The Demand Review Committee: How it Works, and How it Could Work Better

Collins J. Seitz, Jr. is a Justice of the Delaware Supreme Court; and S. Michael Sirkin is a Partner at Ross Aronstam & Moritz LLP. This post is based on their recent article, published in The Business Lawyer, and is part of the Delaware law series; links to other posts in the series are available here.

In Delaware, stockholder derivative litigation follows a familiar path. The plaintiff files a complaint, alleging that demand is futile. The defendants move to dismiss under Court of Chancery Rule 23.1, arguing that the plaintiff failed to make a demand on the board of directors to bring the suit on behalf of the corporation. The motion is usually coupled with a motion to dismiss under Court of Chancery Rule 12(b)(6) for failure to state a claim. If the Court of Chancery grants the motion to dismiss on either ground, the matter ends.

What happens, though, if instead of pleading demand futility, the plaintiff actually makes a litigation demand? This path appears to be traveled less frequently, and appears to be less well understood by practitioners and directors. By making a demand on the board, the would-be plaintiff concedes that demand is not futile and that a majority of the board is capable of impartially considering the demand. As a result, an aggrieved stockholder who believes that the corporation is sitting on a valuable claim faces a stark choice between making a demand and attempting to plead demand futility.

In theory, the interests of a stockholder plaintiff and those of a disinterested, independent board majority should merge. Both should be seeking to maximize the same long-term interests of the corporation, with the directors best suited to deploy the corporation’s assets, including its legal claims, to achieve those goals. In the ideal world of stockholder litigation, a stockholder should be confident of a good outcome for the corporation when she entrusts independent directors with a valuable corporate asset by making a demand, even at the cost of conceding demand futility.

But in practice, stockholder derivative litigation is lawyer-driven. And in many cases, from the perspective of a plaintiff’s lawyer seeking control of a lucrative fee opportunity, making a demand is less appealing than taking a shot at pleading demand futility. As the landscape currently exists in Delaware, a stockholder gets two bites at the apple if she litigates futility first, then makes a demand as a fallback. If the same stockholder makes a demand first, however, then the futility door is closed. This is backwards, if the demand requirement is expected to fulfill an out-of-court dispute resolution function.

But what if a plaintiff could, by agreement with the board, make a conditional demand, reserving their right to argue futility if the demand is refused? In weak cases, this option would not likely change the current practice. Board lawyers would likely not agree to permit a conditional demand, and would instead wait for a stockholder to act and respond accordingly, with either a Rule 23.1/12(b)(6) dismissal motion or a demand refusal. But in stronger cases, or cases involving more sophisticated stockholder plaintiffs, the board could permit a stockholder to make a provisional demand and her attorneys could participate in the board’s demand consideration process. The board could make a faithful demand decision, informed by a deep, adversarial process involving a stockholder plaintiff’s counsel. This would allow the demand requirement to once again fulfill its oft-repeated promise of serving as an internal dispute resolution mechanism, and would lead to more informed demand decisions.

In The Demand Review Committee: How it Works, and How it Could Work Better, which was published in the Spring 2018 edition of The Business Lawyer, we examine the law in this area and propose a modest adjustment that would restore some of the functionality of the demand requirement, which has eroded over time. The article also highlights the review process undertaken by a board committee that is formed to consider a demand, as well as the differences between demand review committee practice and special litigation committee practice.

The complete article is available for download here.

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One Comment

  1. eric waxman
    Posted Monday, May 14, 2018 at 6:00 pm | Permalink

    The right answer would seem to be not to allow a second bite at the apple once demand futility has been alleged. That might encourage demand in closer cases. Given the ability the “use the tools available”, the no second bite at the apple does not seem to be an overly harsh rule.