United States: Shareholder Derivative Actions: From Cradle To Grave

Last Updated: January 28 2010
Article by Seth Aronson, Andrew R Escobar, Ted Hassi and Sharon L. Tomkins

I. DERIVATIVE ACTIONS BROUGHT IN STATE AND FEDERAL COURT

Please click on the following link to read this article and its footnotes in full: Shareholder Derivative Actions: From Cradle To Grave

A. Defining Derivative Claims

1. What Is A Derivative Action?

a. A derivative action is actually two causes of action: it is an action to compel the corporation to sue and it is an action brought by a shareholder on behalf of the corporation to redress harm to the corporation. See Aronson v. Lewis, 473 A.2d 805, 811 (Del. 1984) ("The nature of the action is two-fold. First, it is the equivalent of a suit by the shareholders to compel the corporation to sue. Second, it is a suit by the corporation, asserted by the shareholders on its behalf, against those liable to it."); Brown v. Tenney, 532 N.E.2d 230, 232 (Ill. 1988) (a derivative action is in effect two actions: "one against the directors for failing to sue; the second based upon the right belonging to the corporation.").

b. A derivative action allows shareholders to monitor and redress harm to the corporation caused by management where it is unlikely that management will redress the harm itself. Meyer v. Fleming, 327 U.S. 161, 167 (1946) ("[T]he purpose of the derivative action [is] to place in the hands of the individual shareholder a means to protect the interest of the corporation from the misfeasance and malfeasance of 'faithless directors and mangers'" (quoting Cohen v. Beneficial Indus. Loan Corp., 337 U.S. 541, 548 (1949)); Kamen v. Kemper Fin. Servs., Inc., 500 U.S. 90, 95 (1991) (same); Jones v. H. F. Ahmanson & Co., 1 Cal. 3d 93 (1969) ("A shareholder's derivative suit seeks to recover for the benefit of the corporation and its whole body of shareholders when injury is caused to the corporation that may not otherwise be redressed because of failure of the corporation to act. Thus, 'the action is derivative, i.e., in the corporate right, if the gravamen of the complaint is injury to the corporation, or to the whole body of its stock or property without any severance or distribution among individual holders, or if it seeks to recover assets for the corporation or to prevent the dissipation of its assets.").

c. An action is derivative when brought by a shareholder on behalf of the corporation for harm suffered by all shareholders in common. See Levine v. Smith, 591 A.2d 194, 200 (Del. 1991) ("A shareholder derivative suit is a uniquely equitable remedy in which a shareholder asserts on behalf of a corporation a claim belonging not to the shareholder, but to the corporation."); Lewis v. Knutson, 699 F. 2d 230, 237-38 (5th Cir. 1983) ("When an officer, director, or controlling shareholder breaches [a] fiduciary duty to the corporation, the shareholder has no 'standing to bring [a] civil action at law against faithless directors and managers,' because the corporation and not the shareholder suffers the injury[; e]quity, however, allow[s] him to step into the corporation's shoes and to seek in its right the restitution he could not demand on his own."); Avacus Partners, L.P. v. Brian, CCH Fed. Sec. L. Rep. ¶ 96,232 (Del. Ch. 1990) (action is derivative because it is brought by one or more shareholders on behalf of the corporation rather than by the corporation itself); see also, Katz v. Halperin, 1996 WL 66006, at *4 (Del. Ch. Feb. 5, 1996) ("A proven claim of mismanagement resulting in corporate waste is a direct wrong to the corporation, and all stockholders experience an indirect wrong. Corporate waste claims are derivative, not individual.").

(1) "Although most derivative suits involve claims by a shareholder on behalf of a corporation, derivative suits also may be filed by members of an unincorporated association, such as a limited partnership." Draper Fisher Jurvetson Mgmt. Co. V, LLC v. I-Enterprise Co. LLC, 2004 WL 2944055, at *2 (N.D. Cal. Dec. 15, 2004) (plaintiff invested in venture capital funds, then alleged damages in the millions as a result of the defendants' fraudulent and negligent misrepresentation, breach of contract, breach of fiduciary duty, etc.; court held that most of the plaintiff's claims were derivative and had to be brought on behalf of the funds, of which plaintiff was a limited partner); see also Caparos v. Morton, 845 N.E.2d 773, 781 (Ill. App. 1 Dist. 2006) ("Limited partners seeking redress for the decreased value of their shares in the limited partnership must do so in a derivative action.").

(2) "The same factors that caused the courts to fashion the derivative action procedure for shareholders and limited partners thus apply to condominium unit owners. All are owners of fractional interests in a common entity run by managers who owe them a fiduciary duty that requires protection. Condominium unit owners are, therefore, entitled to the same consideration by the courts as the litigants in those situations in which the courts have historically allowed derivative actions to proceed, independent of any statutory authority." Caprer v. Nussbaum, 825 N.Y.S.2d 55, 67 (2d Dep't 2006).

d. In contrast, an action brought by a shareholder for harm done to an individual shareholder or a group of shareholders is a direct action. See Kahn v. Kaskel, 367 F. Supp. 784 (S.D.N.Y. 1973) (a class action by shareholders is based upon individual rights belonging to each member of the class); Von Brimer v. Whirlpool Corp., 367 F. Supp. 740 (N.D. Cal. 1973) (if the injury is to one of the shareholders and not the corporation, it is direct), aff'd in part, rev'd on other grounds, 536 F.2d 838 (9th Cir. 1976); Behrens v. Aerial Comm., Inc. Del. Ch., No. 17436 (May 18, 2001) ("The distinction between a direct and derivative claim . . . turns on the existence of direct or 'special' injury to the plaintiff stockholder.").

(1) A direct action can take many forms. See, e.g., In re Worldcom, Inc., 323 B.R. 844, 850 (Bankr. S.D.N.Y. 2005) ("Common examples of direct actions include suits to compel the payment of a dividend, to protest the issuance of shares impermissibly diluting a shareholder's interest, to protect voting rights or to obtain inspection of corporate books and records."); The Winer Family Trust v. Queen, 2004 WL 2203709, at *25 (E.D. Pa. Sept. 27, 2004) ("If the injury is one to the plaintiff as an individual shareholder, as where the action is based on a contract to which the shareholder is a party, or on a right belonging severally to the shareholder, or on a fraud affecting the shareholder directly, or if there is a duty owed to the individual independent of the person's status as a shareholder, the shareholder may assert a direct action on his own behalf."); Lefkowitz v. Wagner, 395 F.3d 773, 777 (7th Cir. 2005) (held that partners in a general partnership have a right to bring individual suits against fellow partners; analogizing the position of a general partner's suit "to a suit by a minority shareholder against the majority shareholder, claiming that the latter has violated the fiduciary duty that such a shareholder, especially in a closely held corporation, owes to minority shareholders.").

