Respond to a demand. Although a formal response to a demand is generally not required, a board should respond to all pre-suit demands absent a compelling reason to the contrary. Doing so demonstrates that the corporation has taken the demand seriously and that the board is exercising its appropriate authority. Seidl v. Am. Century Companies, Inc., No. 2012 WL 7986873, at *5–7 (W.D. Mo. Oct. 31, 2012). The response to the demand may simply be a refusal to pursue further investigation of the alleged misconduct or refusal to pursue the anticipated litigation.
Assume control of litigation. If the board determines that the litigation has merit and is in the corporation’s best interest to pursue, it may seek to assume control of the litigation, effectively taking over the claim from the plaintiff. One of the primary purposes of the demand requirement is to give the corporation the opportunity to take over the suit. Elfenbein v. Gulf & W. Indus., Inc., 590 F.2d 445, 450 (2d Cir. 1978). This allows the Board to maintain its control over the affairs of the corporation, and it takes advantage of the corporation’s position to pursue this and other remedies, handle the expense of litigation, and terminate baseless litigation. Lewis v. Graves, 701 F.2d 245, 247, 248 (2d Cir. 1983). To take this action, a corporation generally must file a motion seeking to assume control of the litigation and/or to consolidate a corporation’s suit with the pending derivative suit. If the derivative plaintiff opposes this action, the corporation must demonstrate that there was no collusion between the corporation and any defendants and that the corporation would prosecute the case in good faith. In re Penn Cent. Sec. Litig., 335 F. Supp. 1026, 1040 (E.D. Pa. 1971).
Seek a stay of litigation. If a corporation is unsure of the merits of a derivative claim and/or how it intends to respond, it may seek time to make an appropriate assessment by requesting a stay of the litigation. Under MBCA § 7.43, a court may stay a derivative suit pending the corporation’s investigation of the plaintiff’s allegations. The MBCA does not set forth the criteria that a court should consider when determining whether to issue a stay or how long the stay should remain in effect; however, courts have noted that the determination requires balancing the “interest of the plaintiff, the interests of the defendant, all with an eye to the efficient and fair administration of justice.” Carleton, Inc. v. TLC Beatrice Int’l Holdings, Inc., 1996 WL 33167168, at *8–9 (Del. Ch. June 6, 1996).
Delaware courts have a strong policy in favor of staying litigation pending investigation of the claim. See Biondi v. Scrushy, 820 A.2d 1148, 1163 (Del. Ch. Ct. 2003) (“[T]he general rule under Delaware law is that a stay must be granted when a special litigation committee is formed”). Many other courts have followed Delaware’s lead in this regard. See, e.g., Moradi v. Adelson, 2012 WL 3687576 (D. Nev. Aug. 27, 2012) (staying action until the special litigation committee concluded its investigation); In re: UnitedHealth Grp. Inc. Shareholder Derivative Litig., 2007 WL 803048 (D. Minn. Mar. 14, 2007) (staying litigation pending decision of the special litigation committee). But see Crown Crafts, Inc. v. Aldrich, 148 F.R.D. 547 (E.D.N.C. 1993) (declining to issue stay and finding stay of litigation more appropriate for large corporations). Ultimately, a stay will not help a corporation defend against a derivative claim, but it will permit a corporation time to investigate and analyze the claim and to prepare an appropriate response.
Seek dismissal of derivative claim. If a corporation determines that the derivative suit lacks merit, or is otherwise not in the best interests of the corporation, it can move to dismiss the action. Under MBCA § 7.44, a court must dismiss a derivative suit if the corporation has conducted a reasonable inquiry in good faith and determined that the derivative suit is not in the best interests of the corporation. Lest this appear to be a golden ticket out of court, the corporation must adhere to certain procedures and standards with respect to the investigation to gain the benefit of the provision, as discussed above.
In addition to satisfying the “reasonableness” criteria, the Board must also demonstrate that dismissal is in the best interest of the corporation. This ultimate determination requires “a balance of many factors ethical, commercial, promotional, public relations, employee relations, fiscal as well as legal.” Zapata Corp. v. Maldonado, 430 A.2d 779, 788 (Del. Sup. Ct. 1981); see also Auberbach, 47 N.Y. 2d at 633 (noting that the decision falls squarely within the business judgment rule, involving the weighing of numerous factors “familiar to the resolution of many if not most corporate problems”). While one consideration may be quashing “meritless or harmful litigation,” Curtis v. Nevens, 31 P.3d 146, 151 (Colo. Sup. Ct. 2001), courts have noted that maintaining even meritorious lawsuits may not be in the best interest of the corporation. Cramer v. Gen. Tel. & Elecs. Corp., 582 F.2d 259, 275 (3d Cir. 1978) (noting that even if a suit has some merit, the litigation costs and the adverse effects may outweigh any potential benefit); Maldonado v. Flynn, 485 F. Supp. 274, 285 (S.D.N.Y. 1980).
Once the corporation has determined that maintaining the suit is not in the best interests of the corporation, a plaintiff seeking to maintain a derivative action must allege, with particularity, facts showing that either the directors were not qualified or that any of the other statutory requirements was not satisfied. See, e.g., Sojitz Am. Capital Corp. v. Kaufman, 61 A.3d 566, 573-74 (Conn. App. Ct. 2013)(the statute “imposes a heightened pleading standard…requiring the plaintiffs to allege, with particularity,” facts showing that the statutory criteria were not satisfied) (emphasis in original); Brehm v. Eisner, 746 A.2d 244, 254 (Del. 2000) (“Pleadings in derivative suits…must comply with stringent requirements of factual particularity….”).
Just as states have adopted their own versions of the MBCA, courts have interpreted those statutes slightly differently. There is a dispute among jurisdictions concerning the appropriate deference to afford the corporation’s ultimate decision that the suit is not in the best interests of the corporation. For example, in Auerbach v. Bennett, the New York Court of Appeals declined to review the merits of the corporation’s final decision, instead confining its review to the procedures and methodologies employed. 47 N.Y.2d at 630-31. Likewise, Connecticut courts limit judicial inquiry so as to limit “unnecessary interference” with the corporation’s business judgment. Frank v. LoVetere, 363 F.Supp.2d 327 (D. Conn. 2005).
Delaware courts, on the other hand, have held that even if the statutory criteria are met, the court must use its own business judgment to determine whether the motion to dismiss should be granted. Zapata Corp., 430 A.2d at 790.
Still other courts have taken a middle ground approach, reviewing the merits with a degree of deference. See Alford v. Shaw, 358 S.E.2d 323, 328 (N.C. 1987) (court must make a “fair assessment” of the decision); Houle v. Low, 556 N.E.2d 51, 59 (Mass. 1990) (court must determine whether corporation “reached a reasonable and principled decision”); Lewis on Behalf of Citizens Sav. Bank & Trust Co. v. Boyd, 838 S.W.2d 215, 224 (Tenn. Ct. App. 1992) (court should review “findings and recommendations to determine…whether they are consistent with the corporation’s best interests”). Given the wide ranging views regarding the scope of judicial review, a corporation should be prepared to defend its ultimate conclusion in court.