Lead Opinion
Opinion by Judge GOULD; Dissent by Judge IKUTA.
In this shareholder’s derivative action, Plaintiff-Appellant Katherine Potter (“Potter”) alleges that the Defendants-Appel-lees (collectively, “Defendants”), who are managers and directors of Public Storage, Inc. (“PS”), wrongfully managed PS. The district court dismissed the action on the grounds that Potter failed to make an adequate demand on the Board of Directors of PS (“Board”) before filing her suit. We affirm.
PS is a California corporation that is publicly traded on the New York Stock Exchange. Potter and Co-Plaintiff Charles Krieger (“Krieger”) filed a derivative complaint against PS and sixteen individual defendants on December 30, 2004, alleging twelve causes of action including waste of corporate assets, breach of fiduciary duty, fraud, and violation of the Sar-banes-Oxley Act of 2002, 15 U.S.C. §§ 7201-7266. These allegations related to three alleged transactions: (1) PS’s acquisition of an entity known as PSIC (“PSIC transaction”); (2) the use of PS resources to provide services to a Canadian business owned by the Hughes family, who are prominent members of the Board (“Canadian transaction”); and (3) PS’s payment of management and advisory fees to entities owned by other defendants (“M & A transaction”). Upon Defendants’ motion to dismiss, the district court dismissed the complaint with leave to amend, concluding that Krieger and Potter did not satisfy the requirements of Rule 23.1 of the Federal Rules of Civil Procedure and California law.
Potter and Krieger filed an amended complaint on July 12, 2005, alleging the same twelve causes of action but this time relating them to only two transactions, the PSIC transaction and the Canadian transaction. Defendants once again moved to dismiss, and the district court dismissed the second complaint, concluding that Krieger failed the contemporaneous ownership requirement and that Potter failed to make an adequate demand on the Board.
Krieger does not appeal Ms dismissal, so this appeal concerns only the adequacy of Potter’s demand on the Board. However, Krieger plays a major role in the facts leading to Potter’s appeal. Krieger sent a demand letter to the Board on November 21, 2002. This letter complained of the PSIC transaction but did not discuss the Canadian transaction. It also did not mention Potter by name, but noted that “[t]wo individuals ... who reside in Southern California where the lawsuit will be filed will join with me to bring the action.” Potter alleges that she was one of the two unnamed individuals to whom Krieger was referring in the letter.
On January 6, 2003, Krieger and attorney Douglas Connon (“Connon”) met with members of the special committee established by the Board to investigate the allegations in the November 21 letter. At the meeting, Connon told the members of the committee that he was representing Potter and that he had her power of attorney. In a series of later letters, dated March 19, 2003, April 7, 2003, June 23, 2003, and November 1, 2003, Krieger wrote to the Board reiterating the complaints relating to the PSIC transaction that he had raised in the demand letter, and also asked the Board to provide him information concerning the Canadian transaction. When the Board did not take action that Krieger and Potter found satisfactory, they sued.
II
Having doubts about the foundation for federal question jurisdiction under 28 U.S.C. § 1331, the panel by order raised the issue of subject matter jurisdiction sua
Supreme Court precedent is clear that we “may choose among threshold grounds for denying audience to a case on the merits.” Wilbur v. Locke,
However, there are non-constitutional grounds on which we may dismiss a suit before considering the existence of federal subject matter jurisdiction. These include jurisdictional grounds that are discretionary, such as pendent jurisdiction or Younger abstention, see Steel Co.,
In this case, the issue of whether Potter satisfied the demand pleading requirements of Rule 23.1 is “logically antecedent” to the issue of whether we have jurisdiction over this action. Pursuant to Rule 23.1, a putative derivative plaintiff can initiate a derivative action only if he or she makes an adequate demand on the Board under applicable state law. Fed.R.Civ.P. 23.1 (2008); see also Kayes,
We note also that a valid demand is a requirement for statutory standing under California law. Shields v. Singleton,
III
The parties disagree about the applicable standard of review. Potter argues that because her complaint was dismissed, we should review the district court’s dismissal de novo. Defendants argue that district court determinations regarding the demand requirement for derivative actions are reviewed for abuse of discretion.
