Commercial Division Blog

Posted: February 1, 2014 / Categories Commercial, Derivative Actions, Corporations, Motion to Dismiss; Motion for Judgment on the Pleadings

Derivative Action Dismissed for Failure Adequately to Plead Demand Futility

On January 21, 2014, Justice Kapnick of the New York County Commercial Division issued a decision in Kebis v. Azzurro Capital Inc., 2014 NY Slip Op. 30171(U), dismissing a derivative action for failure adequately to plead demand futility.

In Kebis, the plaintiff brought a derivative action against a corporation's board of directors alleging "breaches of fiduciary duties and unjust enrichment" in connection with the sale of a division of the corporation. The court granted the defendants' motion to dismiss for failing to plead demand futility with particularity as required by Delaware law. The court explained:

The decision whether to initiate or pursue a lawsuit on behalf of the corporation is generally within the power and responsibility of the board of directors. Since a derivative action impinges on the managerial freedom of directors, a shareholder must first make a pre-suit demand on the Board of Directors to take remedial action so that the directors have the opportunity to examine the alleged claim and determine whether pursuing the claim is in the best interests of the corporation. The demand requirement of Rule 23.1 is a form of alternate dispute resolution that is designed to give the corporation the opportunity to rectify shareholder complaints without litigation, and to control any litigation which does arise.

[D]emand upon a Board of Directors is excused where a plaintiff pleads particularized facts (as required by Rule 23.1) which raise a reasonable doubt that: (1) the directors are disinterested and independent or (2) the challenged transaction was otherwise the product of a valid exercise of business judgment. . . . .

In explaining Aronson's second prong, the Delaware Supreme Court has stated that a plaintiff bears a heavy burden of showing that the well-pleaded allegations in the complaint create a reasonable doubt that the board's decisions were the product of a valid exercise of business judgment. Plaintiffs may rebut the presumption that the board's decision is entitled to deference by raising a reason to doubt whether the board's action was taken on an informed basis or whether the directors honestly and in good faith believed that the action was in the best interests of the corporation. Thus, plaintiffs must plead particularized facts sufficient to raise (1) a reason to doubt that the action was taken honestly and in good faith or (2) a reason to doubt that the board was adequately informed in making the decision. . . . [W]hether a transaction falls beyond the bounds of the business judgment rule for Aronson purposes turns on whether a complaint pleads facts sufficient to allow a court to infer that a Board of Directors knew that material decisions were being made without adequate deliberation in a manner that suggests that the Board of Directors did not care shareholders would suffer a loss. . . . [T]his [i]s a scienter-based test, and . . . a complaint must allege not only that the directors were incorrect in their assessment at the time of a decision relating to an insider transaction, but that they either intended to harm shareholders, or at least were absolutely careless in the matter.

(internal quotations and citations omitted) (emphasis added). The court went on to find that the plaintiff had not met the high burden it faced in pleading demand futility based on a failure to exercise proper business judgment.

This decision illustrates that the requirement to plead demand futility in a derivative action is a real one that cannot be met by boilerplate recitations of futility.