§ 3.03 The Demand Requirement

• Jurisdiction: Washington

§ 3.03 THE DEMAND REQUIREMENT

In addition to satisfying the standing requirements discussed above, a shareholder seeking to pursue a derivative claim must satisfy one of two mutually exclusive threshold conditions. The shareholder must either make a "demand" for the corporation to act by presenting the alleged claim to the board of directors and demanding that the corporation pursue the claim directly or, if no demand is made, the shareholder must demonstrate that such a pre-suit demand is "excused." In re F5 Networks, Inc. Deriv. Litig., 166 Wn.2d 229, 236-40, 207 P.3d 433 (2009).

Both the WBCA and CR 23.1 require derivative plaintiffs to allege with particularity the demand made on a corporate board or the reasons for not making a demand: "A complaint in a proceeding brought in the right of a corporation must . . . allege with particularity the demand made, if any, to obtain action by the board of directors and either that the demand was refused or ignored or why a demand was not made." RCW 23B.07.400(2); accord CR 23.1 ("The complaint shall also allege with particularity the efforts, if any, made by the plaintiff to obtain the action the plaintiff desires from the directors or comparable authority and, if necessary, from the shareholders or members, and the reasons for the plaintiff's failure to obtain the action or for not making the effort.").

In the first "demand made" scenario, the shareholder may sue derivatively on behalf of the corporation if the corporation declines to pursue the claim against the alleged wrongdoers—but only if the corporation's decision not to seek relief from the alleged wrongdoers reflected fraudulent, arbitrary, or ultra vires acts or conduct, or bad faith, by corporate directors. Opportunity Christian Church v. Wash. Water Power Co., 136 Wash. 116, 119, 238 P. 641 (1925). As a matter of law, a shareholder who makes a demand on the board "concedes that demand is required" and waives any later right to claim that demand should be excused, regardless of whether legal theories or remedies not asserted in the demand may support this claim. Grimes v. Donald, 673 A.2d 1207, 1219-20 (Del. 1996), overruled on other grounds by Brehm v. Eisner, 746 A.2d 244, 253 n.13 (Del. 2000); accord Spiegel v. Buntrock, 571 A.2d 767, 775 (Del. 1990) ("By making a demand, a stockholder tacitly acknowledges the absence of facts to support a finding of futility."). As discussed in § 3.03[1][g], however, a shareholder whose demand is refused may argue that the demand was wrongfully refused. Opportunity Christian Church, 136 Wash. at 119; Grimes, 673 A.2d at 1218-19.

In the second "demand futility" or "demand excused" scenario, the threshold requirement that the shareholder demand that the board take action will be "excused" if the shareholder adequately alleges in the complaint that it would be futile or useless to make a demand. Establishing demand futility requires that the shareholder allege facts in the complaint sufficient to establish a reasonable doubt that the board of directors could exercise independent and disinterested business judgment in responding to the shareholder's demand. F5 Networks, 166 Wn.2d at 237, 240.

Comment: Washington law governs the demand requirement with respect to Washington corporations. In re Cray, Inc. Deriv. Litig., 431 F. Supp. 2d 1114, 1119 (W.D. Wash. 2006); see Kamen v. Kemper Fin. Servs., Inc., 500 U.S. 90, 108-09, 111 S. Ct. 1711, 114 L. Ed. 2d 152 (1991) (holding that the demand requirement is governed by the law of the state of incorporation). The law regarding derivative actions is less developed in Washington than in some other states; as a result, Washington courts have looked to decisions of Delaware courts, which are "well versed in this area," for guidance on issues related to derivative actions. F5 Networks, 166 Wn.2d at 240. In particular, the Washington Supreme Court has ruled that Washington follows Delaware law with respect to demand-futility standards. Id. This does not mean that Washington law and Delaware law never differ. For example, Washington law expressly requires a derivative plaintiff to fairly and adequately represent the interests of other shareholders, and a derivative action may not be maintained absent satisfaction of the fair and adequate representation requirement. CR 23.1. Delaware Chancery Rule 23.1 on its face contains no similar requirement, and the Delaware Supreme Court has held that a finding of fair and adequate representation is not required before a Delaware court may approve the settlement of derivative claims. Griffith v. Stein ex rel. Goldman Sachs Grp., Inc., 283 A.3d 1124, 1138-39 (Del. 2022). Despite the lack of complete alignment between Washington and Delaware law, absent contrary direction from the Washington legislature, Delaware law serves as a useful guide to understand the demand requirement for derivative actions brought on behalf of Washington corporations.

