In Novel Ruling, Court Says Discovery Rules Don't Trump Delaware Demand Futility Rules

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By Michael Greene

Nov. 5 — Stockholders bringing derivative claims against Delaware corporations cannot circumvent Delaware's demand futility rules by bringing their claims in another state with broader discovery rules, according to an October California Court of Appeals ruling.

According to Paul Hastings LLP, this marks the first time a California appellate court has decided whether plaintiffs filing derivative actions in California against Delaware corporations are entitled to discovery prior to establishing demand futility.

Delaware Law Applies

Here, the plaintiff filed a derivative action against Deckers Outdoor Corp. and shortly thereafter served a discovery request on the company.

Subsequently, a California trial court denied the discovery request because under Delaware law, plaintiffs in derivative lawsuits are not entitled to discovery until they establish a right to bring their cause of action. Accordingly, the trial court granted leave to amend the complaint so the plaintiff could plead particularized facts showing demand futility.

The plaintiff appealed, arguing that California's broader discovery rules should apply because the issue is “purely procedural.”

The California Court of Appeals, however, rejected this argument. The court found that the issue of whether discovery can occur before demand futility is established is a matter of “substance” and not “procedure.”

“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 court opined.

Accordingly, the court held that the plaintiff must comply with the “particularized pleading requirements” of Delaware law without the assistance of discovery.

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The opinion is available at