Defendants are correct. Although dismissals for failure to state a claim are reviewed de novo, the district court’s determination that Potter did not comply with Rule 23.1 or California law regarding the demand and regarding demand futility is reviewed for abuse of discretion. In re Silicon Graphics Inc. Sec. Litig.,
IV
Federal Rule of Civil Procedure 23.1 permits a plaintiff to bring a shareholder derivative suit if two requirements are met. First, the plaintiff must have owned shares in the corporation at the time of the disputed transaction (the “contemporary ownership requirement”). Second, the plaintiff must “allege with particularity the efforts, if any, made by the plaintiff to obtain the action the plaintiff desires from the directors” (the “demand requirement”). However, failure to meet the demand requirement may be excused if the facts show that demand would have been futile. Smith v. Sperling,
A
We first consider whether Potter made a valid demand on the Board for either or both of the transactions raised in the complaint. The parties do not dispute that a valid demand must give the board of directors the opportunity to consider and act upon the proposed litigation by presenting to the board the ultimate facts of each cause of action and the action which plaintiff wishes the board to take to remedy the alleged wrongdoing. Shields,
The gist of the Defendants’ position is that the identity of the plaintiff shareholder is a required element of a valid demand, and for us the dispositive issue is whether Defendants are correct in this respect. Stated another way, the key issue is whether Potter failed to make a demand by remaining anonymous in Krieger’s letters.
In support of their contention, Defendants rely primarily upon a Delaware case, Smachlo v. Birkelo,
Smachlo is directly on point. Although the case applies Delaware law, California law, as we have said, is identical to Delaware law on the demand requirement. See Oakland Raiders,
Potter’s efforts to distinguish Smachlo do not persuade us. It is of no moment that the letter in Smachlo did not identify any potential plaintiffs, while the November 21, 2002 letter identified Krieger, because Krieger’s known presence does not relieve Potter of the obligation to make a valid demand. A plain reading of Rule 23.1 also supports this result. Rule 23.1 requires particularized pleading of the efforts undertaken by the plaintiff. In this case, Potter has alleged only that Krieger undertook efforts to demand action by the Board. Even if Krieger purported also to represent additional unnamed plaintiffs in Southern California, and one of these unnamed plaintiffs was Potter, the complaint simply does not show that Potter herself undertook any efforts to demand action from the Board.
The facts here make the attempt to distinguish Smachlo especially unconvincing, because the district court held that Krieger could not bring a derivative suit because he failed the contemporaneous ownership requirement. Because Krieger was not qualified to make a demand due to his lack of contemporaneous ownership, it would be an odd result if Potter were allowed to remain anonymous in reliance on the demand made by Krieger, who beyond doubt did not satisfy Rule 23.1.
The identity of the shareholder is also an important practical element of a demand. The identity of the complaining shareholder may shed light on the veracity or significance of the facts alleged in the demand letter, and the Board might properly take a different course of action de
This is not merely a technical or unimportant requirement. Rather, the general rule of American law is that the board of directors controls a corporation. Accordingly, strict compliance with Rule 23.1 and the applicable substantive law is necessary before a derivative suit can wrest control of an issue from the board of directors. As a leading treatise observes, “[t]he demand requirement is designed to promote the basic principle of corporate governance that the board of directors, and not individual shareholders, manages the affairs of the corporation.” Id.
Potter argues that her attorney’s attendance at the January 6, 2003 meeting with members of PS’s special committee amounted to a valid demand because the Board learned of Potter’s identity at that time. But as Defendants point out, the complaint does not allege that the attorney said anything at the meeting that would amount to a legal demand. Nor does Potter allege that the attorney submitted any demand to the Board in writing, as California law requires. See Cal. Corp.Code § 800(b)(2). The Board was entitled to receive a valid demand and was not required to piece together by inference the disparate events that, if taken together, might have been sufficient to require corporate action. Accordingly, the district court did not abuse its discretion in concluding that Potter failed to make an adequate demand.