[1] Demand Made

[a] Reason for Demand Requirement

The demand requirement reflects the fundamental principle that a corporation's board of directors—not individual shareholders—controls corporate decision-making. See RCW 23B.08.010(2)(a)-(b) ("[a]ll corporate powers shall be exercised by or under the authority of the corporation's board of directors," which "shall have exclusive authority as to substantive decisions concerning management of the corporation's business"); see also In re Cray, 431 F. Supp. 2d at 1119-20 (explaining demand requirement "is based on the fundamental principle that the 'directors of a corporation and not its shareholders manage the business and affairs of the corporation' and the 'decision to bring a law suit or to refrain from litigating a claim on behalf of a corporation is a decision concerning the management of the corporation' " (quoting Levine v. Smith, 591 A.2d 194, 200 (Del. 1991), overruled on other grounds by Brehm, 746 A.2d at 253 n.13)).

The requirement that a shareholder make a demand on the corporation before filing a derivative lawsuit is almost as old as derivative lawsuits themselves. As the Washington Supreme Court observed in F5 Networks, "[a]s far back as 1907, this court noted that generally, a shareholder 'must show that he has exhausted all means within his reach to obtain within the corporation . . . action in conformity to his wishes, and that the managing body of the corporation has refused to sue or defend.' " 166 Wn.2d at 236 (quoting Williams v. Erie Mountain Consol. Mining Co., 47 Wash. 360, 361-62, 91 P. 1091 (1907)).

[b] Demand Content

Washington courts have not addressed the required content of a pre-suit demand under Washington law. Courts interpreting Delaware law have suggested that, although a demand need not take any particular form or use any special language, the demand generally should include "(i) the identity of the alleged wrongdoers, (ii) the wrongdoing they allegedly perpetrated and the resultant injury to the corporation, and (iii) the legal action the shareholder wants the board to take on the corporation's behalf." E.g., Solak ex rel. Ultragenyx Pharm. Inc. v. Welch, C.A. No. 2018-0810-KSJM, 2019 Del. Ch. LEXIS 1338, at *10 (Del. Ch. Oct. 30, 2019) (unpublished) (quoting Yaw v. Talley, Civ.A. No. 12882, 1994 Del. Ch. LEXIS 35, at *22-23 (Del. Ch. Mar. 2, 1994) (unpublished)), aff'd mem., 228 A.3d 690 (Del. 2020). The demand must articulate each proposed claim with sufficient specificity to give the board a fair opportunity to initiate the action requested by the shareholder. Shlensky v. Dorsey, 574 F.2d 131, 141 (3d Cir. 1978); In re Section 16(b) Litig., 602 F. Supp. 2d 1202, 1213 (W.D. Wash. 2009) (holding demand letters insufficient because they lacked specificity necessary to give the directors a fair opportunity to initiate suit), aff'd in part on relevant grounds, rev'd and vacated in part on other grounds sub nom. Simmonds v. Credit Suisse Sec. (USA) LLC, 638 F.3d 1072 (9th Cir. 2011), vacated and remanded on other grounds, 566 U.S. 221, 132 S. Ct. 1414, 182 L. Ed. 2d 446 (2012).

In addition, the demand should identify the demanding shareholder and the basis for that shareholder's standing. Smachlo v. Birkelo, 576 F. Supp. 1439, 1444 (D. Del. 1983) ("A company's board of directors should not be required to act upon the demand of an alleged shareholder when that shareholder fails to properly identify himself."). The identity of the shareholder may be relevant to the corporation's response to a demand for two reasons. First, the board of directors must know that the person making the demand is a shareholder of the corporation and has standing to pursue the claim. CR 23.1 (requiring derivative plaintiff to allege "that the plaintiff was a shareholder or member at the time of the transaction of which the plaintiff complains or that the plaintiff's share or membership thereafter devolved on the plaintiff by operation of law"); Wang v. Page, No. C 12-1785 PJH, 2012 U.S. Dist. LEXIS 113073, at *6 (N.D. Cal. Aug. 10, 2012) ("Because plaintiff offered no information as to her stock holdings, and because plaintiff's name does not appear on Google's shareholder lists, Google had no way of knowing whether the demand letter was sent from an actual shareholder. . . . [A] corporation has no obligation to investigate a demand if the corporation cannot verify whether the demand was made by an actual shareholder." (footnote omitted)). Second, "[t]he identity of the complaining shareholder may shed light on the veracity or significance of the facts alleged in the demand letter, and the Board might properly take a different course of action depending on the shareholder's identity." Potter v. Hughes, 546 F.3d 1051, 1057-58 (9th Cir. 2008); see also In re Schmitz, 285 S.W.3d 451, 456 (Tex. 2009) ("[A] demand from Warren Buffett may have different implications than one from Jimmy Buffett."). For this reason, a board may reasonably insist that a shareholder identify himself if the shareholder fails...