If you are bringing or defending a derivative action in North Carolina, you may have to look to the law of another state to determine whether a pre-filing demand on the board of directors to pursue the claim is a prerequisite and whether there are any exceptions to the need for a demand. The law depends on the corporation’s state of incorporation. In a case decided by the North Carolina Business Court on Friday, Smith v. Raymond, 2010 NCBC 18, the application of Delaware law resulted in the dismissal of a derivative action against the directors of a Delaware corporation because of the Plaintiff’s failure to establish that the demand should have been excused because a demand would have been futile.
Delaware and North Carolina disagree on the futility exception to the demand requirement. North Carolina does not recognize a futility exception. In a 1998 decision in Greene v. Shoemaker, Judge Tennille observed "it is absolutely clear that the [North Carolina] legislature intended to adopt the universal demand requirement and eliminated the futility exception when it passed the 1995 North Carolina Business Corporation Act." Delaware. with a different point of view, recognizes futility as an excuse to the demand requirement.
So do North Carolina’s lawyers need to know about demand futility when it has been rejected as an exception to demand in North Carolina? Sure, because when a Delaware corporation is the defendant in a derivative action, the application of Delaware law to resolve issues is required by North Carolina statute. The General Statutes provide that "in any derivative proceeding in the right of foreign corporation, the matters . . . shall be governed by the laws of the jurisdiction of incorporation of the foreign corporation." N.C. Gen Stat Sec. 55-7-47 (2009). The failure to make a demand before filing a lawsuit against a Delaware corporation resulted in the dismissal on Friday in Smith v. Raymond.
The defendants in the Smith case were outside directors of Horizon Lines, Inc. Other directors had previously pled guilty to price-fixing charges, and the Complaint in the North Carolina case asserted that the outside directors had "knowingly conspired" in the illegal price-fixing plan and that a demand upon them would therefore have been futile.
Judge Diaz held that the allegations of the Complaint "fell far short of what is required under Delaware law to excuse demand." He described those allegations as "blanket allegations that the directors participated in or approved the alleged misconduct." A 1993 Delaware Supreme Court decision, Rales v. Blasband, 634 A.2d 927 (Del. 1993) requires "particularized factual allegations" as to why a demand would have been futile.
Demand can also be excused under a standard set forth in Aronson v. Lewis, 473 A.2d 805 (Del. 1984), which applies when a particular transaction is being challenged. In such a case, the questions are:
i) whether a reasonable doubt is created that the directors are disinterested and independent; and (ii) whether the pleading creates a reasonable doubt that the challenged transaction was anything other than the product of a valid exercise of business judgment.
The Aronson standard didn’t apply, according to Judge Diaz, because the Complaint did not allege a decision by the Horizon board of directors which would implicate the business judgment rule.