Commercial Litigation and Arbitration

Federal Court May Dismiss Derivative Action for Failure of Demand Without Reaching Question of Subject Matter Jurisdiction

Ordinarily, federal courts must address subject matter jurisdiction as a threshold question. But not always. The Ninth Circuit ruled in Potter v. Hughes, 2008 U.S. App. LEXIS 21306 (9th Cir. Oct. 10, 2008), that a federal court may dismiss for failure to satisfy the demand requirement of Federal Rule of Civil Procedure 23.1 before reaching the question of subject matter jurisdiction:

Supreme Court precedent is clear that we "may choose among threshold grounds for denying audience to a case on the merits." Wilbur v. Locke, 423 F.3d 1101, 1106 (9th Cir. 2005) (quoting Ruhrgas AG v. Marathon Oil Co., 526 U.S. 574, 585 (1999)); see also Ruhrgas AG, 526 U.S. at 584 ("While Steel Co. [v. Citizens for a Better Environment, 523 U.S. 83 (1998),] reasoned that subject-matter jurisdiction necessarily precedes a ruling on the merits, the same principle does not dictate a sequencing of jurisdictional issues."). These precedents apply most commonly where both of the competing threshold issues go to the court's power under the Constitution.

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., 523 U.S. at 100 n.3, grounds of prudential standing, such as statutory standing, see National R. R. Passenger Corp. v. National Ass'n of R. R. Passengers, 414 U.S. 453, 465 n.13 (1974) ("Since we hold that no right of action exists, questions of standing and jurisdiction became immaterial."), and grounds that are "logically antecedent to the existence of any Article III issues," such as class certification under Federal Rule of Civil Procedure 23, see Ortiz v. Fibreboard Corp., 527 U.S. 815, 831 (1999); Amchem Prods. v. Windsor, 521 U.S. 591, 612-13 (1997).

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, 51 F.3d at 1463 n.10. Therefore, unless we determine that a proper demand was made, there is no lawsuit over which to exercise jurisdiction. Thus, as in Ortiz and Amchem, the jurisdictional issue would not exist but for this court's determination regarding the adequacy of Potter's demand. Accordingly, it is appropriate for us to reach the Rule 23.1 issue first. See Ortiz, 527 U.S. at 831; Amchem, 512 U.S. at 613.

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