2. How To Distinguish Between Direct And Derivative Actions?

a. It is not always easy to tell whether an action is derivative or direct. See Abelow v. Symonds, 156 A.2d 416, 420 (Del. Ch. 1959) ("[T]he line of distinction between derivative suits and those brought for the enforcement of personal rights asserted on behalf of a class of stockholders is often a narrow one, the latter type of actions being designed to enforce common rights running against plaintiffs' own corporation or those dominating it, while the former are clearly for the purpose of remedying wrongs to the corporation itself"). Often, the same set of facts gives rise to both direct and derivative claims. See, e.g., Grimes v. Donald, 673 A.2d 1207, 1212 (Del. 1996); H. F. Ahmanson & Co., 1 Cal. 3d at 107 ("The individual wrong necessary to support a suit by a shareholder need not be unique to that plaintiff. The same injury may affect a substantial number of shareholders. If the injury is not incidental to an injury to the corporation, an individual cause of action exists."); Behrens, Del. Ch., No. 17436 ("The distinction between a direct and derivative claim, which is difficult to apply in specific circumstances, turns on the existence of direct or 'special' injury to the plaintiff stockholder."); Tuscano v. Tuscano, 403 F. Supp. 2d 214, 222 (E.D.N.Y. 2005) ("Obviously, any benefit derived by a corporation through derivative litigation will inure to an individual who owns half of that corporation. [But, that] standing alone, is not a reason to dismiss [a] plaintiff''s lawsuit. Under New York law, a shareholder derivative action is an appropriate method for one fifty-percent shareholder to obtain relief in the name of the corporation against the other fifty-percent shareholder."); In re J.P. Morgan Chase & Co. S''holders Litig., 2005 WL 1076069, at *6 (Del. Ch. Apr. 29, 2005) ("[When a] board of directors authorizes the issuance of stock for no or grossly inadequate consideration, the corporation is directly injured and shareholders are injured derivatively . . . [and] mere claims of dilution, without more, cannot convert a claim traditionally understood as derivative, into a direct one."); Gentile v. Rossette, 2005 WL 2810683, at *4-5 (Del. Ch. Oct. 20, 2005) (plaintiffs' claim for dilution for conversion of notes and stock was derivative; when board of directors authorizes the issuance of stock for no or grossly inadequate consideration the corporation itself is directly injured and the stockholders are injured derivatively); Rawoof v. Texor Petroleum Co., Inc., 521 F.3d 750, 757-58 (7th Cir. 2008) (plaintiff brought a direct action invoking the agency doctrine, claiming that he entered into an agreement with defendant corporation as an agent of his own company; court held that plaintiff was barred from bringing a direct claim because his status as a sole shareholder, officer and director of his own company did not "automatically make him an agent of the corporation for purposes of the transaction in question").

(1) In Gentile v. Rossette, 906 A.2d 91, 99 (Del. 2006), the Delaware Supreme Court reversed the Chancery Court ruling in holding that a claim for dilution for conversion of notes and stock is not solely a derivative claim. The Court went on to explain that there is "a species of corporate overpayment . . . that Delaware case law recognizes as being both derivative and direct in character. A breach of fiduciary duty claim having this dual character arises where: (1) a stockholder having majority or effective control causes the corporation to issue 'excessive' shares of its stock in exchange for assets of the controlling stockholder that have a lesser value; and (2) the exchange causes an increase in the percentage of the outstanding shares owned by the controlling stockholder, and a corresponding decrease in the share percentage owned by the public (minority) shareholders. Because the means used to achieve that result is an overpayment (or 'over-issuance') of shares to the controlling stockholder, the corporation is harmed and has a claim to compel the restoration of the value of the overpayment. That claim, by definition, is derivative." Id. at 99-100. However, the "public (or minority) stockholders also have a separate, and direct, claim arising out of that same transaction . . . [b]ecause the shares representing the 'overpayment' embody both economic value and voting power, the end result of this type of transaction is an improper transfer—or expropriation—of economic value and voting power from the public shareholders to the majority or controlling stockholder. . . . A separate harm also results: an extraction from the public shareholders, and a redistribution to the controlling shareholder, of a portion of the economic value and voting power embodied in the minority interest. As a consequence, the public shareholders are harmed, uniquely and individually, to the same extent that the controlling shareholder is (correspondingly) benefited." Id. at 100.

(a) Following the holding in Gentile, the Delaware Supreme Court in Gatz v. Ponsoldt, held that public shareholders who became minority shareholders as a result of recapitalization could bring their claims arising out of the recapitalization as direct claims. 2007 WL 1120338, at *1, 9 (Del. Apr. 16, 2007). The public shareholders argued, and the Court agreed, that the complaint alleged a direct claim for breach of fiduciary duty . . . "because the Recapitalization constituted an expropriation of voting power and economic value from [the Company's] public stockholders, and a transfer of that voting power and economic value to [the defendants], to the corresponding detriment of [the Company's] public shareholders—all accomplished by [the Company's] de facto controlling stockholder . . . ." Id. at *9.

b. Courts "have wide discretion" to determine whether an action is derivative or direct. See e.g., Hanson v. Kake Tribal Corp., 939 P.2d 1320 (Alaska 1997) (looking to the adequacy of the remedies under derivative and direct actions).

c. Deciding whether an action is direct or derivative has been greatly complicated by courts that use a "special injury" test to determine whether a claim is direct or derivative. These courts require shareholders to show that they have suffered a special or distinct injury from other shareholders in order to bring a direct claim. See, e.g., Geer v. Cox, 242 F. Supp. 2d 1009, 1018 (D. Kan. 2003) ("Because plaintiff has failed to show that there was any duty owed to him that was not owed to all shareholders . . . or that he suffered any harm individually, his direct claim must be dismissed . . .") (interpreting Delaware law); Pate v. Elloway, 2003 WL 22682422, at *2 (Tex. App. Hous. Nov. 13, 2003) ("To have standing to assert a direct or individual claim, a stockholder must allege an injury that is separate and distinct from other stockholders . . .") (applying Delaware law). Other cases, however, have rejected this line of reasoning. See, e.g., Strougo v. Bassini, 282 F.3d 162, 172 (2d Cir. 2002) ("[W]here shareholders suffer a distinct injury, i.e., an injury that does not derive from corporate injury, they may bring direct suit, even if their injury is undifferentiated among them.") (interpreting Maryland law and rejecting "undifferentiated effect on shareholders" standard followed in other jurisdictions); Kennedy v. Venrock Assoc., 348 F.3d 584, 591-92 (7th Cir. 2003) ("The charge that [the corporation's] directors issued a misleading proxy statement in violation of their fiduciary obligation is a legitimate direct claim . . . since the effect of the reincorporation was to reduce the shareholders' power over the corporation's affairs rather than to reduce the value of the corporation. It shows that a direct suit is not necessarily precluded by the common shareholders having suffered an 'undifferentiated harm.' They can suffer such a harm without the corporation's being injured."); Dansie v. City of Herriman, 134 P.3d 1139, 1144 (Utah 2006) ("A shareholder does not sustain an individual injury because a corporate act results in disparate treatment among shareholders. Rather, the shareholder must examine his injury in relation to the corporation and demonstrate that the injury was visited upon him and not the corporation."); PricewaterhouseCoopers, LLP v. Massey, 860 N.E.2d 1252, 1262 (Ind. Ct. App. 2007) (shareholder directors could not bring a direct action against company auditor because they did not suffer an injury separate and distinct from that suffered by all other shareholders; the value of their stock declined, but they had no additional out-of-pocket expenses due to their positions on the Board).

