded to suggest that those board members would NOT have responded properly to claims that Apple was engaged in antitrust and anti-competitive behavior.

Call San Diego Corporate Law Today

For further information, please contact Michael Leonard, Esq. of San Diego Corporate Law. Mr. Leonard can help if your San Diego corporation has received a demand letter from a shareholder and can help with corporate maintenance and business contracts for your business. Mr. Leonard has been named a “Rising Star” three years running by SuperLawyers.com and “Best of the Bar” by the San Diego Business Journal. Contact Mr. Leonard today by calling (858) 483-9200 or via email.

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