Mayer v. Adams
1958 Del. LEXIS 91, 141 A.2d 458, 37 Del. Ch. 298 (1958)
Rule of Law:
A shareholder bringing a derivative suit alleging wrongs that a majority of stockholders cannot legally ratify, such as fraud, is not required under Delaware Court of Chancery Rule 23(b) to first demand that the body of stockholders take action to redress the wrong.
Facts:
- A stockholder of Phillips Petroleum Company initiated a lawsuit on behalf of the corporation against its directors and Ada Oil Company.
- The suit alleged that Phillips' directors committed fraud and other wrongs against the company through various business dealings with Ada Oil Company.
- Kenneth S. Adams, Jr., the son of Phillips' Chairman of the Board, was the President and majority stockholder of Ada Oil Company.
- The stockholder claimed these dealings were a conspiracy designed to improperly enrich Ada Oil Company and Kenneth S. Adams, Jr. at the expense of Phillips Petroleum.
- The stockholder made no demand on Phillips' more than 100,000 stockholders to take action before filing the suit, arguing it would be futile and unreasonably burdensome.
Procedural Posture:
- A stockholder filed a shareholder derivative suit in the Delaware Court of Chancery against the directors of Phillips Petroleum Company.
- The complaint alleged reasons for not making a pre-suit demand on the board of directors (futility) and on the stockholders.
- The defendants filed a motion to dismiss the complaint for failure to make a demand on the stockholders as required by Court of Chancery Rule 23(b).
- The Vice Chancellor of the Court of Chancery granted the defendants' motion and dismissed the complaint.
- The plaintiff (appellant) appealed the dismissal to the Supreme Court of Delaware.
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Issue:
Does Delaware Court of Chancery Rule 23(b) require a plaintiff in a shareholder derivative suit to make a pre-suit demand on the corporation's stockholders when the suit alleges fraudulent acts by the directors, which are incapable of being ratified by a majority of stockholders?
Opinions:
Majority - Southerland, Chief Justice
No. Delaware Court of Chancery Rule 23(b) does not require a pre-suit demand on stockholders when the derivative suit alleges fraudulent acts by directors. The court reasoned that such a demand is a futile and unnecessary act because a majority of stockholders cannot legally ratify fraudulent conduct. If stockholders were to disapprove the suit, their action would be legally irrelevant since they cannot sanction fraud, and the suit would proceed anyway. Conversely, stockholder approval adds little to the plaintiff's existing right to sue on the corporation's behalf. To require a demand would effectively allow a majority to prevent a suit for fraud, which is contrary to the substantive law of Delaware that holds fiduciaries strictly accountable. Therefore, the phrase 'if necessary' in the rule exempts cases involving non-ratifiable wrongs from the shareholder demand requirement.
Analysis:
This decision carves out a significant exception to the procedural requirement of shareholder demand in derivative litigation, solidifying a key principle of Delaware corporate law. By linking the necessity of demand to the substantive question of whether the alleged acts are ratifiable, the court protects the minority shareholder's ability to police director misconduct. The ruling prevents the shareholder demand rule from becoming a barrier to legitimate suits challenging fraud or other non-ratifiable breaches of fiduciary duty. This strengthens the judiciary's oversight role and ensures that procedural rules do not inadvertently shield directors from accountability for their most serious wrongdoings.
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