d. In 2004, the Delaware Supreme Court, acknowledging the prior "confusing jurisprudence on the direct/derivative dichotomy," stated that it "disapprove[d] [of] the use of the concept of 'special injury' as a tool" in analyzing whether a claim is direct or derivative. See Tooley v. Donaldson, Lufkin & Jenrette, Inc., 845 A.2d 1031, 1035 (2004). The Court held: "We set forth in this Opinion the law to be applied henceforth in determining whether a stockholder's claim is derivative or direct. That issue must turn solely on the following questions: (1) who suffered the alleged harm (the corporation or the suing stockholders, individually); and (2) who would receive the benefit of any recovery or other remedy (the corporation or the stockholders, individually)?" Id. at 1033. The Court disapproved the concept that a claim is necessarily derivative if it affects all stockholders equally. Id. Rather, the focus, under the new test, is whether the stockholder has shown that he or she has suffered an injury that is not dependent on injury to the corporation. Id. at 1036.

(1) In Tooley, plaintiff stockholders brought a purported class action alleging that the members of the board of directors breached their fiduciary duties by agreeing to a 22-day delay in closing a proposed merger. Plaintiffs alleged that the delay cost them the lost time-value of the cash paid for their shares. See id. at 1033. The Court held that plaintiffs failed to state a derivative claim because they did not show an "injury to the corporate entity" or seek relief that "would go to the corporation. Accordingly, there is no basis to hold that the complaint states a derivative claim." Id. at 1039.

(2) See also, Agostino v. Hicks, 845 A.2d 1110, 1121 (Del. Ch. 2004) ("[W]hat must be discarded is the notion of using special injury, i.e., 'injury which is separate and distinct from that suffered by other shareholders' as a talismanic entreaty to the assertion of an individual claim. . . [T]he more grounded approach [is to ask] whether the plaintiff has suffered injury 'independent of any injury to the corporation.'").

(3) Many courts have subsequently applied the principles set forth in Tooley. See, e.g., Marcoux v. Prim, 2004 WL 830393, at *12 (N.C. Super. April 16, 2004) (relying on Tooley, held that plaintiffs stated a direct breach of fiduciary duty claim that directors failed to get a fair price for the corporation's stock in a merger because the injury was to the shareholders, not the corporation); In re Syncor Int'l Corp. S'holders Litig., 857 A.2d 994, 996-97 (Del. Ch. 2004) (applying Tooley, the court found that shareholders did not have a direct claim against the company for the reduced price they received for their shares in a merger due to the misconduct of the company's founder and former chairman; rather, the claim was derivative because "the alleged misconduct was in connection with Syncor's core business activities and, if proven, would involve a breach of the duty of loyalty owed to Syncor. Moreover, although the immediate effect of the misconduct might have been to benefit Syncor through increased sales and profits, there is no mistaking that the alleged misconduct caused substantial injury to Syncor, which became the focus of multiple criminal and civil proceedings."); Dieterich v. Harrer, 857 A.2d 1017 (Del. Ch. 2004) (mismanagement that precluded company from entering more lucrative merger transaction deemed derivative under Tooley); Smith v. Waste Mgmt, Inc., 407 F.3d 381, 385 (5th Cir. 2005) (using the test articulated in Tooley, the court held that "when a corporation, through its officers, misstates its financial condition, thereby causing a decline in the company's share price when the truth is revealed, the corporation itself has been injured," and not just the shareholder); Schuster v. Gardner, 127 Cal. App. 4th 305, 313, 315-16 (2005) (action arising from alleged mismanagement improprieties of officers and directors of corporation and the attendant decline in company's stock value deemed derivative under either California or Delaware (applying Tooley) law); McCarthy v. Middle Tennessee Elec. Membership Corp., 466 F.3d 399, 409-10 (6th Cir. 2006) (Sixth Circuit held that the Tennessee Supreme Court, if presented with the issue, "would likely adopt the rule articulated in Tooley").

