Summary of a Recent
Judicial Development in
Cooperatives

Failure to Make Demand on Board of Directors or
Show Demand Was Futile Results in Dismissal

Walt McCarter
National AgLaw Center Research Associate

Summary of Decision

In West Hills Farms, Inc. v. RCO Ag Credit, Inc., No. F054539, 2008 WL 5341350 (Cal. Ct. App. Dec. 23, 2008), the California Court of Appeal, Fifth District, held that minority shareholder plaintiffs had not plead sufficiently particular facts to show that a demand had been made on their corporate board of directors or that such a demand would have been futile, and therefore their derivative suit was dismissed.

Background

After minority shareholders in RCO Ag Credit discovered that RCO was paying substantial sums of money in unnecessary fees to Ranchers Cotton Oil, they brought an action against both Ranchers and RCO to recover the unnecessary fees. Id. at *1. Since this was a derivative suit, the plaintiffs had to show either that they had made a demand to RCO's board of directors or that such a demand would have been futile in order to have standing to bring their claim. Id. The trial court found that they had failed to show either, and it dismissed their case. Id. The shareholders appealed. Id.

Arguments

The shareholders argued that their pleading had adequately set forth facts of futility as a basis for excusing the demand requirement under Corporations Code section 800, subdivision (b)(2). Id. at *6.

Analysis and Holdings

The court explained that "[t]he test for proving demand futility is whether the facts show a reasonable doubt that (1) the directors are disinterested and independent, and (2) the challenged transaction was otherwise the product of a valid exercise of business judgment." Id. at *8. Regarding those requirements, the court added that "a director's lack of disinterestedness exists 'whenever divided loyalties are present, or a director either has received, or is entitled to receive, a personal financial benefit from the challenged transaction which is not equally shared by the stockholders,'" and a lack of independence "exists when his decision in regard to a transaction is not based on the corporate merits of the subject matter before the board but on extraneous considerations or influences that sterilize his ability to fairly exercise discretion in the performance of his duties with respect to the transaction." Id. at *9-10. The court found that the shareholders' "broad and conclusory allegations of fraud, conspiracy or other wrongdoing on the part of the board of directors" was insufficient to show demand futility. Id. at *10-13. Regarding the second prong of the test, the court noted that the business judgment rule requires judicial deference be given to the business judgment of corporate directors so long as there is no fraud, breach of trust, or conflict of interest, and it held that the shareholders' complaint failed to allege particular facts sufficient to overcome that deference. Id. at *14. Therefore, the court affirmed the lower court's order dismissing the shareholders' claims. Id.

The case was decided on December 23, 2008.