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How the Failure to Establish ‘demand Futility’ Derailed One Group’s Shareholder Derivative Action

Poole Huffman, LLC

While not occurring here in Georgia, a recent federal court ruling dismissing a shareholder derivative action in California is a prime example of the extreme importance of the procedural demands placed on the plaintiffs in a derivative claim. As a shareholder plaintiff, satisfying these procedural steps is essential to getting your case to trial. On the flip side, these requirements can be the keys to a successful dismissal motion if you’re the board of directors. Either way, having an experienced Atlanta derivative action lawyer is crucial to success.

To understand the lawsuit from California, one must know the background. In 2021, the State of California took legal action against a well-known Santa Monica-based video game publishing and development company. According to the state, the company fostered a “frat boy culture” that led to rampant sexual harassment, gender discrimination (in the form of unequal pay and promotions,) and retaliation.

According to some shareholders, the 2021 legal action was the culmination of a state investigation that dated back to 2018. Allegedly, despite its knowledge of the state’s investigation, the company’s board of directors failed to take appropriate corrective steps to stop the company’s discriminatory practices.

On that basis, the shareholders filed a derivative action on behalf of the company, alleging that the board breached its fiduciary duty when it failed to curb discrimination and harassment even in the face of “red flags of illicit activity.” Even armed with a great deal of information about the extensiveness of the alleged harassment, discrimination, and retaliation, the shareholders’ derivative suit failed.

Demand and Demand Futility

One of the essential procedural hurdles in any derivative claim is the demand. Before you can seek relief in court, you first have to demand action from the company’s board or else establish that making such a demand would be futile.

The standard for futility varies by state. In Delaware, which is where a very large number of companies are incorporated (including entities headquartered here in Georgia like The Home Depot and Delta Airlines,) the law says that, for a court to find a demand to be futile, a majority of the board of directors must have been (1) receiving personal benefit from the misconduct, (2) facing “a substantial likelihood of liability” on the claims asserted, and (3) lacking independence.

In the video game entity case, the shareholders did not make a demand and came up short in proving futility. Specifically, the court determined that the shareholders didn’t satisfy the second of the three futility elements. The shareholder provided extensive detail about the alleged illegal conduct going on at the company but, as the judge noted, Delaware will “routinely” turn down a derivative action’s “conclusory allegation that because illegal behavior occurred, internal controls must have been deficient, and the board must have known so.” The law places the onus on the shareholders to allege in detail how the entity’s internal policies were inadequate and that the board knew about that inadequacy but refused to take action.

The video game shareholders didn’t satisfy that requirement, meaning they fell short of meeting the second futility prong, so the court dismissed their lawsuit with prejudice.

Whether you’re a shareholder who believes a board has not fulfilled its fiduciary duty, or you’re a board seeking to fend off a derivative action, the right legal representation matters. The skilled Atlanta derivative lawsuit attorneys at Poole Huffman, LLC can help. Whether it’s sorting through the claims of your action, litigating a motion to dismiss, or trying the case, our team has the experience you need to get results. Contact us online or by calling 404-373-4008 to schedule your confidential consultation today.

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