e. An increasing number of courts have also abandoned the distinction between direct and derivative actions in the context of closely held corporations. See Marcuccilli v. Ken Corp., 766 N.E. 2d 444, 450 (Ind. Ct. App. 2002) (quoting Barth v. Barth, 659 N.E. 2d 559 (Ind. 1995)) (quoting A.L.I., Principles of Corporate Governance § 7.01(d)) ("In the case of a closely held corporation, the court in its discretion may treat an action raising derivative claims as a direct action, exempt it from those restrictions and defenses applicable only to derivative actions, and order an individual recovery, if it finds that to do so will not (i) unfairly expose the corporation or the defendants to a multiplicity of actions, (ii) materially prejudice the interests of creditors of the corporation, or (iii) interfere with a fair distribution of the recovery among all interested persons."); see also Sharkey v. Emery, 272 B.R. 574, 582-83 (Bankr. D.N.J. Nov. 2001) (relying on Brown v. Brown, 323 N.J. Super. 30, 36 (App. Div. 1999) (the distinction between derivative and direct actions in a closely held corporation is immaterial where defendants will not be exposed to a multiplicity of actions, creditors, interests could be protected, and proceeds could be distributed fairly among interested persons); Hubbard v. Tomlinson, 747 N.E. 2d 69, 71-72 (Ind. Ct. App. 2001) (quoting the Indiana Supreme Court in G & N Aircraft, Inc. v. Boehm, 743 N.E. 2d 227, 236 (2001)) ("[A] shareholder in a close corporation need not always bring claims of corporate harm as derivative actions[;] rather, in such an arrangement, the shareholders are more realistically viewed as partners, and the formalities of corporate litigation may be bypassed."); DeHoff v. Veterinary Hospital Operations of Central Ohio, Inc., 2003 WL 21470388, at *14 (Ohio App. 10 Dist. June 26, 2003) (allowing minority shareholder of closely held corporation to bring a direct action for breach of fiduciary duty against controlling shareholder because a derivative remedy would primarily benefit the alleged wrongdoers); Fritzmeier v. Krause Gentle Corp., 669 N.W.2d 699, 707-08 (2003) (allowing shareholders of wholly owned corporations to pursue a direct action because there is no distinction between the shareholder and the corporation, and thus, no danger of duplicative recovery); but see Mynatt v. Collis, 57 P.3d 513, 529-30 (Kan. 2002) (although it recognized the "close corporation exception," the Court emphasized that "the decision whether to allow a party to proceed with a direct suit in lieu of a derivative action is entrusted to the court's discretion"; even if all three prongs are met (as discussed in Marcuccilli above) a court, "in its equitable power and discretion," can deny a shareholder from bringing a direct action); Redeker v. Litt, 2005 WL 1224697, at *5 (Iowa Ct. App. May 25, 2005) ("If a closely held corporation operates more like a partnership, some jurisdictions allow the shareholders to bring an individual action, even though the cause of action may technically be that of the corporation."); Woolard v. Davenport, 601 S.E.2d 319, 324-25 (N.C. Ct. App. 2004) (quoting Norman v. Nash Johnson & Sons' Farms, Inc., 537 S.E.2d 248, 258 (N.C. Ct. App. 2000)) ("[I]t seems particularly appropriate to allow minority shareholders to file individual actions when a dispute arises within the context of a family owned corporation, or other corporation in which all shares of stock are held by a relatively small number of shareholders . . . . When the close relationships between the shareholders in a 'family' or closely held corporation tragically break down, the majority of shareholders are obviously in a position to exclude the minority shareholders from management decisions, leaving the minority shareholders with few remedies."); Durham v. Durham, 871 A.2d 41, 46 (N.H. 2005) ("A direct action may be appropriate in this case because all of the corporation's shareholders are before the court as either the plaintiff or defendants; thus, there is no risk that a direct suit would expose the corporation to a multiplicity of actions.").

f. Most states, including Delaware, however, have yet to adopt this so-called "closely held corporation exception." See Ferrara, Abikoff, Gansler, Shareholder Derivative Litigation: Besieging the Board §-1.02[2] (hereinafter "Ferrara, et al."); see also Glod v. Baker, 851 So. 2d 1255, 1264-67, 1276 (La. App. 3rd Cir. Aug. 6, 2003) (shareholders in closely held corporations, partnerships and limited liability companies could not pursue individual claims on their own behalf even though they were "severely personally damaged as a result of the wrongs done to their entities" because the right of action belonged solely to the entities); Mannos v. Moss, 155 P.3d 1166, 1172 (Idaho 2007) (shareholder in closely-held corporation could not bring a direct claim; "[a]ny claim . . . regarding the defendants depletion of corporate assets [could] only be pursued by [plaintiff] through a derivative action").

3. State Law Applies

a. State law controls the determination of whether an action is derivative or direct in diversity actions brought in federal court. Sax v. World Wide Press, Inc., 809 F.2d 610, 613 (9th Cir. 1987) (characterization of an action as derivative or direct question of state law); Seidel v. Allegis Corp., 702 F. Supp. 1409 (N.D. Ill. 1989) (same); Gadd v. Pearson, 351 F. Supp. 895 (M.D. Fla. 1972) (same); Sybold v. Groenink, 2007 WL 737502, at *5-6 (S.D.N.Y. Mar. 12, 2007) (court applied New York's "internal affairs" doctrine to hold that plaintiff lacked standing to bring a derivative action under Dutch law).

B. Standing Requirements

1. Plaintiffs Must Be A Shareholder At Time Of Suit

a. Most states and Federal Rule of Civil Procedure 23.1 require a plaintiff to be a shareholder of the corporation at the time a derivative action is filed and at the time of the challenged transaction. See Ferrara, et al., § 4.02[1] and [2] and cases and statutes cited therein; see also Wright, Miller & Kane, Federal Practice and Procedure: Civil 2d § 1826 and § 1828 and cases cited therein. The second requirement is often known as the "contemporaneous ownership" requirement. This requirement is designed to curtail strike suits by prohibiting potential plaintiffs from buying into a lawsuit or commencing a derivative action by simply purchasing shares after the alleged wrong has occurred. See, e.g., Brambles USA, Inc. v. Blocker, 731 F. Supp. 643 (D. Del. 1990); In re Penn Cent. Transp. Co., 341 F. Supp. 845 (E.D. Pa. 1972).

(1) When all of a company's stock is owned through an Employee Stock Ownership Plan ("ESOP"), the ESOP shareholders "must be left with some type of recourse if the trustee is unable or unwilling to sue the officers of the corporation for a breach of their fiduciary duties." Housman v. Albright, 368 Ill. App. 3d 214, 220 (2006). Hence, ESOP participants are considered "equitable stockholders and have standing to maintain a shareholders' derivative suit." Id.

(2) In Tzolis v. Wolff, 10 N.Y.3d 100, 109 (2008), the court held that members of Limited Liability Companies ("LLC") may sue derivatively. Because the court found "no clear legislative mandate" barring the courts from entertaining derivative actions by LLC members, it concluded that derivative actions by LLC members should be recognized "even though no statute provides for them." Id.

(3) In Schoon v. Smith, 953 A.2d 196, 200 (Del. 2008), appellant, a director, but not a shareholder, of a privately held Delaware corporation filed a derivative action on behalf of the company alleging breaches of fiduciary duties by his fellow directors. The appellant argued that "as a matter of equity and public policy, a director should be entitled to assert a derivative claim on behalf of the corporation for the same reasons that stockholders are permitted to do so[,] []...urg[ing] that equipping directors with standing to sue derivatively is consistent with the fiduciary duties of directors and 'promotes the core Delaware public policy of protecting against misconduct by faithless fiduciaries.'" Id. The Delaware Supreme Court found no statutory authority for standing to sue as a director, and although it was empowered to extend the doctrine of equitable standing for a director to bring a derivative action, it declined to do so because it did not want to embrace "a policy that w[ould] divert the doctrine from its original purpose: to prevent a complete failure of justice." Id. 210. The appellant did not show that a "complete failure of justice" would occur unless he was granted standing to sue as a director, so the court affirmed the Chancery Court's dismissal for lack of standing. Id.

