§3.4 The Demand Requirement

• Jurisdiction: Washington

§3.4 THE DEMAND REQUIREMENT

In addition to satisfying the standing and related requirements discussed above, a shareholder seeking to pursue a derivative claim first must either present the claim to the board of directors and give the corporation an opportunity to pursue the claim directly or demonstrate that such a pre-suit demand is excused. In re F5 Networks, Inc., 166 Wn.2d 229, 236-40, 207 P.3d 433 (2009); see also Dreiling v. Jain, 151 Wn.2d 900, 904-05, 93 P.3d 861 (2004). Shareholders may not pursue derivative claims on behalf of a corporation that decides not to pursue a claim itself unless the corporation's decision reflected fraudulent, arbitrary, or ultra vires acts or conduct by corporate officers or directors. Opportunity Christian Church v. Wash. Water Power Co., 136 Wash. 116, 119, 238 P. 641 (1925). Demand will be excused only if the shareholder can show that the demand would be futile or useless. To establish futility, the complaint must establish a reasonable doubt that the board of directors could exercise independent and disinterested business judgment in responding to a shareholder demand. In re F5 Networks, 166 Wn.2d at 240.

The demand requirement thus contemplates two circumstances in which a shareholder may pursue a derivative claim. In the first, the shareholder makes a demand on the corporation's board and the board declines to pursue the claim. The shareholder may pursue the claim derivatively only if the shareholder shows that the board's decision was wrongful. In the second scenario, the shareholder files a derivative suit without making a pre-suit demand on the board and argues that demand was excused because it would be futile. Each scenario poses similar but distinct challenges for a derivative plaintiff.

Practice Tip: The demand requirement is governed by the law of the state of incorporation. Kamen v. Kemper Fin. Servs., Inc., 500 U.S 90, 108-09, 111 S. Ct. 1711, 114 L. Ed. 2d 152 (1991).

(1) Demand made

(a) 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" and "[t]he business and affairs of the corporation shall be managed under the direction of its board of directors"); see also Aronson v. Lewis, 473 A.2d 805, 811 (Del. 1984) ("A cardinal precept...is that directors, rather than shareholders, manage the business and affairs of the corporation.").

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 has held, "[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.'" In re F5 Networks, 166 Wn.2d at 236 (quoting Williams v. Erie Mountain Consol. Mining Co., 47 Wash. 360, 361-62, 91 P. 1091 (1907)).

Both the WBCA and CR 23.1 recognize the demand requirement by requiring derivative plaintiffs to allege with particularity the demand made or the reasons for not making a demand: "A complaint in a proceeding brought in the right of a corporation must be verified and 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."RCW23B.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 he desires from the directors or comparable authority and, if necessary, from the shareholders or members, and the reasons for his failure to obtain the action or for not making the effort.").

Practice Tip: Washington law concerning derivative actions is less extensive than the equivalent law in some other states, including Delaware In some instances, Washington law and Delaware law differ. Washington law, for example, requires a derivative plaintiff fairly and adequately to represent the interests of other shareholders, while Delaware law does not. Compare CR 23.1 with Del. Ch. R. 23.1. Nevertheless, Washington courts often look to Delaware law for guidance, and the Washington Supreme Court has expressly ruled that Washington follows Delaware with respect to at least some aspects of the demand requirement. See In re F5 Networks, 166 Wn.2d at 240 (Washington follows Delaware with respect to demand-futility standards). Thus, absent contrary direction from the Washington legislature, Delaware law serves as a useful guide to understanding the demand requirement for derivative actions in Washington.

(b) Demand contents

There is little Washington case law regarding the required contents of a pre-suit demand. Authority in other states suggests that, although a demand need not be in any particular form or use any special language, a demand generally should set forth the following: (i) the identity and standing of the shareholder making the demand; (ii) the persons to be sued; (hi) the corporate wrongs complained of; (iv) the facts supporting the claims; and (v) the action or relief requested. See, e.g., Smachlo v. Birkelo, 576 F. Supp. 1439, 1443-44 (D. Del. 1983) ("The demand itself must be more than pro forma; the plaintiff must make a serious request upon the board and specify the nature of the activity in question." (citing Hawes v. Oakland, 104 U.S. 450, 460-61, 26 L. Ed. 827 (1881))).

Each proposed claim must be articulated 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 (3dCir. 1978);Allisonexrel. Gen. Motors Corp. v. Gen. Motors Corp., 604 F. Supp. 1106, 1117 (D. Del.) ("At a minimum, a demand must identify the alleged wrongdoers, describe the factual basis of the wrongful acts and the harm caused to the corporation, and request remedial relief. In most instances, the shareholder need not specify his legal theory, every fact in support of that theory, or the precise quantum of damages. Decisions as to how and on what theory the corporation will pursue wrongdoers are the proper province of the Board of Directors."), aff'd, 782 F.2d 1026 (3d Cir. 1985).

The identity of the shareholder may play an important role in how the corporation responds to a demand. This is because "[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) ("In other words, 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 herself if the shareholder failed to do so in the first instance. Smachlo, 576 F. Supp. at 1444 (shareholder failed to satisfy demand requirement where he failed to identify himself and refused to do so when requested by the board).

(c) Demand recipient

A shareholder must make demand on the entire board. E.g., Raster v. Modification Sys., Inc., 731 F.2d 1014, 1017 (2d Cir. 1984) (citing Greenspun v. Del E. Webb Corp., 634 F.2d 1204, 1209 (9th Cir. 1980)) (demand upon controlling shareholder did not constitute demand on a "comparable authority" under rule requiring that demand be made upon directors or comparable authority before filing of a shareholders' derivative suit in view of fact that controlling shareholder was not vested with full powers of board of directors).

No appellate decision in Washington addresses whether a derivative plaintiff may make a demand on the shareholders rather than the board. The WBCA and the Civil Rules, however, suggest that this is not a permissible option. See RC W 23B. 07.400(2) (discussing requirement that demand be made "to obtain action by the board of directors"); see also CR 23.1 ("The complaint shall also allege with particularity the efforts, if any, made by the plaintiff to obtain the action he desires from the directors or comparable authority and, if necessary, from the shareholders or members....") (the conjunctive, rather than disjunctive, inclusion of "shareholders" suggests that demand on directors is required).

(d) Board consideration

Upon receiving a demand, the board should determine whether pursuing the asserted claim serves the corporation's best interests. See In re Oracle Corp. Deriv. Litig., 808 A.2d 1206, 1212 (Del. Ch. 2002). The board itself may evaluate the demand, or the board may appoint a committee to investigate the facts underlying a demand and make a report and recommendation regarding the claim. See, e.g., Spiegel v. Buntrock, 571 A.2d 767, 777 (Del. 1990); Aronson, 473 A.2d at 813. In either case, the board is obligated to reasonably evaluate the demand. Levine v. Smith, 591 A.2d 194, 213 (Del. 1991), overruled on other grounds by Brehm v. Eisner, 746 A.2d 244 (Del. 2000). The reasonableness of the board's response to a demand "implicates the business judgment rule's requirement of procedural due care; that is, whether the [board] acted on an informed basis in [responding to the] demand." Id.; see also §3.6 (discussing the business judgment rule).

Although a board has a duty to act on an informed basis in responding to a demand, there is "no prescribed procedure that a board must follow." Levine, 591 A.2d at 214. In some cases an investigation may be appropriate; in others, the board may reject or...