Harry Lewis, a shareholder of Meyers Parking System, is hopping made. Leo Fink -- the 75-year-old retiring CEO of MPS and 47% shareholder -- has gotten a sweet retirement gift from the board:

• For 5 years and then renewable forever, MPS pays Fink $150,000 per year, plus a 5% bonus on profits over $2,400,000.
• Fink becomes a lifetime consultant to MPS for at least $100,000 per year (whether he can perform or not).
• MPS loaned $225,000 to Fink interest-free.

• demand on board of directors
• contemporaneous owner
• adequate representative of corporation
• payment of defendant's fees, if sued without reasonable cause
• court approval of any settlement
• dismissal by board, board committee or special legal counsel

You are the attorney for Harry Lewis. Since 1970, Harry Lewis has brought 33 shareholder suits in state courts (mostly Delaware) and 55 in federal court (mostly alleging proxy fraud). Should you make a demand on the board of directors?  the pros / the cons  What does the Delaware statute say?  What did Lewis allege in his complaint
concerning demand?  What were the arguments by the defendant directors?  What did the Delaware court decide?  Harry Lewis's suit must be dismissed?

In a derivative action ... the complaint shall allege ... with particularity the efforts, if any, made by the plaintiff to obtain the action he desires from the directors ... and the reasons for his failure to obtain the action or for not making the effort.

13.... Demand would have been futile:

(a) All of the current directors are named defendants and are personally liable for the alleged wrongs.
(b) Fink, having selected each director, controls and dominates every member of the Board.
(c) If the current board took over this action, the directors would have to sue themselves.

"...in determining demand futility the Court of Chancery ... must decide whether, under the particularized facts alleged, a reasonable doubt is created that:

(1) the directors are disinterested and independent and [or]
(2) the challenged transaction was otherwise the product of a valid exercise of business judgment.

Harry Lewis files a complaint that states: "All the directors approved the sweetheart deal with Lewis. They have all been named defendants, and all have a conflict of interest as concerns any decision about this lawsuit. Demand would be pointless."  Is demand futile under Delaware law?

"Plaintiff's argument ... that demand is excused because the directors otherwise would have to sue themselves ... [is a] bootstrap argument [that] would effectively abrogate Rule 23.1 and weaken the managerial power of directors."

Harry Lewis files a complaint that states:  "Fink dominated and controlled the board. Before his retirement, Fink arranged an increase in director fees from $10,000 to $50,000 per year. What is structural bias?  Is this allegation enough to avoid demand?

"Critics will charge that we are ignoring the structural bias common to corporate boards throughout America, as well as the other unseen socialization processes cutting against independent discussion and decisionmaking in the boardroom."

"There must be coupled with the allegation of [domination and] such facts as would demonstrate that through personal or other relationships the directors are beholden to the controlling person."

Rales v. Blasband
634 A.2d 927 (Del. 1993)

In challenge to self-dealing investment by major shareholders (Rales brothers), court found doubts directors could exercise business judgment

• Rales brothers - "a substantial likelihood" of liability for approval of junk bond investment in acquired company
• Sherman, CEO of company - subject to influence of Rales bothers, who chair company's board and exec committee
• Ehrlich, president of bank - subject to influence of Rales brother, who are bank's majority shareholders and sit on board

Harry Lewis files a complaint that states:  "At the time of the transaction, all the directors gave themselves a severance package essentially identical to that of Fink.  Assume all the directors who received the package are still on the board. Is demand required?

".... if this is an "interested" director transaction, such that the business judgment rule is inapplicable to the board majority approving the transaction, then the inquiry ceases. In that event futility of demand has been established by any objective or subjective standard."

Harry Lewis files a complaint that states:  "At the time of the transaction, a majority of the board received the same severance package as Fink." Assume there has been a change in board composition. The current board is composed of a majority of new directors who never got a severance package.  Is demand required?

"...in determining demand futility the Court of Chancery ... must decide whether, under the particularized facts alleged, a reasonable doubt is created that:

(1) the directors are disinterested and independent AND
(2) the challenged transaction was otherwise the product of a valid exercise of business judgment.

Harry Lewis files a complaint that states:  "The consulting agreement with Fink was a waste of corporate assets. There was nothing required of Fink."  How can waste be protected by the business judgment rule?

"The complaint does not allege particularized facts indicating that the agreement is a waste of corporate assets. Indeed, the complaint as now drafted may not even state a cause of action, given the directors' broad corporate power to fix the compensation of officers."

Heineman v. Datapoint Corp.
    (Del. 1992)

"We read the complaint to allege that a majority of the board ... reimbursed themselves for the costs ... in excess of $1 million [incurred in their successful proxy contest]"

"The plaintiff need only raise a reasonable doubt that the business judgment rule applies."

Harry Lewis submitted a demand to the board before filing his complaint.  The board exercises its business judgment and decides the case should not be pursued. The board asks the court to dismiss the complaint.  What should a Delaware court do?  What is the effect of demanding on whether excused or required?  What about an MBCA court?  Why universal demand?  See Judge Easterbrook (reversed).

"... where demand on a board has been made and refused, we apply the business judgment rule in reviewing the board's refusal to act pursuant to a stockholder's demand. Unless the business judgment rule does not protect the refusal to sue, the shareholder lacks the legal managerial power to continue the derivative action, since that power is terminated by the refusal."