b. In diversity actions brought under Federal Rule 23.1, a threshold question is whether the court looks to state or federal law to determine a plaintiff's standing. The first requirement (i.e., that the plaintiff be a shareholder of the corporation at the time the action was filed) is governed by state law. See Wright & Miller § 1826 and cases cited therein. Courts have also generally held that the contemporaneous ownership requirement is procedural and have applied the contemporaneous ownership requirement found in Federal Rule 23.1 in the face of inconsistent state law. See, e.g., Kona Enter., Inc. v. Estate of Bishop, 179 F.3d 767, 769 (9th Cir. 1999); Perrott v. U.S. Banking Corp., 53 F. Supp. 953 (D. Del. 1944); Piccard v. Sperry Corp., 36 F. Supp. 1006 (S.D.N.Y.), aff'd without opinion, 120 F.2d 328 (2d Cir. 1941).

c. The size of plaintiff's financial stake in the corporation is immaterial. Koster v. (American) Lumbermens Mut. Cas. Co., 330 U.S. 518 (1947); Subin v. Goldsmith, 224 F.2d 753, 761 (2d Cir. 1955). The only time a plaintiff's financial stake may be of consequence is where state law provides security-for-expenses. States that have adopted security-for-expenses statutes include Arizona, California, Colorado, Florida, Nebraska, New Jersey, New York, Pennsylvania, and Wisconsin. For a general discussion on securities-for-expenses statutes see Wright & Miller § 1835 and cases cited therein.

2. The Requirement That A Shareholder Own Stock When A Derivative Action Is Started

a. Maryland and New York have statutes that expressly require stock ownership at the time an action is commenced. See Md. Code Ann. § 4A-802 and N.Y. Bus. Corp. L. § 626. Other jurisdictions have judicially imposed this requirement. See, e.g., Weffel v. Kramarsky, 61 F.R.D. 674, 679 (S.D.N.Y 1974).

b. In some jurisdictions, beneficial owners are not permitted to bring derivative actions. See Ferrara, et al., § 4.02[1]. Other states expressly allow beneficial owners to bring such suits. See id. and statutes cited therein.

(1) The Court of Appeals of Kansas, in a case that involved record, but not beneficial, owners of stock held that a shareholder need not be a beneficial owner of stock in the corporation to have standing, finding that a "mere nominal owner of stock" has standing to bring a derivative suit because the nominal owner has an ongoing proprietary interest in the corporation. Quality Dev., Inc. v. Thorman, 31 P.3d 296, 301-02 (Kan. Ct. App. 2001).

(2) In Daly v. Yessne, 131 Cal. App. 4th 52, 60-61 (2005), the defendants asserted that plaintiff lacked standing to bring a shareholder derivative action because it was undisputed that all but one of the alleged acts took place before she acquired her shares. Plaintiff conceded this fact, but maintained she held a "vested beneficial interest" in the stock from the time she signed the Stock Repurchase Agreement. Id. The court disagreed, finding that "plaintiff had no current investment, direct or through a third party, in [the company] when most of the challenged events occurred," therefore, her interest before she acquired her shares was "only a contractual arrangement that permitted her to buy stock in the company; like a holder of a warrant or convertible debenture, she had not assumed the risks and benefits of stock ownership." Id. The court concluded that the "plaintiff had no standing to bring a derivative claim for acts that took place before she converted her options into shares." Id.

c. In some community property states, a spouse has a beneficial interest arising from the other spouse's ownership of stock. See, e.g., American Guar. & Liab. Ins. Co. v. Keiter, 360 F.3d 13, 18 (1st Cir. 2004) ("In Washington, a community property state, one spouse is deemed to have a beneficial interest in stock owned by the other spouse by virtue of the one-half community property interest" and is not contingent upon the other spouse's death because the non-ownership spouse is not merely a legatee, but rather, is an owner of the one-half community interest).

d. Those jurisdictions that do not have statutes addressing the issue, such as Delaware, look to see if the plaintiff has an equitable interest in the stock. Quality Dev., 31 P.3d at 301-02. (citing Anadarko Petroleum Corp. v. Panhandle E. Corp., 545 A.2d 1171, 1176 (Del. 1988); Harrf v. Kerkorian, 324 A.2d 215, 218 (Del. Ch. 1974), aff'd in part, rev'd in part 347 A.2d 133 (Del. 1975); Rosenthall v. Burry Biscuit Corp., 60 A.2d 106, 113 (Del. Ch. 1948)).

e. The British Virgin Islands—an increasingly popular jurisdiction for incorporating—has a "leave to sue" provision requiring a shareholder in a B.V.I. corporation to obtain leave to initiate a derivative suit. On May 26, 2009, a California appellate court held that the "internal affairs doctrine" required the court to apply B.V.I. law and affirm a derivative action's dismissal because the plaintiff had not complied with the "leave to sue" provision. Vaughn v. LJ Int'l, Inc., 174 Cal. App. 4th 217, 223-25 (2009).

3. The Contemporaneous Ownership Requirement

a. In most jurisdictions, a derivative plaintiff must have been a shareholder at the time of the challenged transaction and must remain a shareholder pending the outcome of the litigation. See, e.g., Lewis v. Anderson, 477 A.2d 1040, 1049 (Del. 1984) ("[A] plaintiff who ceases to be a shareholder, whether by reason of a merger or for any other reason, loses standing" to sue derivatively); see also Brambles USA, Inc., 731 F. Supp. at 648 ("[A] derivative plaintiff [must] be a shareholder of the corporation at the time of the transaction of which he complains . . . [and] must also maintain that status throughout the lawsuit"); Schilling v. Belcher, 582 F.2d 995, 996 (5th Cir. 1978) ("[A] shareholder who sells his stock pending appeal of a favorable judgment in a stockholder's derivative suit . . . loses standing to further prosecute or defend the case"); Strategic Asset Mgmt., Inc. v. Nicholson, 2004 WL 2847875, at *3 (Del Ch. Nov. 30, 2004) (rejecting the argument that a shareholder need not maintain his or her status as a shareholder in situations where a settlement agreement has been reached; holding, instead, that a settlement agreement "without a final judgment by the Court" does not terminate the litigation). The purpose of this rule is "to prevent what has been considered an evil, namely, the purchasing of shares in order to maintain a derivative action designed to attack a transaction which occurred prior to the purchase of stock." Burry Biscuit Corp., 60 A.2d at 111.

(1) Courts have increasingly rejected general allegations of stock ownership "at all relevant times" and required shareholders to plead contemporaneous ownership with particularity. See In re Computer Sciences Corp. Deriv. Litig., 2007 WL 1321715, at *15 (C.D. Cal. Mar. 26, 2007) ("[G]eneral allegation[s] [are] insufficient to allege contemporaneous ownership during the period in which the questioned transactions occurred."); see also Belova v. Sharp, 2008 WL 700961, at *3 (D. Or. Mar. 13, 2008) ("A plaintiff's allegation of ownership must be sufficiently particularized."); Travis v. Mittelstaedt, 2008 WL 755842, at *2 (E.D. Cal. Mar. 19, 2008) (finding general allegations of stock ownership insufficient). But see Plymouth County Retirement Ass'n v. Schroeder, 576 F. Supp. 2d 360, 374 (E.D.N.Y. 2008) ("[T]he law of [the Second] Circuit does not require that the plaintiff indicate the specific dates or time-periods on which it obtained MSC stock.").

