The opinion of the court was delivered by: BY THE COURT; D. BROOKS SMITH
Plaintiffs Joseph H. Levit and George M.D. Richards (the derivative plaintiffs) bring this action individually and derivatively on behalf of Westinghouse Electric Corporation against nominal defendant Westinghouse Electric Corporation, and thirteen individual defendants who sat on the Board of Directors of Westinghouse or one of its subsidiaries at times relevant to this action. Plaintiffs allege that defendants issued materially false and misleading proxy statements from 1987 through 1992, in violation of Section 14(a) of the Exchange Act and Rule 14a-9 promulgated thereunder by the SEC (Counts I and II), and that the individual defendants breached their state law fiduciary duties to Westinghouse and its shareholders by committing gross mismanagement and wasting corporate assets (Count IV). Finally, plaintiffs allege that the individual defendants may have violated federal securities laws by failing to disclose material facts in connection with the sale of Westinghouse securities, and should be liable to the corporation for contribution or indemnity in connection with any judgment or settlement of the Purchaser Class Actions (Count III).
Defendants first argue that the derivative portions of plaintiffs' complaint (Counts II, III and IV) should be dismissed because plaintiffs have not made pre-litigation demands on Westinghouse's Board of Directors and Westinghouse shareholders, and have not pled particularized facts excusing the demand requirement, as required by Fed. R. Civ. P. 23.1.
Defendants' Memorandum in Support of Motion to Dismiss Amended and Supplemental Derivative Complaint (Defendants' Memo), at 7-25. As the Supreme Court noted in Kamen v. Kemper Financial Services, 500 U.S. , 111 S. Ct. 1711, 1716, 114 L. Ed. 2d 152, 164 (1991), Rule 23.1 "contemplates" but does "not create" the requirement that shareholders make a demand upon the corporate directors before bringing derivative actions on behalf of the corporation. It is a procedural rule that "speaks only to the adequacy of the shareholder representative's pleadings." Id. The demand requirement itself is substantive; it is a principle of states' corporate law. The requirement is based upon, and is an essential part of, the allocation of governing powers within a corporation. Its major premise is that directors of corporations are best positioned to determine whether prosecuting a lawsuit is in the corporation's best interest, and that their judgment on that matter should generally be accorded deference. See Kamen, 111 S. Ct. at 1719, 114 L. Ed. 2d at 167 ("The purpose of requiring a precomplaint demand is to protect the directors' prerogative to take over the litigation or to oppose it."); Cramer v. Gen. Tel. & Elec. Corp., 582 F.2d 259, 274-5 (3d Cir. 1978), cert. denied 439 U.S. 1129, 59 L. Ed. 2d 90, 99 S. Ct. 1048 (1979) (demand requirement is "inextricably linked" to the business judgment rule). However, the demand requirement is not absolute; it must not be permitted to defeat the important role derivative actions serve in overcoming collective action barriers where managers or directors who are allegedly intent on serving their own interests rather than those of the firm refuse to sue themselves or others on behalf of the corporation. Id. See generally Jonathan R. Macey and Geoffrey P. Miller, The Plaintiffs' Attorneys' Role in Class Action and Derivative Litigation: Economic Analysis and Recommendations for Reform, 58 U. Chi. L. Rev. 1, 8-11 (1991). To balance these competing interests, courts permit shareholders to proceed derivatively if they can first show that making a demand upon the board would be futile. Kamen, 111 S. Ct. at 1716, 114 L. Ed. 2d at 165.
It is undisputed that plaintiffs did not make a prelitigation demand on the Westinghouse Board of Directors. Therefore, plaintiffs must "plead with particularity" the reasons why they did not make such demands. Accordingly, plaintiffs argue that under the circumstances, it would have been futile to demand that the Westinghouse Board of Directors litigate this action against the corporation.
The parties agree that Pennsylvania law, supplemented by relevant Delaware case to the extent it is necessary, provides the substance of the demand requirement in the case at bar. Pennsylvania's demand requirement, 42 Pa.C.S.A. § 1506(a)(2), provides that a derivative plaintiff must "set forth the efforts made to secure enforcement by the corporation or similar entity or the reason for not making any such efforts." Pennsylvania courts have traditionally been aggressive in enforcing the demand requirement. In Wolf v. Pennsylvania R. Co., 195 Pa. 91, 45 A. 936 (Pa. 1900), the Pennsylvania Supreme Court held that making a demand "upon the regular corporate management" was an "imperative requisite." Id. See also Law v. Fuller, 217 Pa. 439, 66 A. 754, 756 (Pa. 1907) (in order to satisfy the demand requirement, a derivative plaintiff "should allege its refusal or failure to sue, and facts showing that he has left undone nothing which in reason he might have done to prevail on the corporate management to bring the action."). The Court in Law v. Fuller acknowledged a futility exception, but rejected plaintiff's contention that the exception obtained because their argument did
not rest on any acts averred, but [rather] on an inference that, by reason of the circumstances of their election, the directors will violate their duty and commit a breach of trust. There is, however, no presumption that officers will commit a breach of trust. The charge should rest on some act, affirmative or permissive, manifestly in violation of duty, and manifestly the result of fraud, and not of erroneous judgment.
Similarly, in Evans v. Diamond Alkali Co., 315 Pa. 335, 172 A. 678 (Pa. 1934), the Supreme Court of Pennsylvania taught with respect to demand futility:
Where it appears that fraudulent acts prejudicial to the interests of the corporation have been committed, so interwoven with the conduct of the corporate managers and of such nature that it might be presumed that the officers would commit a breach of trust in refusing to proceed, a demand is not necessary and it would be 'vain and useless.' Ordinarily there is no presumption that officers will commit such breach of trust, and the charge that they will should rest on acts, affirmatively or permissive, duly averred, manifestly in violation of duty, and manifestly the result of fraud, and not of erroneous judgment. It is not always necessary for the complaining shareholder to appeal to stockholders at a meeting, but he is in duty bound to make every reasonable effort to prevail on the corporate management to bring action.
Id. at 679 (citations omitted). Accord Passmore v. Allentown & Reading Traction Co., 267 Pa. 356, 110 A. 240 (Pa. 1920); Kelly v. Thomas, 234 Pa. 419, 83 A. 307 (Pa. 1912); Burdon v. Erskine, ...