Spiegel v. Buntrock
        (Del. 1990)

"The effect of a demand is to place control of the derivative litigation in the hands of the board of directors ... the board's decision [is subject only] to juridical review according to the traditional business judgment rule."

No shareholder may commence a derivative proceeding until:

(1) a written demand has been made upon the corporation to take suitable action; and
(2) 90 days have expired from the date the demand was made unless the shareholder has earlier been notified that the demand has been rejected by the corporation or unless irreparable injury to the corporation would result by waiting for the expiration of the 90 day period.

Kamen v. Kemper Financial Services, Inc
    (7th Cir. 1990)

• demand usually counterproductive
• plaintiff does not demand in Delaware
  (1) time constraints
  (2) futile - board does not sue its own
  (3) risk attorney fees
• waste time litigating whether would have demanded

   (a) A derivative proceeding shall be dismissed by the court on motion by the corporation if [a group] specified in subsection (b) ... has determined in good faith after conducting a reasonable inquiry upon which its conclusions are based that the maintenance of the derivative proceeding is not in the best interests of the corporation.

   (b) ... The determination in subsection (a) shall be made by:

    (1) a majority of independent directors present at a [board] meeting ... if the independent directors constitute a qourum;
    (2) a majority vote of a committee consisting of two or more independent directors appointed by majority vote of independent directors present at a meeting of the board of directors, whether or not such independent directors constituted a quorum.

 (c) None of the following shall be itself cause a director to be considered not independent for purposes of this section

  (1) nomination or elelction of the director by persons who are defendants
  (2) the naming of the director as a defendant
  (3) the approval by the director of the act being challenged in the derivative proceeding or demand if the act resulted in no personal benefit to the director MBCA § 7.44

 (e) ... If a majority of the board of directors consists of independent directors at the time the determination [in (b)] is made, the plaintiff shall have the burden of providing that the requirements of subsection (a) have not been met.

(a) An action may be brought in the superior court of this State, which shall have exclusive original jurisdiction over actions brought hereunder, in the right of any domestic or foreign corporation by a shareholder or holder of a beneficial interest in shares of such corporation; provided that the plaintiff or plaintiffs must comply with the provisions of subsection (g) of this section, if applicable, and must allege, and it must appear, that each plaintiff was a shareholder or holder of a beneficial interest in such shares at the time of the transaction of which he complains or that his shares or beneficial interest in such shares devolved upon him by operation of law from a person who was a shareholder or holder of a beneficial interest in such shares at such time.

(b) The complaint shall allege with particularity the efforts, if any, made by the plaintiff to obtain the action he desires from the directors or comparable authority and the reasons for his failure to obtain the action or for not making the effort. Whether or not a demand for action was made, if the corporation commences an investigation of the charges made in the demand or complaint, the court may stay any proceeding until the investigation is completed.

(c) Upon motion of the corporation, the court may appoint a committee composed of two or more disinterested directors or other disinterested persons, acceptable to the corporation, to determine whether it is in the best interests of the corporation to pursue a particular legal right or remedy. The committee shall report its findings to the court. After considering the report and any other relevant evidence, the court shall determine whether the proceeding should be continued or not.

(d) Such action shall not be discontinued, dismissed, compromised or settled without the approval of the court. If the court shall determine that the interest of the shareholders or any class or classes thereof, or of the creditors of the corporation, will be substantially affected by such discontinuance, dismissal, compromise or settlement, the court, in its discretion, may direct that notice, by publication or otherwise, shall be given to such shareholders or creditors whose interests it determines will be so affected. If notice is so directed to be given, the court may determine which one or more of the parties to the action shall bear the expense of giving the same, in such amount as the court shall determine and find to be reasonable in the circumstances, and the amount of such expense shall be awarded as costs of the action.

(e) If the action on behalf of the corporation is successful, in whole or part, whether by means of a compromise and settlement or by a judgment, the court may award the plaintiff the reasonable expenses of maintaining the action, including reasonable attorneys' fees, and shall direct the plaintiff to account to the corporation for the remainder of any proceeds of the action.

(f) In any such action the court, upon final judgement and a finding that the action was brought without reasonable cause, may require the plaintiff or plaintiffs to pay to the defendant or defendants the reasonable expenses, including attorneys' fees, incurred by them in the defense of the action.

(g) In addition to all other provisions of this section, any action brought on behalf of a corporation that is a public corporation at the time of such action against one or more of its directors for monetary damages the plaintiff or plaintiffs must (i) allege, and it must appear, that each plaintiff has been a shareholder or holder of a beneficial interest in shares of the corporation for at least one year; (ii) bring the action within two years of the date of the transaction of which he complains; and (iii) execute and deposit with the clerk a written undertaking with sufficient surety, approved by the judge, in an amount to be fixed by the judge to indemnify the corporation against any and all expenses expected to be incurred by the corporation in connection with the proceeding, including those arising by way of indemnity, if the court in its discretion so requires.

(h) In proceedings hereunder, no shareholder shall be entitled to obtain or have access to any communication within the scope of the corporation's attorney-client privilege which could not be obtained by or would not be accessible to a party in an action other than on behalf of the corporation.