In a shareholder derivative action, the plaintiff-shareholder is not permitted to pursue claims on behalf of the corporation without first making a demand on the company’s board of directors or pleading with particularity that such a demand should be excused as futile. In re NYFIX, Inc. Derivative Action, No. 3:06cv01320(AWT), 2008 WL 2890889 (D. Conn. July 25, 2008) (citing Rales v. Blasband, 634 A.2d 927, 932 (Del. 1993)). In a recent case, a district court was required to assess under Delaware law what effect the filing of subsequent amended complaints should have on this requirement. In NYFIX, the court concluded that the plaintiffs were required to look to the board as it was constituted at the time of the filing of their second amended complaint. NYFIX, 2008 WL 2890889, at *3. In other words, the plaintiffs could not survive the motion to dismiss by merely pleading that demand would have been futile as to the board that existed at the time the lawsuit was originally filed or at the time of the alleged conduct at issue.
By the time the issue of demand futility was before the court in NYFIX, the complaint at issue had been amended several times. Plaintiffs, for example, could not stand on their first amended complaint, which had asserted claims based on alleged backdating of stock options from 1997 through 2003. See id. at *1. The defendants moved to dismiss that complaint based on, among other defects, the plaintiffs’ failure to submit a verified complaint and to specify that they owned company stock at any point during the challenged time period. See id. In a derivative action, the complaint must be verified and must allege that the plaintiff was a shareholder at the time of the complained-of transaction. See id. at *2. The court, however, allowed plaintiffs the opportunity to replead. Plaintiffs’ second amended complaint included additional allegations associated with supposedly false and misleading public statements made in 2005 and represented that the plaintiffs purchased the company’s stock in 2005 and continuously held these shares from the date of purchase. See id. at *1.
Because of significant turnover on the company’s board, the court ordered the parties to brief the issue of whether the filing of the second amended complaint placed a new obligation on plaintiffs to make demand on the board. See id. The Court concluded that the filing of the complaint did establish such an obligation because, as discussed above, plaintiffs’ original complaint would not have survived the motion to dismiss. See id. at *1-*2. The court next determined the proper board of directors for purposes of assessing whether a demand would have been futile. Quoting the Delaware Supreme Court, the district court stated:
when an amended derivative complaint is filed, the existence of a new independent board of directors is relevant to a . . . demand inquiry only as to the derivative claims in the amended complaint that are not already validly in litigation. [T]he term “validly in litigation” means a proceeding that can or has survived a motion to dismiss.
Id. (quoting Braddock v. Zimmerman, 906 A.2d 776, 779, 786 (Del. 2006) (internal citations omitted)). Under the Braddock test, a plaintiff is excused from making a demand when a complaint is amended after a new board is in place if: (1) “the original complaint was well pleaded as a derivative action;” (2) “the original complaint satisfied the legal test for demand excusal;” and (3) “the act or transaction complained of in the amendment is essentially the same as that challenged in the original complaint.” See NYFIX, 2008 WL 2890889, at *2 (quoting Braddock, 906 A.2d at 786).
Applying Braddock, the court determined that plaintiffs’ claims in the first amended complaint were not “validly in litigation” because that complaint was not “‘well pleaded as a derivative action.’” See id. at *2. Also, the second amended complaint revealed that plaintiffs did not become shareholders until after the backdating conduct alleged in the first amended complaint had occurred. See id. Accordingly, dismissal of the first amended complaint would have been required under any circumstances and, thus, the claims in that complaint were not validly in litigation. See id.
Because no claims were validly in litigation when the second amended complaint was filed, the proper board for assessing the demand was the board in place at the time the second amended complaint was filed. See id. at *3. As noted above, by that time, most of the directors who had been on the board when the allegedly false or misleading public statements were issued had left the board. See id. at *5. Not surprisingly, the court concluded that plaintiffs’ arguments as to the supposed futility of making a demand on this new board were unpersuasive. See id. at *4.
For example, the court rejected one of the traditional arguments made in support of demand futility – namely, that the board could not have entertained a demand because they faced a substantial threat of personal liability. See id. at *5-*6. As noted above, most board members were not on the board at the time of the allegedly false public statements and, for that reason, were not named as defendants in the case. See id. at *5. Most directors were similarly not on the board when the alleged backdating occurred and, regardless of that fact, no derivative claims were possible as to the alleged backdating due to plaintiffs’ lack of standing to pursue such claims. See id. at *5-*6. Accordingly, these individuals faced no threat of personal liability regarding the claims in the second amended complaint (or on the backdating issues) and, therefore, were more than capable of considering a demand. See id.
For all these reasons, the court granted the defendants’ motion to dismiss for failure to make a demand or to plead that the required demand was excused. See id. at *7.