Rethinking Aronson

Abstract:     
Shareholders who wish to sue derivatively for breach of directors' fiduciary duties face significant obstacles. Chief among these is the requirement that they demand that the corporation's board pursue the action, unless such demand would be futile. The general test in Delaware for demand futility was set forth almost twenty-five years ago in Aronson v. Lewis. The second prong of that test asks whether the board decision underlying the complaint was the subject of a "valid business judgment." When Aronson was decided, this question served as a satisfactory proxy for the principle motivating the demand futility exception - the need to restrain board authority where the board is expected to be unable to make an impartial decision. If the original decision was not the product of a valid business judgment, directors would likely face personal liability from the derivative suit.

With the almost universal adoption of exculpatory charter provisions, however, a space has opened between the spirit of Aronson and its test. Under the second prong, claims based on directors' due care breaches will not require demand despite the fact that directors have no reason to fear personal liability. Judging demand to be futile in such cases improperly undercuts board authority over corporate litigation decisions. In addition, when combined with the different test for demand futility applied in cases of board non-action, Aronson's second prong provides directors with incentives to delegate more decisionmaking authority to committees and management than they might have otherwise. Accordingly, the longstanding Aronson test should be revised.

Keywords: demand, demand futility, derivative litigation, Aronson, Rales, exculpation clause

JEL Classifications: g30, k22

Accepted Paper Series