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Delaware Law Applies to California Shareholder Derivative Suit, According to Court

1999_DE_Proof.pngA California appellate court applied Delaware law in its ruling against a shareholder’s derivative action. Jones v. Martinez, 230 Cal. App. 4th 1248 (2014). The corporation is headquartered in California but incorporated in Delaware. The court held that the plaintiff had failed to establish standing to bring a shareholder derivative suit by meeting specific pleading requirements under Delaware law. Neither party disputed that Delaware law applied to the claim. The question for the court was whether the pleading requirement was a substantive matter, which would make it a fundamental part of the plaintiff’s case, or merely a procedural one. The court held that it was substantive, and therefore it affirmed the dismissal of the lawsuit.

The plaintiff owned 1,900 shares of common stock in Deckers Outdoor Corporation, a publicly traded Delaware corporation with its headquarters in Goleta, California. He filed a derivative shareholder action in California state court in July 2012 against the corporation’s officers and board of directors, alleging that the defendants had made “false and misleading public statements to investors.” Id. at 1251. The lawsuit’s claims included breach of fiduciary duty, breach of the duty of honest services, insider trading, and unjust enrichment.

In August 2012, the plaintiff served the corporation with requests for production of documents, a common type of discovery used during litigation to obtain evidence from an opposing party. The corporation served written objections to the requests, noting that the plaintiff had not made a demand to the board of directors with “specific assertions of mismanagement or malfeasance,” nor had he pleaded facts to indicate that such a demand would be “futile.” Id. Rule 23.1(a) of Delaware’s Court of Chancery Rules prohibits a lawsuit from moving forward to the discovery phase without such a demand on a corporation’s board of directors.

The trial court consolidated the plaintiff’s case with another similar lawsuit. After the defendants demurred to the consolidated complaint, the court ruled that the plaintiff could not serve discovery requests until his “right to sue derivatively had been established.” Id. at 1252. The plaintiff appealed, arguing that the trial court erred “by applying the law of Delaware to a purely procedural matter concerning the timing of discovery,” id. at 1253 (emphasis in original), and that the trial court should have applied “California’s policy favoring broad access to discovery.” Id.

The Court of Appeals rejected the plaintiff’s argument that the issue was a procedural question of “the timing of discovery.” The demand requirement under Delaware’s Rule 23.1(a), it held, has long been established as a substantive matter, “not a procedural issue that may vary from jurisdiction to jurisdiction.” Id. at 1253-54, citing Kamen v. Kemper Fin. Svcs., 500 U.S. 90, 96-97 (1991). Since it was a substantive issue, Delaware law applied, making California’s discovery policy irrelevant. Even if California law did apply, the court noted, its demand requirement is nearly the same as that of Rule 23.1(a). Jones, 230 Cal.App.4th at 1254, citing Cal. Corp. Code ยง 800(b)(2).

If you or your business is involved in a dispute, you should seek the assistance of a diligent business litigation attorney to protect your interests. James G. Schwartz has represented businesses in the San Francisco Bay Area since 1976. To schedule a free and confidential consultation, contact us today online or at (925) 463-1073.

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Photo credit: By United States Mint [Public domain], via Wikimedia Commons.