B
We next consider whether Potter sufficiently alleged that making a demand on the Board would have been futile. Potter argues that her suit should be allowed to proceed even if she failed to make a valid demand, because making such a demand would have been futile. The test for proving the futility of a demand for relief is whether the facts show a reasonable doubt that “(1) the directors are disinterested and independent, or (2) the challenged transaction was otherwise the product of a valid exercise of business judgment.” In re Silicon Graphics Inc. Sec. Litig.,
Potter’s demand futility argument fails. Most significantly, Potter’s allegations are not complete and detailed enough to excuse her from the demand requirement. “[I]n order to evaluate the demand futility claim, the court must be apprised of facts specific to each director from which it can conclude that .that particular director could or could not be expected to fairly evaluate the claims of the shareholder plaintiff.” Shields,
The complaint contains few details about the members of the Board aside from the fact that they voted for the transactions that Potter disputes. These alie-
Accordingly, Potter’s allegations do not create a reasonable doubt as to the Board’s overall honesty or independence, and she is not excused from the demand requirement.
AFFIRMED.
Notes
. Rule 23.1 imposes only a pleading requirement with regard to demand; the substantive demand requirement is an issue of state law. Kayes v. Pacific Lumber Co.,
. The dissent argues that our consideration of the demand requirement prior to the jurisdictional issue is improper under Sinochem Int’l Co. v. Malaysia Int’l Shipping Corp.,
. Potter has also not shown that demand should be excused because the Canadian transaction was not the result of valid business judgment. The business judgment rule is a "presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company.” Aronson,
Potter alleges only that the Board failed to disclose the terms of the Canadian transaction, and that PS was reimbursed for expenses at less than the fair market value of the services rendered to the Canadian entities. Absent an indication that the Board lacked good faith as a whole (or at least in the majority), the allegations that some members were interested in the transaction does not rebut the presumption that the board’s decision was a legitimate business judgment. Telxon Corp. v. Meyerson,
Dissenting Opinion
dissenting:
Katherine Potter (Potter) has filed a state law derivative shareholder suit on behalf of nominal defendant Public Storage, Inc. The district court dismissed her suit on the ground that her failure to name herself in the written demand presented by the plaintiffs to the corporation deprived her of standing to maintain this action under Rule 23.1 of the Federal Rules of Civil Procedure.
I
“[A] federal court generally may not rule on the merits of a case without first determining that it has jurisdiction over the category of claim in suit (subject-matter jurisdiction) and the parties (personal jurisdiction).” Sinochem,
The Supreme Court has clarified that this general rule has exceptions: “a federal court has leeway ‘to choose among threshold grounds for denying audience to a case on the merits.’ ” Sinochem,
The Supreme Court has also held it may avoid reaching subject matter jurisdiction and instead dismiss an action for failure to meet class certification requirements under Rule 23 of the Federal Rules of Civil Procedure. See Ortiz v. Fibreboard Corp.,
Neither Sinochem nor the class action certification cases, Amchem and Ortiz, change the Supreme Court’s command that we address subject matter jurisdiction at the outset in the “mine run of cases,” and reach other issues first only where the jurisdictional issue is “difficult to determine” and the other ground is relatively “less burdensome.” Sinochem,
If ... a court can readily determine that it lacks jurisdiction over the cause or the defendant, the proper course would be to dismiss on that ground. In the mine run of cases, jurisdiction will involve no arduous inquiry and both judicial economy and the consideration ordinarily accorded the plaintiffs choice of forum should impel the federal court to dispose of those issues first.
Id. (internal quotation marks and alterations omitted).
In sum, federal courts normally must resolve questions of subject matter jurisdiction before reaching other threshold issues. Only where the other issue itself creates the jurisdictional issue (as in the class action certifications under Rule 23 in Ortiz and Amchem), or the resolution of the issue is clear while the jurisdictional issue is difficult, see Sinochem,
II
In this case, the district court dismissed Potter’s claim on the ground that Potter lacked standing under Rule 23.1 of the Federal Rule of Civil Procedure due to her failure to make a valid demand on the
The majority starts down the wrong path by characterizing the threshold question in this case as being “whether Potter satisfied the demand pleading requirements of Rule 23.1,” and asserting that “[pjursuant to Rule 23.1, a putative derivative plaintiff can initiate a derivative action only if he or she makes an adequate demand on the Board under applicable state law.” Maj. op. at 1055. But Rule 23.1(b) of the Federal Rules of Civil Procedure is a rule of pleading only; it does not impose any substantive demand requirement. Kamen v. Kemper Fin. Servs., Inc.,
[Although Rule 23.1 clearly contemplates both the demand requirement and the possibility that demand may be excused, it does not create a demand requirement of any particular dimension. On its face, Rule 23.1 speaks only to the adequacy of the shareholder representative’s pleadings. Indeed, as a rule of procedure issued pursuant to the Rules Enabling Act, Rule 23.1 cannot be understood to “abridge, enlarge or modify any substantive right.” 28 U.S.C. § 2072(b).
