Chancery Court Dismisses Derivative Lawsuit against GM Directors Relating to Recalled Ignition Switches, Finding That Plaintiffs Failed to Show Demand Futility

By Scott Waxman and Lauren Garraux

In a June 26, 2015 Memorandum Opinion, Vice Chancellor Sam Glasscock III dismissed a derivative complaint filed by stockholders of General Motors (“GM”) relating to defective ignition switches that led to the recall of approximately 13 million GM vehicles beginning in February 2014.  According to Vice Chancellor Glasscock, Plaintiffs failed to adequately plead bad faith on the part of the GM directors named as defendants in the lawsuit and, therefore, failed to show demand futility under Chancery Rule 23.1.

The general facts underlying this derivative lawsuit have been widely publicized and relate to GM’s recall of approximately 13 million vehicles for issues with the vehicles’ ignition switch, which caused a vehicle’s engine and electrical system to shut off, disabling power steering and power brakes and causing the vehicle’s airbags to not deploy in the event of a crash.

Plaintiffs, stockholders of GM, subsequently filed this derivative lawsuit seeking to hold GM’s directors personally liable for these losses, which Plaintiffs allege amount to breaches of the duty of loyalty.  Because Plaintiffs did not make a pre-suit demand on GM’s Board prior to filing suit, the issue before the Court was whether Plaintiff’s sufficiently demonstrated demand futility, a necessarily “rigorous” standard to “prevent usurpation of a core director function by a stockholder, with all the distraction and chaos that would portend.”  Vice Chancellor Glasscock concluded that the stockholders failed to plead demand futility and, therefore, dismissed their complaint pursuant to Rule 23.1.

First, Vice Chancellor Glasscock concluded that Plaintiffs failed to show that certain actions taken by GM’s directors — namely, transferring risk management responsibilities to the general auditor and the audit committee, decisions which Plaintiffs alleged made an already poorly-functioning risk management system even worse — were not a valid exercise of business judgment because they were taken in bad faith.  According to the Vice Chancellor, Plaintiffs identified no “red flags” that would have made the Board aware that its risk management system was not functioning as it should. As a result, Vice Chancellor Glasscock was unable to conclude that the board’s transfer of responsibility — a decision which he described as squarely within the realm of director decision-making — was the product of bad faith or reflected a conscious disregard of the Board’s duties.

Vice Chancellor Glasscock similarly rejected Plaintiffs’ contentions relating to the Board’s alleged inaction, in particular, the Board’s alleged failure to implement a reporting system which would have apprised it specifically of serious injuries and deaths resulting from safety defects, as well as lawsuits that potentially involved punitive damages.  As the Vice Chancellor explained, GM did have a risk reporting system and Plaintiffs’ claim that that system was insufficient in hindsight did not amount to an “utter[] fail[ure] to implement any reporting or information system or controls,” as is required to raise a reasonable doubt as to the directors’ good faith under the standard set forth in the Chancery Court’s decision in In re Caremark International Inc. Derivative Litigation.

Finally, Vice Chancellor Glasscock determined that Plaintiffs failed to plead with particularity that the Board consciously failed to monitor or oversee the company’s operations, an alternative basis for liability under Caremark.  Specifically, the Vice Chancellor concluded that Plaintiffs had not pled with particularity the existence of “red flags” that the Board consciously ignored and otherwise failed to plead that the Board knew that its existing systems were inadequate.

For these reasons, Vice Chancellor Glasscock granted GM’s motion to dismiss the derivative complaint under Chancery Rule 23.1.

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