Shareholder’s derivative suit against board of directors dismissed

A shareholder’s derivative complaint was dismissed where the futility of a pre-suit demand on the board of directors was not stated with clarity.

A shareholder may file a "derivative" suit to enforce the rights of a corporation, but the shareholder is ordinarily required to first make a demand to the board of directors to pursue the matter. An exception to this rule is provided where the shareholder's demand to the board would be "futile" (that is, useless). A federal procedural rule requires the plaintiff filing a derivative suit to provide a detailed statement of the specific reasons for not making the pre-suit demand. In the case of Kococinski v. Collins, the federal district court in Minnesota dismissed a shareholder's derivative action under this rule, finding that the pleadings failed to state "with particularity" the shareholder's reasons for not making a demand on the board of directors before filing the derivative suit.

Background and procedural history

The case involved a Minnesota corporation engaged in the manufacture of medical devices. In 2012, the shareholder, a citizen of Pennsylvania, filed a derivative action against 11 of the 12 current members of the corporation's board of directors, three former board members, one current corporate executive who was not a member of the board and two other individuals who formerly served as CEOs and chairmen of the board.

The suit alleged that the defendants had breached fiduciary duties and violated federal securities laws by failing to prevent and misleadingly concealing the corporation's illegal marketing and sales practices for one of its drugs.

The decision by the district court

The district court noted that the demand requirement may be excused where it is readily apparent from the circumstances that the demand would be futile. The demand futility issue was governed by Minnesota law, as the corporation involved in the case was incorporated in Minnesota. The purpose for requiring that the shareholder make a demand upon the board of directors prior to filing suit is to give the board an opportunity to consider the merits of the claim and to decide whether it would serve the interests of the corporation and the shareholders to resolve the claim without the expense and delay of litigation. The board was familiar with the company's product and business history, making it better suited to weigh and balance the commercial, promotional, legal, ethical, public relations, fiscal and other factors involved in resolving the claim.

A clause in the corporation's articles of incorporation provided that the corporation's directors could not be held liable for a breach of fiduciary duty unless they breached a duty of loyalty, acted in bad faith, engaged in intentional misconduct or knowingly violated the law. The directors were exempted from liability for claims involving a mere breach of a duty of care, such as negligence or even gross negligence .

Also, only one of the current board members was actually employed by the corporation. The other 10 director defendants were independent "outside directors." They had no material relationship to the corporation, other than their service as members of the board, as was required under the rules of the New York Stock Exchange. There was no direct evidence that any of the outside directors had actual knowledge that statements were false or misleading when made, nor that the outside directors were involved in any matters other than routine business decisions made in the interest of the corporation.

Contact an attorney

Entities involved in the formation or dissolution of a business enterprise, or facing business litigation matters, should consult qualified legal counsel, experienced in such matters, to ensure that the legal rights of the business are fully protected.

Keywords: derivative action, shareholder suit, corporate, Minnesota, board of directors