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  4.  | HASTE MAKES WASTE–CORPORATE DIRECTORS’ FIDUCIARY DUTIES—FAILURE TO MAKE DEMAND ON BOARD BEFORE FILING DERIVATIVE ACTION

HASTE MAKES WASTE–CORPORATE DIRECTORS’ FIDUCIARY DUTIES—FAILURE TO MAKE DEMAND ON BOARD BEFORE FILING DERIVATIVE ACTION

On Behalf of | May 19, 2022 | Firm News |

Tola v. Bryant, 76 Cal.App.5th 746 (March 24, 2022 Ca. Ct. App., First District, Division Five)

Certain species of legal birds (either vultures—if one favors corporate defense; or eagles, if one favors stockholders) seem to circle the air above public corporations, waiting for the stock price to drop following the announcement of bad news. When this happens, they quickly flock to the local courthouse to file claims against directors for breach of fiduciary duty and other wrongs. In their rush to be first to file, they often omit a demand to the board of directors to pursue the claim against the directors on behalf of the corporation. This may doom the lawsuit.

In a case involving both computer microprocessors and the process that a plaintiff must follow to assert a derivative action against a corporate director for breach of fiduciary duty, the California Court of Appeal recently upheld the dismissal of a lawsuit because the plaintiff shareholder (Mr. Tola) failed to make a prior demand that the Intel corporate board pursue the claim on behalf of the corporation. (Tola v. Bryant (2022) 76 Cal.App.5th 746) The court ruled that Mr. Tola failed to establish that making the demand would have been futile. His legal claim was therefore as defective as the allegedly flawed microprocessors at the heart of the lawsuit.

Mr. Tola asserted that directors of Intel Corporation breached their fiduciary duties of care and loyalty (among other things) by failing to monitor and oversee security vulnerabilities in Intel’s microprocessors, which allegedly contained hackable flaws named “Spectre” and “Meltdown”. He sued Intel directors, including Andy Bryant (Intel’s Chairman), Reed Hunt (former chairman of Federal Communications Commission), Charlene Barshefsky (former U.S. Trade Representative), and Tsu-Jae King Liu (an electrical engineer and professor at UC Berkeley).

The issue was whether Mr. Tola had skipped an essential step before filing the lawsuit. A derivative lawsuit occurs when a shareholder sues on behalf of a corporation alleging the corporation’s failure to assert a claim belonging to the corporation (in this case, its directors’ alleged breaches of fiduciary duty). Before a derivative action may be filed, under Delaware and California law, the shareholder-plaintiff must affirm that a demand was made on the board of directors to pursue the claim, and that the board declined to pursue it. This step can be skipped if it would have been “futile.” Mr. Tola argued that his lawsuit fell within the futility exception.

The court applied a three-part test: (1) whether the director(s) received a material personal benefit from the challenged transaction; (2) whether the director(s) faced a substantial likelihood of liability on any of the claims; or (3) whether the director(s) were sufficiently independent from persons who would fall under the first 2 criteria. (Tola v. Bryant, 76 Cal. App. 5th 746, 752.) Facts establishing these criteria must be pleaded with particularity. After reviewing the pleadings, the court of appeal held that Mr. Tola had not pleaded, and could not reasonably plead, qualifying facts with particularity. The court found it especially significant that the board had employed an outside auditor; had set up an audit committee; the audit committee was tasked with investigating major financial risk exposures; and management had reported the risks at issue. (Tola v. Bryant, 76 Cal. App. 5th 746, 753-54.) Mr. Tola argued that the disclosure was too little, too late; but the court found that “there is a vast difference between an inadequate or flawed effort to carry out fiduciary duties and a conscious disregard for those duties.” (Tola v. Bryant, 76 Cal. App. 5th 746, 755.) Under these circumstances, the court found that the futility exception to the demand-before-filing rule in derivative actions was not satisfied.

In the race to the courthouse, haste made waste, and the lawsuit had to be dismissed.