Seventh Circuit Holds That A Demand on the Board of Directors Was Not Required

In a shareholder derivative lawsuit, the plaintiffs are the shareholders of the company. They bring a lawsuit against someone for wrongdoing. Because the proceeds of the case really belong to the corporation, a doctrine of corporate law has developed under which the plaintiffs must first "demand" that the directors of the corporation bring the lawsuit themselves. What happens when the directors themselves are accused of wrongdoing? Can they really be expected to comply with a demand that they sue themselves for money? Thus, under this exception, courts have held that the "demand" requirement is "excused" in certain cases. The Seventh Circuit has recently decided one such case.

See Westmoreland County Employee Retirement System v. Parkinson, Jr. et. al. No.12- 3342  (August 16, 2013).

According to the opinion, Baxter International had severe problems with a medical device called Colleague Infusion Pump (Pump). The Pumps were used to deliver intravenous fluids to patients. The Pumps had a range of difficulties over a period of years. At first Baxter worked diligently to fix the problems but then its efforts allegedly tapered off.  The FDA sent a series of warning letters to Baxter.

The plaintiff shareholders filed their lawsuit several years after the problems became known. By that time, about 200,000 Pumps were in use throughout the country. Plaintiffs sued 13 directors of Baxter and several corporate officers.  Plaintiffs made no demand before filing the lawsuit that the directors take action. According to the District Court the plaintiffs failed to show that demand was not necessary.  The district court dismissed the lawsuit.

The Seventh Circuit reversed and reinstated the case.



The defendants were directors and a few interested officers. The complaint alleged that the  defendants breached their fiduciary duties by consciously disregarding their duties to bring Baxter in compliance with a consent decree and applicable law.
 According to the court demand is necessary unless there is reasonable doubt that the directors are disinterested or the action was otherwise the product of a valid exercise of business judgment.

According to the Court if a director breaches his duty of loyalty he can not rely on the business judgment rule. The 7th circuit said that the Defendants gave up in trying to fix the pumps and threw in the towel. Baxter began to focus on the development of a new pump  and to a great extent did not continue to fix the problems with the old pump despite warnings of the FDA.

According to the 7th Circuit, the defendant directors actions fell outside the protection of the business judgment rule. The Court said ”the directors knew of the problem, having been warned but took no steps to remedy the situation.” The Court went on to say that there was a reasonable probability of a finding of bad faith by the directors.

The judgment of the district court was reversed.

Cases holding that the demand requirement was excused are rare, but significant.

Edward X. Clinton, Sr.