Id. at 96,
Neither the district court nor the majority disputes that Potter satisfied Rule 23.1’s formal pleading requirements. Rather, the majority holds that the district court correctly dismissed Potter’s action on a different threshold ground, namely, that her action is deficient on the merits because she failed to establish the substantive adequacy of her demand as required under California corporate law. Maj. op. at 1055, 1057-58. In effect, the majority holds that this issue of state law is an appropriate “threshold ground! ] for denying audience to a case on the merits.” Sinochem,
I disagree with this conclusion. Sino-chem, Ortiz, and Amchem made only limited exceptions to the general rule that we must address our jurisdiction first. They do not support dismissing an action based on a threshold ground that raises an unsettled issue of state law. California courts have not considered whether California law requires plaintiffs bringing a derivative action to identify themselves by name in a written demand. In declaring that California law imposes such a requirement, the majority relies on a two-step analysis. First, the majority notes California decisions that stand generally for the proposition that “corporate law developed in the State of Delaware ... is identical to California corporate law for all practical purposes.” Oakland Raiders v. Nat’l Football League,
In Smachlo, the court’s jurisdiction was premised on diversity and exclusive federal jurisdiction for claims alleging violations of Section 10(b) of the Securities Exchange Act, 15 U.S.C. § 78j(b) and Rule 10b-5 of the Securities and Exchange Commission, 17 C.F.R. § 240.10b-5. Id. at 1441. The district court held that a shareholder demand letter was inadequate because, among other faults, it failed to identify a single complaining shareholder, gave the board only a two-week deadline for action, and answered the corporation’s request for additional information by filing the derivative complaint. Smachlo,
Based on this two-step analysis, the majority concludes that a decision by a federal district court sitting in Delaware has established a bright line California rule that plaintiffs lack standing to bring a derivative action unless they identify themselves by name in a written demand to the corporation. But the majority points to no California or Delaware case holding that the failure to self-identify constitutes a failure to make a valid demand. As noted, Smachlo does not expressly interpret Delaware law, and more fairly stands for the limited proposition that a putative derivative plaintiff must permit the board, as part of its reasonable investigation of the claims at issue, to ascertain the identity of the shareholder. See id. Considering that the directors of Public Storage were informed in a pre-suit meeting of Potter’s identity, the demand in this case was arguably sufficient under Smachlo. Smachlo is thus a thin reed on which to avoid consideration of our subject matter jurisdiction in favor of a dismissal on state standing grounds.
Not only is the threshold issue identified by the majority an open issue of California law, but nothing in Sinochem suggests that a state standing requirement would ever be an appropriate threshold basis for dismissal. The threshold issues identified in Sinochem as appropriate bases for dismissing a case before reaching the question of the court’s jurisdiction were federal procedural rules, not requirements of substantive state law. See
Nor does the exception for class action certifications in Ortiz and Amchem avail the majority. As stated, Ortiz and Am-chem created only “a limited exception for suits in which the class certification issues are ‘logically antecedent to the existence of any Article III issues.’ ” Rivera,
The majority’s approach allows a federal court to bypass subject matter jurisdiction and dispose of a case by adjudicating a difficult state law issue, despite the Supreme Court’s direction that we should generally address subject matter jurisdiction at the outset. Sinochem,
Ill
The correct path here is to consider our subject matter jurisdiction first. Under 28 U.S.C. § 1331, we have jurisdiction over “only those cases in which a well-pleaded complaint establishes either that [1] federal law creates the cause of action or that [2] the plaintiffs right to relief necessarily depends on resolution of a substantial question of federal law.” Franchise Tax Bd. v. Constr. Laborers Vacation Trust,
The state law claims Potter raises also do not “necessarily raise a stated federal issue, actually disputed and substantial, which a federal forum may entertain without disturbing any congressionally approved balance of federal and state judicial responsibilities.” Grable,
The district courts of the United States and the United States courts of any Territory or other place subject to the jurisdiction of the United States shall have exclusive jurisdiction of violations of this chapter [the Securities Exchange Act of 1934, 15 U.S.C. § 78a-78111], or the rules and regulations thereunder, and of all suits in equity and actions at law brought to enforce any liability or duty created by this chapter or the rules and regulations thereunder.
