Background
Tortoise Pipeline & Energy Fund, Inc. (TYG) and Tortoise Energy Independence Fund, Inc. (NTG) are Maryland closed-end investment funds managed by Tortoise Capital Advisors, L.L.C. under advisory contracts tying Tortoise’s fees to total assets under management. The funds used financial leverage—at times reaching 37–40% of assets, well above their stated 20–30% policy—to invest in master limited partnerships in the energy sector. The board of directors, composed of four ostensibly independent directors and one non-independent director (Tortoise’s CEO), exercised no meaningful controls over leverage levels or liquidity risk. When energy prices fell sharply in early 2020, the funds were forced to sell holdings into a declining market to satisfy debt-ratio covenants, resulting in combined losses exceeding $1 billion by the end of the first quarter.
Shareholders Howard Nathanson and Gus Gordon initially filed a derivative action in federal court in Kansas in August 2022, but the case was dismissed on a forum selection clause. They refiled in the Circuit Court for Baltimore City in May 2023, asserting—among other claims—a derivative count (Count II) against the directors and Tortoise for breach of duties. Critically, the shareholders never made a pre-suit demand on the board before filing, instead invoking the “futility exception” to Maryland’s demand requirement. The circuit court dismissed Count II, finding the shareholders had not adequately pleaded futility, and the Appellate Court of Maryland affirmed. The Supreme Court of Maryland then granted certiorari.
To support futility, the shareholders argued principally that the directors’ mismanagement exposed them to over $1 billion in personal liability—making any demand pointless—and that the board’s post-collapse conduct (renewing Tortoise’s contracts, publicly praising its management, adopting defensive by-laws, rejecting a books-and-records request, and opposing the earlier federal action) demonstrated that the directors could not impartially consider a litigation demand. The Supreme Court rejected both theories and affirmed dismissal with prejudice.
The Court’s Holding
The Supreme Court of Maryland affirmed and used the case to clarify the demand-futility standard under Werbowsky v. Collomb, 362 Md. 581 (2001). The Court held that futility turns on the board’s capacity to consider a litigation demand in conformity with the director standard of conduct codified in Corporations & Associations Article § 2-405.1(c)—not on the shareholders’ prediction of how the board would likely rule. A board that would probably refuse a demand is not thereby incapable of considering it; equating probable refusal with futility “confuses futility with failure,” quoting the Seventh Circuit’s formulation in Kamen v. Kemper Financial Services, Inc., 939 F.2d 458, 462 (7th Cir. 1991). The Court further held that the phrase “conflicted or committed to the decision in dispute” from Werbowsky describes a single, unified inquiry into whether directors can act in good faith, in the corporation’s best interests, and with ordinary prudence—not two alternative pathways to excuse demand.
The Court also rejected the shareholders’ liability-exposure theory. Allegations that directors who were disinterested at the time of the challenged decisions now face substantial personal liability from the derivative claims themselves do not establish futility. Accepting that theory would require courts to assess the merits of the underlying derivative claims—precisely what Werbowsky forbids at the demand stage. Because the board’s conduct did not clearly and particularly show that a majority of directors were so conflicted or committed that they could not reasonably consider a demand under § 2-405.1(c)’s standards, the futility exception did not apply and the failure to make a pre-suit demand was fatal to Count II.
Key Takeaways
- Maryland’s demand-futility exception is narrow: to excuse a pre-suit demand, shareholders must clearly and particularly allege either that a demand or delay would cause irreparable harm, or that a majority of directors are so personally and directly conflicted or committed to the challenged decision that they cannot respond in good faith under § 2-405.1(c).
- “Conflicted or committed” is a single test focused on the board’s capacity to consider a demand impartially—a board that would likely refuse a demand is not automatically disqualified from considering one.
- Potential personal liability of directors who were disinterested when the challenged decisions were made does not establish futility; courts may not assess the merits of derivative claims at the demand stage to determine whether liability is “substantial” or “unexculpated.”
- Post-collapse board conduct—such as renewing the adviser’s contracts, defending prior decisions, or opposing shareholder litigation in other forums—may show hostility to litigation but does not, without more, demonstrate that directors are incapable of discharging their § 2-405.1(c) duties when presented with a demand.
- If a demand is made and refused by a disinterested board, that refusal is reviewable under ordinary business-judgment standards, providing shareholders with a meaningful check without bypassing the demand requirement.
Why It Matters
This decision significantly tightens Maryland’s demand-futility doctrine and raises the pleading bar for shareholders seeking to bypass the pre-suit demand requirement in derivative litigation. By reframing the inquiry around a board’s objective capacity—rather than the probable outcome of a demand—the Court removes what had been a tempting shortcut: pointing to a board’s self-interest in defending past decisions, or to the magnitude of its potential liability, as a proxy for futility. Maryland corporations and their boards gain clearer protection against derivative suits filed without ever affording the board the opportunity to evaluate the claims.
The decision also reinforces Maryland’s alignment with the national trend toward stricter enforcement of the demand requirement, and it provides practitioners with a unified analytical framework: the sole question at the futility stage is whether a majority of directors could discharge their § 2-405.1(c) duties when presented with a litigation demand. Counsel representing institutional investors or activist shareholders in Maryland derivative matters should expect that allegations of leverage mismanagement, large paper losses, and post-crisis defensive board conduct will not, standing alone, satisfy the futility exception.