You probably thought that you would never again have to argue that a demand on a corporation’s board of directors before filing a derivative action should be excused because it would have been futile.
That’s because the North Carolina Legislature amended NC corporate law in 1995 to make clear that a demand on the corporation to take action is an essential prerequisite to the filing of a derivative action. Section §55-7-42 of the General Statutes, as amended twelve years ago, says that a shareholder “may not commence a derivative proceeding” without having made a written demand “upon the corporation to take suitable action.” In other words, there is no excuse for not making a pre-filing demand.
But demand futility was alive and directly before the Business Court last week in Finley v. Brown, 2017 NCBC 78.
It’s easy to forget that there is an entire set of statutes that apply to non-profit corporations (Chapter 55A of the North Carolina General Statutes) than to “business corporations” (Chapter 55 of the North Carolina General Statutes). The lawsuit in Finley involved a non-profit corporation: the Finley Foundation.
Before the Legislature amended the demand requirement in Chapter 55 in 1995, the parallel provision regarding demand applicable to non-profit corporations (N.C. Gen. Stat. §55A-7-40) was virtually identical to its “business corporation” partner. That unamended statute applicable to non-profit corporations says that:
(b) The complaint shall allege with particularity the efforts, if any, made by the plaintiff to obtain the action the plaintiff desires from the directors or comparable authority and the reasons for the plaintiff’s failure to obtain the action or for not making the effort.
The North Carolina appellate courts had made it pretty clear, before the amendment, that a demand on a business corporation before filing a derivative action could be excused if it would have been futile. Op. ¶¶26-27 (citing Norman v. Nash Johnson & Sons’ Farms, Inc., 140 N.C. App. 390, 409, 537 S.E.2d 248, 261 (2000); Roney v. Joyner, 86 N.C. App. 81, 84, 356 S.E.2d 401, 403 (1987); Seaboard Air Line R.R. v. Atl.Coast Line R.R., 240 N.C. 495, 515, 82 S.E.2d 771, 785 (1954)).
So, looking at the “old” law applicable to for-profit corporations, Business Court Judge Bledsoe ruled that the Plaintiff had established that a pre-lawsuit demand would have been futile.
This Plaintiff, a board member of the Finley Foundation did a pretty good job of showing why it would have been futile to make a demand on the four Foundation directors he was suing.
He was attacking them for violating their fiduciary duties, saying that they had “grossly mismanaged the Foundation, and unjustly enriched themselves . . . , by, among other things, failing to prudently manage the assets of the Foundation, incurring unnecessary expenses, paying themselves excessive compensation, and dishonoring Mr. Finley’s intent as the donor of charitable gifts to the Foundation.” Op. ¶12.
Given that the Defendants were direct participants in the conduct that Plaintiff Finley was complaining of, especially in controlling their allegedly “excessive compensation,” Judge Bledsoe agreed that the Plaintiff had pled enough to establish that a demand on them to take action would have been futile.