California Court Of Appeal Applies Delaware Law To Deny Discovery In Shareholder Derivative Action

In Jones v. Martinez, 230 Cal. App. 4th 1248 (2014), the California Court of Appeal, Second Division, held that a plaintiff asserting a shareholder derivative action against directors of a Delaware corporation in a California state court may not obtain discovery before the plaintiff establishes legal standing to sue derivatively as required under Delaware law. Under Delaware law, a stockholder-plaintiff may not prosecute a derivative suit unless he alleges that he demanded that the directors pursue the claim and the directors have wrongfully refused to do so, or that such demand is excused because it would have been futile. In order for pre-suit demand to be excused as futile, the stockholder-plaintiff must plead particularized facts creating reasonable doubt that the directors were unlikely to act in good faith in considering the demand. Delaware courts hold routinely that a derivative plaintiff is not entitled to discovery unless and until he has met the threshold standard for pleading demand futility. The decision in Jones marks the first time that a California appellate court has applied this rule to a derivative plaintiff suing in California state court under Delaware law.

Plaintiff held fewer than 2,000 shares of stock in Deckers Outdoor Corporation ("Deckers") when he filed a shareholder derivative action on behalf of Deckers to recover damages he claimed Deckers suffered because of alleged misconduct by various Deckers officers and directors, including its CEO. The California Superior Court for Santa Barbara County sustained defendants' demurrer with leave to amend, but plaintiff did not file an amended complaint. The trial court thereafter dismissed the action. Plaintiff appealed, asserting the trial court erred by applying Delaware law, instead of California law, to bar the discovery requests he served upon Deckers shortly after his complaint was filed.

The Court of Appeal agreed that a stockholder seeking to qualify as a plaintiff in a derivative action involving a Delaware corporation may not obtain discovery unless he first complies with the particularized pleading requirement of Delaware Court of Chancery Rule 23.1, outlining the demand requirements in shareholder derivative actions. Thus, plaintiff was not entitled to discovery before first establishing his right to sue derivatively.

In arriving to its ultimate decision, the Jones court addressed an issue that often arises in shareholder derivative actions: whether the demand...