(2) If a plaintiff sells its shares during a derivative action's pendency, another qualified shareholder can intervene to maintain the lawsuit because their rights are no longer represented. In re Extreme Networks, Inc. S'holders Deriv. Litig., 573 F. Supp. 2d 1228, 1237 (N.D. Cal. 2008) (after dismissing derivative complaint without prejudice because lead plaintiff sold all his shares in the company, the court requested other plaintiffs and intervening shareholders to file new motions to appoint lead plaintiff).

b. Exceptions To The Contemporaneous Ownership Rule

(1) Statutory Exceptions

(a) Several state statutes provide exceptions to the contemporaneous ownership rule. See, e.g., Alaska Stat. § 10.06.435; Cal. Corp. Code § 800; Ill. Ann. Stat., Ch. 32, § 7.80; 15 Pa. Stat. § 1782; Va. Code Ann. § 13.1-672.1.

(i) In Lynn v. Martin County Marine Corp., 980 So. 2d 536 (Fla. App. 4 Dist. Apr. 2, 2008), shareholders brought a derivative action and then sold their shares and assigned their rights in the action to a third-party buyer. The third-party buyer wanted to maintain the derivative action and was allowed to do so under Section 607.07401(1) of the Florida Statutes. Id. Section 607.07401(1) states that "A person may not commence a proceeding in the right of a domestic or foreign corporation...unless the person became a shareholder through transfer by operation of law from one who was a shareholder at that time." Id.

(b) Factors used to determine whether the exception should apply include: (1) whether there is a strong prima facie case in favor of the claim; (2) whether a similar action has or is likely to be commenced; (3) whether the shareholder acquired shares in the corporation before public disclosure of the alleged misconduct; (4) whether the defendant(s) will be permitted to retain ill-gotten gains if the suit does not go forward; and (5) whether the suit, if successful, will result in unjust enrichment to the shareholder. Ferrara, et al., § 4.02[3] collecting factors from Alaska's and California's statutes.

(2) The Continuing Wrong Doctrine

(a) Under the continuing wrong doctrine, the contemporaneous ownership requirement will not apply where the alleged wrong is occurring at the time the shareholder bought stock even if it began before the shareholder purchased the stock. See, e.g., Brambles USA, Inc., 731 F. Supp. at 643; Noland v. Barton, 741 F.2d 315 (10th Cir. 1984); see also cases cited in Wright & Miller § 1828.

(b) Recently, the Second Circuit, declining to adopt an expansive interpretation of the continuing wrong doctrine, held that plaintiff "must have acquired his or her stock in the corporation before the core of the allegedly wrongful conduct transpired." In re Bank of New York Deriv. Litig., 320 F.3d 291, 298 (S.D.N.Y. 2003). See also Lerner v. Allaire, 2003 WL 22326504, at *3 (D. Conn. Sept. 30, 2003) ("[A] proper plaintiff must have acquired his or her stock in the corporation before the core of the allegedly wrongful conduct transpired").

(c) The cost of defending against related class-action lawsuits and the negative impact of a company's standing in the financial markets does not constitute continuing harm. In re Omnivision Tech., Inc., 2004 WL 2397586, at *3 (N.D. Cal. Oct. 26, 2004) (concluding that "such open-ended injuries" as a company's "legal woes" and "reduced standing" in the capital markets "are well outside the bounds of the continuing wrong doctrine" because they could "continue for years").

(d) Not all courts allow a plaintiff to allege a continuing wrong to overcome the contemporaneous ownership rule. See, e.g., Pullman-Peabody Co. v. Joy Mfg., 662 F. Supp. 32 (D. N.J. 1986) (rejecting continuing wrong exception to the contemporaneous ownership rule); Herald Co. v. Seawell, 472 F.2d 1081 (10th Cir. 1972) (same); Lowell Wiper Supply Co. v. Helen Shop, Inc., 235 F. Supp. 640, 647 (S.D.N.Y. 1964) (shareholder could not maintain action on the theory that payment of dividends subsequent to plaintiff's ownership constituted continuing wrong); Cadle v. Hicks, 2008 WL 895992, at *2-3 (10th Cir. Apr. 2, 2008) (shareholder filed derivative action challenging indemnification of corporation's CEO for legal fees incurred in connection with litigation, even though he purchased his shares after the company's indemnification decision; court held that periodic indemnification payments did not amount to a continuing wrong); Conrad v. Blank, 940 A.2d 28, 41-42 (Del. Ch. 2007) (rejecting continuing wrong theory in stock-option backdating context).

(3) The Contemporaneous Ownership Rule And Mergers

(a) Normally, a merger destroys a derivative claim. Thus, under the general rule, a plaintiff loses standing to maintain a derivative action where a merger has occurred. See, e.g., Schreiber v. Carney, 447 A.2d 17, 21 (Del. Ch. 1982) ("[U]pon the merger the derivative rights pass to the surviving corporation which then has the sole right or standing to prosecute the action"); Lewis v. Anderson, 477 A.2d 1040, 1047 (Del. 1982) ("A merger which eliminates ownership of stock eliminates standing to pursue a derivative claim."); see also, Lewis v. Ward, 852 A.2d 896, 904 (Del. 2004) (affirming Lewis v. Anderson) (concluding that "the established principle of Delaware corporate law recogniz[es] the separate corporate existence and identity of corporate entities, as well as the statutory mandate that the management of every corporation is vested in its board of directors, not its stockholders."); In re Countrywide Fin. Corp. Deriv. Litig., 581 F. Supp. 2d 650, 653 (D. Del. 2008) (adhering to long line of Delaware state law precedent when granting motion to dismiss for lack of standing following Countrywide's merger with Bank of America).

(i) The issue of whether a plaintiff maintains standing to continue to prosecute a derivative action following a merger under California law was recently resolved by the California Supreme Court in Grosset v. Wenaas, 42 Cal. 4th 1100 (2008). The Court held "California law, like Delaware law, generally requires a plaintiff in a shareholder's derivative suit to maintain continuous stock ownership throughout the pendancy of the litigation. Id. at 1119. "Under this rule, a derivative plaintiff who ceases to be a stockholder by reason of a merger ordinarily loses standing to continue the litigation. Although equitable considerations may warrant an exception to the continuous ownership requirement if the merger itself is used to wrongfully deprive the plaintiff of standing, or if the merger is merely a reorganization that does not affect the plaintiff's ownership interest...." Id.

