It is well-established that a shareholder-plaintiff may not assert derivative claims against a corporation’s officers or directors unless he or she makes a pre-suit demand on the corporation’s board of directors and alleges particularized facts showing that the demand was wrongfully refused, or alleges particularized facts showing that a demand on the board would have been futile. One question that frequently arises is whether the shareholder-plaintiff may obtain discovery from the corporation and its officers and directors in order to assist his or her compliance with this threshold pleading obligation.
Under Delaware law, the answer is no. In a derivative case brought on behalf of a Delaware corporation, the derivative plaintiff is not entitled to discovery at the pleading stage concerning whether a demand was wrongfully refused or would have been futile. In part because of this rule, shareholder-plaintiffs have avoided the jurisdiction, hoping to persuade other state courts to ignore this feature of Delaware law and instead apply local laws more permissive of such discovery. A recent California appellate decision unequivocally held that this tactic will not work for shareholders of Delaware corporations who sue in California state court.
In Jones v. Martinez, 230 Cal. App. 4th 1248 (2014), review denied (Feb. 25, 2015), the California Court of Appeal held that “[d]iscovery is not available to a person seeking to qualify as a plaintiff in a shareholder derivative action involving a Delaware corporation.” In doing so, the court rejected the plaintiff’s argument that, because discovery is typically a matter of procedure, and thus governed by the law of the forum state, California’s policy favoring broad access to discovery should trump Delaware law. The court also held that, irrespective of Delaware law, the “proper purpose of discovery in a shareholder derivative action is to find out additional facts about a well-pleaded claim, not to find out whether such a claim exists.”
The Jones decision is consistent with other recent decisions that tackled the question of whether Delaware’s prohibition against demand-stage discovery applies in derivative proceedings filed outside of Delaware. In Lerner v. Prince 119 A.D.3d 122 (N.Y. App. Div. 2014), for example, the Appellate Division of the New York Supreme Court held that a plaintiff’s right to discovery in a derivative action filed on behalf of a Delaware corporation in a New York state court is governed by Delaware law, because the Delaware law on discovery is an integral part of the legal framework governing derivative proceedings. Accord In re Crown Castle Int’l Corp., 247 S.W.3d 349 (Tex. Ct. App. 2008).
For years, California derivative plaintiffs have ignored Delaware’s demand requirement, filed complaints with conclusory demand-refused or demand futility allegations, and immediately propounded broad discovery, claiming an unfettered right under California procedural law to do so. Jones puts an end to this practice and instead holds putative derivative plaintiffs who sue on behalf of a Delaware corporation to the same standards, regardless of where they bring their lawsuit.