Grimes v. Donald

Supreme Court of Delaware
673 A.2d 1207 (1996)

ELI5:

Rule of Law:

A stockholder who makes a pre-suit demand on the board of directors to redress a grievance waives the right to later claim that demand is excused with respect to other legal theories arising from the same transaction. The board's refusal of such a demand is reviewed under the business judgment rule.

Facts:

DSC Communications Corporation ('DSC') entered into several employment and compensation agreements ('Agreements') with its CEO, James L. Donald.
The Agreements stipulated that Donald 'shall be responsible for the general management of the affairs of the company.'
A key provision allowed Donald to unilaterally declare a 'Constructive Termination Without Cause' if he, in his own good-faith judgment, determined that the Board of Directors had engaged in 'unreasonable interference' with his duties.
Such a constructive termination would trigger substantial severance payments to Donald, including his base salary for the remainder of his term, incentive awards, and lifetime medical benefits.
C.L. Grimes, a DSC stockholder, sent a formal demand letter to the Board, asserting that these provisions constituted an illegal delegation of directorial authority and demanded that the Board abrogate them.
The Board, after retaining and reviewing reports from an outside benefits consultant and outside legal counsel, formally refused Grimes' demand.

Procedural Posture:

C.L. Grimes sued James L. Donald and the Board of Directors of DSC Communications Corp. in the Delaware Court of Chancery (trial court).
The complaint asserted a direct claim for abdication of directorial duty and derivative claims for waste, excessive compensation, and lack of due care.
The defendants filed a motion to dismiss for failure to state a claim upon which relief can be granted.
The Court of Chancery granted the defendants' motion to dismiss all claims.
Grimes, as the appellant, appealed the dismissal to the Supreme Court of Delaware.

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Issue:

Does a stockholder, by making a pre-suit demand on the board of directors regarding certain claims, waive the right to later argue that demand is excused for other legal theories arising from the same underlying transaction?

Opinions:

Majority - Chief Justice Veasey

Yes, a stockholder waives the right to argue demand is excused. By making a pre-suit demand, a stockholder tacitly concedes the independence of the board of directors to consider that demand. Therefore, the stockholder cannot later 'bifurcate' his claims by arguing that demand is excused for other legal theories (such as waste or lack of due care) that arise from the same set of facts as the initial demand. Once demand is made and refused, the stockholder's sole recourse is to challenge the board's refusal as wrongful, a decision that is protected by the presumption of the business judgment rule. The court also held that Grimes' direct claim for abdication failed because the Agreements did not formally prevent the board from exercising its duties; they merely created a financial disincentive to do so, which is a business decision. The potential severance payment was not so onerous as to constitute a de facto abdication of the board's ultimate authority.

Analysis:

This case solidifies the 'one arrow in the quiver' rule for shareholder derivative litigation established in Spiegel v. Buntrock. It forces a potential plaintiff to make a critical strategic choice: either make a demand and concede the board's independence, thereby limiting a future lawsuit to overcoming the business judgment rule's protection of the board's refusal; or, forgo demand and bear the high burden of pleading with particularity that the board is interested or lacks independence, rendering demand futile. This decision prevents stockholders from hedging their bets and reinforces the board's primacy in managing corporate affairs, including the decision to litigate. It also clarifies that employment agreements creating large financial consequences for board actions do not, by themselves, constitute an illegal abdication of directorial duty unless they formally strip the board of its power.

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