(ii)When a federal court sits in diversity jurisdiction, it will apply the law of the state of incorporation, rather than "federal common law" when analyzing standing in the post-merger context. In re Merrill Lynch & Co., Inc. Sec., Deriv. & ERISA Litig., 597 F. Supp. 2d 427, 430-31 (S.D.N.Y. 2009) (applying Delaware law when ruling that Merrill Lynch merger with Bank of America eliminated the plaintiff's standing to continue the derivative action).

(b) There are, however, exceptions to this rule. For example, Delaware allows a shareholder to maintain a derivative action if the merger is the subject of a fraud claim and was perpetrated merely to deprive shareholders of standing. See Kramer v. Western Pac. Indus., 546 A.2d 348, 354 (Del. 1988); see also Arnett v. Gerber Scientific, Inc., 566 F. Supp. 1270, 1273 (S.D.N.Y. 1983) (shareholders had standing to sue after merger because "(1) plaintiffs' disposition of the stock was involuntary; (2) the disposition was related to the allegedly illegal acts of defendants; and (3) the remedy sought [rescission of the merger] would result in plaintiffs regaining shareholder status"). This exception is difficult to plead. See,e.g., Lewis v. Ward, 2003 WL 22461894, at *5 (Del. Ch. Oct. 29, 2003) (the exception to the contemporaneous ownership rule in the merger context "requires a showing that the sole basis for [the corporation's] decision to enter the merger was to divest the plaintiff of derivative standing"; the absence of well-pled facts suggesting that defendants' derivative liability was so substantial as to have been the motivating factor for a pre-textual merger with another company is fatal); Kolancian v. Snowden, 532 F. Supp. 2d 260, 263 (D. Mass. 2008) ("plaintiff must plead fraud not only on the part of the acquired corporation, but also on the part of the surviving entity..."). Shareholders relying on this exception must plead with particularity facts showing the fraud. Id. at *4-5.

(c) A shareholder also has standing to bring a derivative suit if the merger is simply a reorganization that does not affect plaintiff's ownership in the business enterprise. See Kramer, 546 A.2d at 354; see also Schreiber, 447 A.2d at 17 (because the "structure of the old and new companies [was] virtually identical" and thus "had no meaningful effect on the plaintiff's ownership of the business enterprise," the plaintiff did not lose standing to maintain derivative action).

(d) The American Law Institute proposed a rule that would allow a derivative plaintiff to maintain suit following the loss of stockholder status if that loss was the result of a corporate action in which the holder did not acquiesce, and either: (1) the derivative action was commenced prior to the corporate action terminating the holder's status, or (2) the court finds that the holder is better able to represent the interests of the shareholders than any other holder who has brought suit. Principles of Corp. Governance § 7.02(a)(2) (2003).

(e) Compare FirstCom, Inc. v. Qwest Corp., 2004 WL 2315289, at *2-3 (D. Minn. Oct. 13, 2004) (under Minnesota's Business Corporations Act, shareholders of defunct company still had standing to bring derivative suit).

4. Standing For Derivative Action Involving Insolvent Company Subject to Bankruptcy Court Jurisdiction

a. Upon the commencement of a bankruptcy proceeding, derivative claims become the property of the bankruptcy estate and are subject to the control of the Bankruptcy Court. See, e.g., Thornton v. Bernard Tech., Inc., 2009 WL 426179, at *3 (Bankr. D. Del. Feb. 20, 2009); In re The 1031 Tax Group, LLC, 397 B.R. 670, 680-81 (Bankr. S.D.N.Y. 2008) (holding that breach of fiduciary duty and negligence claims are derivative and belong to the trustee). The right to bring a derivative action asserting claims for injury to the debtor corporation by its officers and directors vests exclusively to the trustee. Thornton, 2009 WL 426179, at *3 n.9.

b. If a derivative action is pending at the time the bankruptcy petition is filed, it must be dismissed unless the plaintiff is able to show: (1) the bankruptcy trustee has affirmatively assigned or abandoned the derivative claims to the plaintiff; and (2) the Bankruptcy Court approves of the plaintiff's continued prosecution of the derivative claims. Thornton, 2009 WL 426179, at *3-4 (dismissing derivative suit because the plaintiff failed to show that the trustee had abandoned or assigned the derivative claims).

C. The Demand Requirement

1. As discussed above, a derivative action redresses harm to the corporation. See, e.g., H. F. Ahmanson & Co., 1 Cal. 3d at 93 ("A stockholder's derivative suit is brought to enforce a cause of action which the corporation itself possesses against some third party, a suit to recompense the corporation for injuries which it has suffered as a result of the acts of third parties."). Thus, there is a presumption that the corporation, through its directors and officers, controls the decision to pursue a claim on behalf of the company. Accordingly, a shareholder that wishes to maintain a derivative action must attempt to secure corporate action through a demand to the board that it initiate the litigation. See Grimes, 673 A.2d at 1207 (citing Kamen, 500 U.S. at 90); see also Delaware & Hudson Co. v. Albany & Susquehanna R.R. Co., 213 U.S. 435, 447 (1909) (demand requirement "recognizes the right of the corporate directory to corporate control; in other words, to make the corporation paramount, even when its rights are to be protected or sought through litigation"). The demand requirement is not limited to corporations, but also applies to business trusts and investment funds. See ING Principal Protection Funds Deriv. Litig., 369 F. Supp. 2d 163, 171 (D. Mass. 2005) (applying universal demand requirement to derivative action brought on behalf of business trust). One way around this requirement, as discussed below, is to allege demand futility.

2. To satisfy the demand requirement, a complaint must "allege with particularity the efforts, if any, made by the plaintiff to obtain the action the plaintiff desires . . . and the reasons for the plaintiff's failure to obtain the action or for not making the effort." Del. Ch. Ct. R. 23.1; see also Cal. Corp. Code § 800(b)(2) ("[P]laintiff [must] allege in the complaint with particularity plaintiff's efforts to secure from the board such action as plaintiff desires, or the reasons for not making such effort"); N.Y. Bus. Corp. Law § 626(c) ("The complaint shall set forth with particularity the efforts of the plaintiff to secure the initiation of such action by the board or the reasons for not making such effort"). Because of the particularity requirement, notice pleading is insufficient. Grobow v. Perot, 539 A.2d 180, 187 (Del. 1989) ("[C]onclusionary allegations of fact or law not supported by allegations of specific fact [are] not [to] be taken as true"); Allison ex rel. General Motors Corp. v. General Motors Corp., 604 F. Supp. 1106, 1112 (D. Del. 1985) (Rule 23.1 "is a marked departure from the 'notice' pleading philosophy of the Federal Rules of Civil Procedure").

a. In re Merck & Co., Inc. Sec., Deriv. & ERISA Litig., 493 F.3d 393 (3d Cir. 2007), shareholders filed a derivative action against the directors and officers of Merck. The District Court granted Merck's motion to dismiss and denied shareholders leave to amend their complaint. The shareholders appealed. The Third Circuit, "agree[d] with the District Court and Merck that, as a general rule, a plaintiff in a shareholder derivative suit may not use discovery to amend demand futility allegations. Whether the discovered materials existed before or after the filing of the operative complaint does not alter [the] analysis. However, this case presents a rare exception to this rule because both parties voluntarily entered into a stipulated discovery agreement that did not preclude the plaintiffs from using this after-acquired information in an amended complaint. Thus, the standard argument——that allowing discovery in demand futility scenarios undermines the authority of the corporation to decide whether to bring suit against itself and gives incentive to shareholder to engage in fishing expeditions——has no applicability when the plaintiffs and the corporation voluntarily agree to permit limited discovery." Id. at 401.

