Deference When Board Refuses Shareholder Litigation Demand

Basic tenets of corporate law entrust the corporate board with the power to make decisions on the corporation's behalf, including the power to decide whether (and when) to initiate litigation.¹ As a result, when a shareholder believes the corporation should take legal action, the shareholder must make a demand on the board, asking the board to investigate and consider taking the requested action. If, however, “the directors are deemed incapable of making an impartial decision regarding the pursuit of the litigation” and making a demand would, thus, be futile, the demand requirement will be excused, and the shareholder may pursue litigation derivatively on the company's behalf.² Delaware law imposes stringent requirements on plaintiffs seeking to establish demand futility, however, because a shareholder derivative suit “inherently impinges upon the directors' power to manage the affairs of the corporation.”³

Under this well-established corporate governance regime, a shareholder who believes the company should pursue claims has two options: (1) make a demand and entrust the matter to the board's judgment or (2) bring a shareholder derivative suit and attempt to meet the high standard to demonstrate demand futility. In some cases, however, shareholders try to have it both ways, demanding that the board investigate a potential claim and then seeking to sue on the company's behalf after the board has declined to sue, by alleging that the board refused the demand wrongfully.

The Delaware Chancery Court's recent decision in one such “demand refused” case brought by a DuPont shareholder—Ironworkers District Council of Philadelphia & Vicinity Retirement & Pension Plan v. Andreotti⁴—confirms that, once a shareholder has made a demand on the board, the courts will not disturb the board's decision without particular allegations demonstrating that the decision itself was made in bad faith. The court stressed that the inquiry in a demand-refused case focuses on the board's process of investigating the demand, not on the conduct underlying the demand or on the substantive outcome of the board's investigation. The Andreotti decision provides strong support for corporate boards exercising their business judgment when making litigation decisions on behalf of the corporations they manage.