Self-consciously adopting a new rule from which the majority of other states are recoiling, the Washington Supreme Court this morning released its decision in In re F5 Networks, Inc., a case that sets an important legal standard for corporate litigation in Washington State.
The issue involves the standard by which shareholders may commandeer control of a corporation to sue in its name in what is called a shareholder derivative lawsuit. Such suits are a limited and disfavored exception to the rule that corporate governance is vested in the business judgment of officers and directors. Before taking the reins of a company in a lawsuit, must a shareholder first make demand of the corporation to take action itself, and then only proceed if the corporate leaders refuse the demand? Or could shareholders excuse themselves from the requirement by claimint demand would be "futile"? Far from an esoteric journey through the business law textbook, the question has real consequences for current and potential Washington companies because shareholder derivative suits are very susceptible to a form of lawsuit abuse called the "strike suit."
AWB filed a friend of the court brief in the case and in its introduction, framed the case this way:
For corporate entities, location is a choice. States vigorously compete with one another to attract and retain enterprise in order to stimulate job growth and creation, spur private investment and economic development, and expand revenue flow to state and local governments. One of the bedrock components of a competitive business climate is the legal structure under which firms incorporate. Does the state's statutory and common law of corporations appropriately recognize the paramount role of officers and directors in managing the corporation? Does it contain appropriate limitations on the liability of corporations, including exposure to meritless litigation? Is it enforced by clear and consistent procedural rules and a policy of judicial minimalism with respect to proposed expansions of corporate liability?
This case evokes these questions because it asks the court to clarify that Washington follows the "universal demand" standard by which a shareholder, in order to proceed derivatively in the name of the corporation, must always make a demand to the corporate board of directors, or, in contract, establish that this requirement may be excused by a showing that demand would be futile. If Washington law departs from the clear national trend favoring universal demand and instead recognizes a "demand futility" standard, the court must then explain what substantive standards govern the evaluation of demand futility and whether, in this regard, Washington follows Delaware's flawed approach, particularly as set forth in the [Ryan] decision.
AWB's argument was supported by a letter from UW law professor and Washington corporate law expert Richard Kummert, a member of the state bar association's corporate act revision committee since its inception. Professor Kummert pointed out (a) Washington has never codified a "futility" standard, (b) the "demand" standard is now generally accepted as far superior to the "futility" standard, and (c) Washington courts have never routinely applied Delaware corporate law.
Unfortunately, after recognizing the national trend against which it was deciding, and admitting it was adopting a pro-plaintiff standard, the court answered AWB's questions above with a resounding "No":
We hold that until our legislature says otherwise, Washington follows Delaware's demand futility standard and the reasoning of Ryan.
In light of AWB's argument and Prof. Kummert's commentary, this deference to the Legislature rings a little hollow. Real judicial minimalism would be"until our Legislature acts, we decline to adopt for the first time the disfavored standard of another state."
But perhaps that's where the issue now heads -- to the Legislature. More likely, some will take to the real courts of last resort -- the law reviews -- to debate the right standard. In the meantime, we hope the court's decision is not an invitation to shareholder lawsuit abuse. Our business climate doesn't need that.