3. To make a demand a shareholder generally must send a letter or draft complaint or other comparable communication to the board of directors although some state statutes and Federal Rule 23.1 do allow a demand to be made on someone other than the board if that party is of "comparable authority." For a list of state statutes allowing demand on "comparable authority" see Ferrara, et al., § 3.03[1] n.11.

a. The following cases have considered the issue of who besides the board of directors may be served with a demand: Kaster v Modification Sys., Inc., 731 F.2d 1014, 1017-19 (2d Cir. 1984) (demand on individual who was president and chairman of the board and who owned 71% of voting stock was not sufficient); Greenspun v. Deb E. Webb Corp., 634 F.2d 1204, 1209 (9th Cir. 1980) (demand to individual who was president, director, and general counsel of company insufficient); In re Penn Cent. Sec. Litig., 335 F. Supp. at 1026 (demand on receiver or trustee for a bankrupt company sufficient); Kemper v. Am. Broad. Cos., 365 F. Supp. 1272, 1274 (S.D. Ohio 1973) (same); Womble v. Dixon, 585 F. Supp. 728, 731 (E.D. Va. 1983), aff'd in part, vacated in part 752 F.2d 80 (4th Cir. 1984) ("demand to bring suit on the savings and loan association's behalf must be made on the receiver or agency possessing the right to assert the associations claim").

b. The demand does not need to "assume a particular form . . . [or] be made in any special language." Stoner v. Walsh, 772 F. Supp. 790, 796 (S.D.N.Y. 1991); see also Khanna v. McMinn, 2006 WL 1388744, at *13 (Del. Ch. May 9, 2006) (there are no "magic words" that establish "that a communication is a demand for purposes of Court of Chancery Rule 23.1."). It must simply "fairly and adequately apprise the directors of the potential cause of action so that they, in the first instance, can discharge their duty of authorizing actions that 'in their considered opinion . . .[are] in the best interest of the corporation.'" Id. Accordingly, the demand typically must (1) identify the alleged wrongdoers; (2) describe the factual basis for the allegations; (3) describe the harm caused to the corporation; and (4) describe the request for relief. See, e.g., Levner v. Saud, 903 F. Supp. 452, 456 (S.D. N.Y. 1994), aff'd 61 F.3d 8 (2d Cir. 1995); Seidel v. Allegis Corp., 702 F. Supp. 1409, 1412 (N.D. Ill. 1989); Lewis ex rel. Nat'l Semiconductor Corp. v. Sporck, 646 F. Supp. 574, 578 (N.D. Cal. 1986).

4. A new demand is not typically required where there has been a change in the board's make-up. See Nelson v. Pac. Sw. Airlines Indus., Inc., S'holder Litig., 399 F. Supp. 1025 (S.D. Cal. 1975); In re Fuqua Indus., 1997 WL 257460 (Del. Ch. May 13, 1997) (new demand not required even where the entire membership of the board has changed). But where an amended complaint raises issues not previously included in the earlier demand, these issues need to be presented to the board, absent futility, before they can be litigated. In re Fuqua Indus., 1997 WL 257460, at *15.

a. "When an amended derivative complaint is filed, the existence of a new independent board of directors is relevant to a Rule 23.1 demand inquiry only as to derivative claims in the amended complaint that are not already validly in litigation." Braddock v. Zimmerman, 906 A.2d 776, 786 (Del. 2006). "Three circumstances must exist to excuse a plaintiff from making demand under Rule 23.1 when a complaint is amended after a new board of directors is in place: first, the original complaint was well pleaded as a derivative action; second, the original complaint satisfied the legal test for demand excusal; and third, the act or transaction complained of in the amendment is essentially the same as the act or transaction challenged in the original complaint." Id.

5. In assessing the reasonableness of the time between a demand and the filing of a derivative action, courts balance the needs of a corporation to make a conscientious decision against the potential desire of the corporation to delay the suit by engaging in "idle ceremony." See Mills v. Esmark, Inc., 91 F.R.D. 70, 73 (N.D. Ill. 1981) (failure to respond to demand within three months tantamount to admitting demand futility); but compare Recchion ex rel. Westinghouse Elec. Corp. v. Kirby, 637 F. Supp. 1309, 1319 (W.D. Pa. 1986) (two months deemed insufficient to complete adequate investigation); see also Mozes ex rel. General Elec. Co. v. Welch, 638 F. Supp. 215, 221 (D. Conn. 1986) (eight months deemed insufficient where investigation impeded by parallel criminal proceedings); Gen. Motors Corp., 604 F. Supp. at 1117-18 ("amount of time needed for a response will vary in direct proportion to the complexity of the technological, quantitative, and legal issues raised by the demand"); MacCoumber v. Austin, 2004 WL 1745751, at *4 (N.D. Ill. Aug. 2, 2004) ("[C]ourts have not formulated a specific rule as to what constitutes a reasonable response time," instead, they "determine reasonable response time by examining the complexity of the issues presented by the demand and the surrounding circumstances"); Piven v. Ryan, 2006 WL 756043, at *3-4 (N.D. Ill. Mar. 23, 2006) ("A board's decision to delay responding to a demand in order to focus on related litigation is reasonable"; until the related litigation is complete "it would be unreasonable to require the board to expend [the company's] resources unnecessarily.").

O'Melveny & Myers LLP routinely provides advice to clients on complex transactions in which these issues may arise, including finance, mergers and acquisitions, and licensing arrangements. If you have any questions about the operation of the applicable statutory provisions or the case law interpreting these provisions, please contact any of the attorneys listed on this alert.

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    This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

    Correcting/Updating Personal Information

    If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

    Notification of Changes

    If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

    How to contact Mondaq

    You can contact us with comments or queries at enquiries@mondaq.com.

    If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.

    By clicking Register you state you have read and agree to our Terms and Conditions