A&O Shearman | M&A and Corporate Governance Litigation Blog | Delaware Court of Chancery Invokes Equitable Exception to Rule That Demand Futility Is Assessed as of the Time Complaint Is Filed<br >  
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  • Delaware Court of Chancery Invokes Equitable Exception to Rule That Demand Futility Is Assessed as of the Time Complaint Is Filed

    Under well-established Delaware law, a plaintiff seeking to pursue a shareholder derivative suit on behalf of the corporation must first either (a) make a demand on the company’s board of directors and have such demand wrongfully refused or (b) establish that such a demand would be futile.  Shareholder plaintiffs that opt for the latter approach often claim that the majority of directors who would have been tasked with deciding whether the company should act upon their demands were (or are) unable to reliably exercise their business judgment on the company’s behalf, particularly in cases where the lawsuits would target those same board members. 

    Delaware courts have traditionally analyzed demand futility based on the board as of the time the complaint is filed.  Any changes in the composition of a board of directors following the filing of the complaint are typically considered irrelevant as to whether the shareholder’s demand would have been futile.   However, in Park Employees’ and Retirement Bd. Employees’ Annuity and Benefit Fund of Chicago v. Smith, C.A. No. 11000-VCG (Del. Ch. May 31, 2016), Vice Chancellor Glasscock of the Delaware Court of Chancery held that plaintiff was required to establish demand futility based not on the directors in place as of the date the complaint was filed but based instead on the board’s composition four days later. 

    The shareholder plaintiff in Smith sought to sue, among others, certain directors and officers of nominal defendant BioScrip Inc., on the company’s behalf.  Plaintiff alleged that defendants concealed damaging information about BioScrip while simultaneously selling their BioScrip shares before disclosing the company’s problems.
    Plaintiff filed the complaint on May 7, 2015, and alleged that a demand on the then-current board to pursue the claims against the directors and officers would have been futile because the majority of the board members faced a substantial threat of personal liability. But the composition of BioScrip’s board changed just four days later, on May 11, such that plaintiff’s allegations would not have established that a demand on the new board would have been futile. 

    The court held that the May 11 board was the relevant board for purposes of assessing demand futility.  Vice Chancellor Glasscock explained that the rule of assessing demand futility as of the date the complaint is filed is an equitable one for which “exceptions arise where equity dictates.”   In concluding that such an equitable exception was warranted, Vice Chancellor Glasscock noted that:  (a) plaintiff was aware based on public documents that a change to the board of directors was imminent; (b) even if the board received plaintiff’s demand on May 7, it lacked sufficient time to consider the demand before being replaced by the new board; and (c) the complaint was not served until three weeks after it was filed, by which time the board had changed.  Vice Chancellor Glasscock asserted that he was “not disturb[ing] the general rule—that demand should be assessed as of the date a complaint is filed”—but had simply found that a departure from that rule based on the “unique facts” before him was the “equitable” result. 
    Category: Injunctions