In Sparta Surgical Corp. v. Nat’l Ass’n of Sec. Dealers,
In this case, however, Potter’s allusions to federal law play a minor role in the complaint’s claims for state law breaches of fiduciary duties. In the context of the myriad alternative (and factually specific) bases for relief asserted by Potter for each claim, the complaint does not fall under the Sparta rule. Potter’s passing references to alleged breaches of federal law (for which there is no private right of action) are insufficient in this context to “convert a state law claim into a federal cause of action.” Easton v. Crossland Mortg. Corp.,
Potter’s complaint does not allege a federal cause of action, raise a substantial disputed issue of federal law, or turn entirely on the question whether defendants violated federal law. Accordingly, there is no basis for subject matter jurisdiction. And because we should generally consider our subject matter jurisdiction in the first instance, and there is a clear path to do so in this case, I would vacate the decision of the district court and remand with instructions to dismiss the case for lack of subject matter jurisdiction.
. Rule 23.1(b)(3) requires a shareholder to “state with particularity: any effort by the plaintiff to obtain the desired action from the directors or comparable authority and, if necessary, from the shareholders or members; and the reasons for not obtaining the action or not making the effort."
. National Railroad Passenger Corp. v. National Ass’n of Railroad Passengers,
. Fed. R. Civ. Proc. 23(a) provides:
(a) Prerequisites.
One or more members of a class may sue or be sued as representative parties on behalf of all members only if:
(1)the class is so numerous that joinder of all members is impracticable,
(2) there are questions of law or fact common to the class,
(3) the claims or defenses of the representative parties are typical of the claims or defenses of the class; and
(4) the representative parties will fairly and adequately protect the interests of the class.
. Count I of the complaint asserts a claim for breach of fiduciary duty against all individual defendants based upon the defendants' completion of the Public Storage, Inc. transaction.
Count II asserts a claim against all individual defendants for waste of corporate assets in light of the defendants' alleged transfer of corporate assets from Public Storage to the Hughes Family Defendants.
Count III asserts a claim of violation of Cal. Corp.Code § 25402 (prohibiting insider trading under California law) against the Hughes Family Defendants.
Count IV asserts a claim for breach of fiduciary duty and seeks a constructive trust against the Hughes Family Defendants.
Count V asserts a claim against the director defendants for aiding and abetting the Hughes Family Defendants' breaches of fiduciary duties.
Count VI asserts a claim against all individuals for breach of fiduciary duties and dissemination of "materially misleading and inaccurate ... or incomplete information.” Count VI also asserts that Public Storage "has suffered damages ... including ... exposure to liability for violations of federal law, including but not limited to, the provisions of the Sarbanes-Oxley Act of 2002.”
Count VII asserts a claim against all individual defendants for failure to pursue claims against the Hughes Family Defendants "in
Count VIII alleges that certain management defendants "executed certifications pursuant to 18 U.S.C. [§ ] 1350 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act,” and that these management defendants are required to return their compensation to Public Storage.
Count IX asserts a claim against all individual defendants for “abuse of ... control” over Public Storage.
Count X asserts a claim against all individual defendants for “Gross Mismanagement.” As part of this claim, the complaint asserts that the individual defendants "abdicated their responsibilities” under the Sarbanes-Oxley Act, and by so doing, “breached their duties of care, diligence and candor in the management and administration” of Public Storage.
Count XI asserts a claim of constructive fraud against all individual defendants.
Count XII asserts a claim of unjust enrichment against all individual defendants.
. Potter argues also that its claims and Public Storage's affirmative defenses will require ex-