Chancery Court Dismisses Derivative Claims Alleging Breach of Fiduciary Duty in Connection with the Vesting of a Former Director’s Equity Compensation

By: Naomi R. Ogan and H. Corinne Smith

In Friedman v. Maffei, et al, C.A. No. 11105-VCMR (Del. Ch. Apr. 13, 2016), the Court of Chancery dismissed derivative claims brought by Julie Friedman on behalf of TripAdvisor, Inc. (“TripAdvisor”) concerning the vesting of 200,000 restricted stock units (“RSUs”) of Expedia stock belonging to Dara Khosrowshahi, a former TripAdvisor director and current CEO of Expedia, Inc. (“Expedia”). In considering defendants’ motion to dismiss, the court concluded that Friedman failed to plead particularized facts that raise a reasonable doubt that the TripAdvisor board (the “Board”) validly exercised its business judgment in refusing her demand. Because the plaintiff could not show the Board wrongfully refused her demand, the court granted the motion to dismiss.

Per an agreement covering the vesting of Khosrowshahi’s RSUs (the “RSU Agreement”), in the event of a change of control of TripAdvisor, 50% of the RSUs would vest immediately, and the remaining 50% would vest only if either (1) Khosrowshahi remained employed by TripAdvisor one year after the change in control, in which case certain performance goals must have been met, or (2) Khosrowshahi was terminated without cause within one year following the change in control.

Subsequently, Liberty Interactive Corporation purchased control of TripAdvisor, which constituted a change in control under the RSU Agreement. Half of Khosrowshahi’s RSUs vested immediately. When Expedia purchased a majority stake in Trivago, a competitor of TripAdvisor, Khosrowshahi offered to resign from the Board, if the Board so requested. Ultimately, the Board did ask Khosrowshahi to tender his resignation, which he promptly did. The Board considered his resignation to be involuntary and without cause, resulting in the vesting of his remaining RSUs.

Following the vesting of Khosrowshahi’s remaining RSUs, Friedman sent a letter to the Board demanding that it investigate claims, initiate legal action, and take necessary and appropriate remedial measures regarding the accelerated vesting of the challenged RSUs. The Board formed a special committee to evaluate Friedman’s demands, and the special committee, together with its legal advisors, concluded that the Board should take no action in response to Friedman’s demand. The Board followed the special committee’s recommendation and refused the demand.

Friedman’s filed a derivative suit alleging breach of fiduciary duty and waste of corporate assets against all defendants except Khosrowshahi, and unjust enrichment against Khosrowshahi. In addition, the complaint asserted that the Board wrongfully refused Friedman’s demand. In response, defendants moved to dismiss the complaint under Court of Chancery Rule 23.1. In the context of a derivative lawsuit, a board’s decision to refuse a plaintiff’s demand to initiate legal action on behalf of a corporation is afforded the protection of the business judgment rule unless the plaintiff alleges particularized facts that raise a reasonable doubt as to whether the board’s decision to refuse the demand was the product of a valid business judgment.  The court considered breaches of the duties of care and loyalty in turn.

Vice Chancellor Montgomery-Reeves, writing for the court, held that Friedman had not raised a reasonable doubt as to whether the Board complied with its duty of care. The special committee looked into Friedman’s claims and determined that Khosrowshahi’s termination was neither voluntary nor for cause, and therefore he was entitled to compensation under the RSU Agreement. The Board, via the findings of the special committee, informed itself of material reasonably available to it. Friedman failed to raise a reasonable doubt that the Board was not grossly negligent in refusing her demand.

The court also held that Friedman had not raised a reasonable doubt as to whether the Board complied with its duty of loyalty. By making a demand to a board of directors, a plaintiff concedes the board’s independence and disinterest; therefore, the duty of loyalty can only be breached if the board acts in bad faith. The standard of bad faith requires that the board’s decision was so far beyond the bounds of reasonable judgment that it would be inexplicable absent bad faith. The merits of the complaint’s underlying claims are examined only to the extent necessary to determine whether they are so overwhelmingly obvious that the Board’s decision not to pursue them must have been made in bad faith. Here, the court determined that because the Board’s decision was not inexplicable, and in fact the Board had support for its decision, the complaint failed on this point. Within the discussion of the duty of loyalty, the court considered, in turn, the alternative arguments that Khosrowshahi voluntarily resigned, that he was terminated for cause, and other factors.

The complaint alleged that Khosrowshahi voluntarily resigned from the Board, because he offered his resignation before the Board requested it. On this issue, the court found that the decision of whether Khosrowshahi should be removed from the Board was always in the hands of TripAdvisor and its controlling stockholder. However, the court was careful to note that even crediting Friedman’s interpretation of those documents—that Khosrowshahi left voluntarily—would not suffice to find that the Board had wrongfully refused Friedman’s demand.

Friedman’s alternative argument was that TripAdvisor terminated Khosrowshahi’s directorship for cause because he engaged in a competitive activity under his non-competition provision of the RSU Agreement. However, the RSU Agreement expressly exempted Khosrowshahi’s employment with Expedia from the definition of competitive activity, and the court found that it was reasonable for the Board to have concluded that this carve-out prevented them from removing Khosrowshahi for cause. Friedman failed to raise a reasonable doubt as to whether the Board refused her demand in good faith.

Finally, Friedman’s complaint claims that the court should ignore other factors on which the Board made its decision to refuse Friedman’s demand, including costs that TripAdvisor would incur (1) defending a potential claim brought by Khosrowshahi, (2) prosecuting claims against certain TripAdvisor executives to satisfy their indemnification rights, and (3) dealing with the distraction from TripAdvisor operations that would result from litigation against TripAdvisor executives. Friedman claims that these factors are all either contradicted by common sense or are vague and unsubstantiated. In response, the court points to specific and detailed language in the demand refusal letter issued by the Board. Additionally, the court notes that Friedman could have made a demand for the Special Committee’s underlying, comprehensive report, but that Friedman chose not to seek that report because she was satisfied with the demand refusal letter’s account of the Board’s decision. Thus, Friedman failed to access a source of information that would have been useful if the demand refusal was indeed vague or nonsensical.

The last issue for consideration was whether dismissal would be with or without prejudice as to Friedman’s ability to amend her complaint. Because Friedman did not provide justification supporting a finding that dismissal with prejudice would be unjust, the court dismissed the complaint with prejudice.

Friedman v. Maffei, et al

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