Demand Futility: Everything You Need to Know
Demand futility is a specific type of civil lawsuit in which a company's board decisions and/or decision-making skills, in general, are challenged.3 min read
Demand futility is a specific type of civil lawsuit in which a company's board decisions and/or decision-making skills, in general, are challenged. Essentially, the lawsuit will allege an individual decision was either made or not made based on bias, obstruction, or other unfair means. The issue is complex, and most of the United States' statutes hinge on Delaware's Standards, which have been set and revised over time through legal decisions.
Delaware Standards for Demand Futility
If a plaintiff alleges demand futility is at play, the court must first consider whether one specific decision is being challenged, or all decisions in general. The scope of the two options varies widely, but in both cases the composition of the board itself is important. If a specific decision is at question, the plaintiff must show invalid business judgment used by the board. This is known as the Aronson test.
If no specific decision is challenged, the plaintiff must show that the majority of the board is not impartial or is acting unfairly in some way. This is known as the Rales Test for demand futility cases. The tests are related and often applied in a 'two-pronged' fashion by civil court judges, as cases are not always clear from a judge's perspective whether the entire board demand or just a specific demand is in legal dispute.
Judicial Decisions for Demand Futility
The Demand Futility standards originate from a collection of business decisions in business law throughout the years. Legal experts argue whether the main tests, Aronson and Rales, are fundamentally similar enough to combine, and new cases reach the courts regularly that advance the standards. Jurisdictions are also free to interpret the standards differently.
One aspect of demand futility cases nearly universally agreed upon is that court decisions are tested for demand from the date the complaint is filed. Unless the filing is amended or dropped and refiled, future composition or decisions of the board are not in question in demand futility. A plaintiff may validly amend the date of the filing, however, to include past and current compositions of the board. Often the court hears evidence for each test individually and if the case is currently in litigation the judge may amend previous decisions based on new evidence added by an amended date.
The Aronson Test for Demand Futility Cases
The Aronson test is the first basic test the court will need for a plaintiff's case to be demonstrated sufficiently. If the board members challenged are the same as those who made the decision, then only the decision in question need be addressed by the court, and the Aronson test is valid. The test hinges upon these questions:
- Were the board members impartial and indifferent when the decision was made, or were they unduly influenced by outside factors into making a decision that was detrimental to the company?
- Was the rationale for the decision based on sound business judgment, or was incomplete or otherwise flawed reasoning employed?
The Rales Test for Demand Futility Cases
Per the Rales test, the plaintiff enacting the test must show specific evidence of a pattern of past board decisions detrimental to the company. Often specific cases will be planned or are running concurrently in derivative suit, which can use the results of the Rales test as well.
The focus of the Rales test is impartiality, an important point in demand futility cases. Foremost, the Rales test determines if the board has jurisdiction over past or future decisions in question:
- Is the current board comprised of members who have since been replaced from the time of the specific decision in question?
- Are more than half the members of the board implicated in the demand futility case?
- Does the board actually have the authority to make such a business decision?
- Is/was the decision being made by the board of a different company?
The last question might seem obvious, but with mergers, buyouts, and acquisitions, the board of the company making the decision might be entirely the same but belonging to a different company at current time.
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