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Chancery Addresses Pre-Suit Demand Refusal Standard for Special Committees

City of Tamarac Firefighters’ Pension Trust Fund v. Corvi, C.A. No. 2017-0341-KSJM (Del. Ch. Feb. 12, 2019).

Under Delaware law, stockholders who wish to pursue a derivative claim on the corporation’s behalf face an important decision—whether to make a pre-suit demand on the board to handle the suit itself, or bring the suit oneself and plead that the board cannot disinterestedly and independently consider a pre-suit demand under the circumstances. Neither path is easy. 

Bringing the suit oneself subjects the stockholder to a heightened pleading standard. The stockholder must allege with particularity the board cannot disinterestedly and independently consider the subject matter of the pre-suit demand under the circumstances. So, making a demand would be a futile exercise and the demand requirement is excused. 

Making the pre-suit demand on the board, however, makes a critically important concession. The stockholder concedes that a majority of the full board is capable of considering the subject matter of the suit in a disinterested and independent manner. That concession limits the stockholder’s recourse if the board refuses the demand. A subsequent suit must sufficiently allege that the board’s refusal was itself wrongful. That generally is an even more difficult task than pleading demand futility for the underlying subject matter. It requires particularized allegations that the board acted with gross negligence or bad faith in rejecting the demand.

But, what happens when a stockholder makes a pre-suit demand and the full board, in response, forms a special committee of directors to consider it?  Has the stockholder also conceded that the particular directors making up the committee can disinterestedly and independently consider a pre-suit demand?  Or, does the stockholder retain the right to argue that, although there might have been enough disinterest and independence among the full board to consider the demand, that is not true with respect to the committee, and therefore the board’s delegation was grossly negligent or evidence of bad faith?  This decision finds it is the latter.  Thus, where a board delegates a pre-suit demand to a special committee, the plaintiff has not conceded the disinterestedness and independence of all directors for all purposes.