Stockholder Letter Requesting Remedial Action Deemed a Pre-Suit Demand

By: Joanna Diakos Kordalis and Zack Sager

In Solak v. Welch, the Court of Chancery found that a letter from a stockholder to the board of directors, which requested remedial action to address allegedly excessive non-employee director compensation, was a pre-suit demand and dismissed the stockholder’s complaint for failing to allege wrongful demand refusal.

Plaintiff John Solak (the “Plaintiff”) was a stockholder of Ultragenyx Pharmaceutical Inc., a Delaware corporation (the “Corporation”).  In June of 2018, the Plaintiff sent a letter (the “Letter”) to the board of directors of the Corporation (the “Board”), which provided that that its purpose was “to suggest that the [Board] take corrective action to address excessive director compensation as well as compensation practices and policies pertaining to directors.”  The Letter included a footnote providing the letter was intended only as a “good faith-attempt to encourage corrective action by the Board” and should not be construed as a pre-suit litigation demand under Delaware Chancery Rule 23.1.  In addition, the letter made clear that  the stockholder did “not seek or expect the Board to initiate any legal action against its members” but stated that if the Board failed to respond to the Letter within thirty days, the Plaintiff would consider all available stockholder remedies.

Despite the footnote, the Board viewed the Letter as a demand under Rule 23.1.  In its response to the Plaintiff, the Board explained that it conducted an investigation into the issues raised in the Letter and concluded that it was in the best interests of the Corporation to not commence a civil action or make changes to the Corporation’s compensation policy.  The Plaintiff subsequently brought a derivative action, and the Board moved to dismiss it, arguing that the Letter constituted a pre-suit demand under Rule 23.1 and the Plaintiff failed to plead wrongful demand refusal.

Under Rule 23.1, a stockholder may either (a) make a pre-suit demand on the board or (b) plead with particularity the reasons that it would have been futile to do so.  If the stockholder makes a pre-suit demand, the stockholder cannot then allege that demand would have been futile in a subsequent complaint; the stockholder must make the claim that the board wrongfully refused the demand.

Under the Court’s decision in Yaw v. Talley, a pre-suit communication is a demand under Rule 23.1 if it provides (1) the identity of the alleged wrongdoers, (2) the wrongdoing they allegedly perpetrated and the injury to the corporation, and (3) the legal action the stockholder wants the board to take on the corporation’s behalf.  The parties’ dispute turned on whether the Letter satisfied the third prong of the test.  The Plaintiff argued that because the Letter did not expressly demand that the Board commence litigation, it could not have satisfied the third prong.  The Court disagreed.  According to the Court, because the Letter clearly articulated the need for immediate remedial measures, proposed remedial action, requested the Board to take such action, and contained “strong overtures of litigation,” the third prong was satisfied.  The Court also held that the disclaimer in the Letter, that nothing therein should have been construed as a pre-suit demand, did not have the desired effect.  Such language did not obviate the need for the Court to analyze the Letter under Yaw because the test for determining whether a pre-suit communication constitutes a demand under Rule 23.1 does not look to the subjective intent of the sender, but rather, the substance of the communication objectively to determine whether it gives notice of potential wrongdoing in a manner that enables corrective action to be taken.

Since the Court found that the Letter constituted a pre-suit demand, it proceeded to conduct the demand refusal analysis.  When demand on a board of directors has been made and refused, the Court applies the business judgment rule in reviewing the board’s refusal.  A stockholder asserting wrongful refusal of a demand must allege with particularity facts that give rise to a reasonable doubt as to the good faith reasonableness of the board’s investigation and deliberations.  To do so, the stockholder must plead particularized facts to support an inference that the board committed gross negligence or acted in bad faith in rendering its decision.  Here, the Plaintiff’s complaint failed to allege any facts supporting an inference that the Board wrongfully rejected the demand.  As such, the Court dismissed the Plaintiff’s complaint.

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