Nevada law endows a board of directors “full control over the affairs of the corporation”. NRS 78.120(1). This control is subject only to such limitations as may be provided by NRS chapter 7, or the articles of incorporation of the corporation. Id. This means the board controls decisions about whether the corporation should bring suit. The ability of stockholders to file derivative suits are therefore fundamentally at odds with the board’s statutory authority. Consequently, NRCP 23.1 requires that in a derivative action a stockholder must “allege with particularity the efforts, if any, made by the plaintiff to obtain the action the plaintiff desires from the directors or comparable authority and, if necessary, from the shareholders or members, and the reasons for the plaintiff’s failure to obtain the action or for not making the effort”. In other words, Nevada, like many other jurisdictions (including California and Delaware) requires that stockholder plead either that demand was made or that demand is excused.
Some boards respond to the filing of a derivative suit by forming a special litigation committee. The SLC will then conduct an investigation into the stockholder’s claims and make a recommendation about whether the litigation should be continued or dismissed. Neither Nevada’s private corporation law nor NRCP 23.1, however, prescribe the standard of review to be applied by a court to an SLC’s recommendation. Courts, therefore, have fashioned two approaches. Under both approaches, the court determines whether the SLC is independent and conducted a good-faith, thorough investigation. New York courts end the enquiry there. Auerbach v. Bennett, 393 N.E. 2d 994 (N.Y. 1979). In Delaware, courts will proceed to determine in their own business judgment whether the SLC’s motion to dismiss should be granted. Zapata v. Maldonado, 430 A.2d 779 (Del. 1981). Until last Thursday, it was not known whether Nevada would follow the New York (Auerbach) one-step or Delaware (Zapata) two-step approach.
In In re Dish Network Derivative Litigation, 133 Nev. Adv. Op. 61 (2017), the Nevada Supreme Court sided with New York even though it has followed Delaware precedent in other cases:
Pursuant to Auerbach, 393 N.E.2d at 996, and consistent with Shoen v. SAC Holding Corp., 122 Nev. 621, 645, 137 P.3d 1171, 1187 (2006), and In re AMERCO Derivative Litig., 127 Nev. 196, 222, 252 P.3d 681, 700 (2011), a shareholder must not be permitted to proceed with derivative litigation after an SLC requests dismissal, unless and until the district court determines at an evidentiary hearing that the SLC lacked independence or failed to conduct a thorough investigation in good faith.
The Court based its election on Nevada’s business judgment rule that precludes courts from substituting their own business judgment for that of the board.
I’ll have more to say about the Nevada Supreme Court’s opinion tomorrow.