COURT OF CHANCERY DISMISSES EXCESSIVE PAY CLAIMS

By: Scott Waxman and Claire Suni

In Dahle et al. v. Pope et al., C.A. No. 2019-0136-SG (Del. Ch. 2020), the Delaware Court of Chancery (the “Court”) dismissed a derivative suit by stockholders of R.R. Donnelly & Sons Company (the “Company”) under Delaware Chancery Rule 23.1 (“Rule 23.1”) alleging excessive pay of the Company’s board of directors (the “Board’).  The Court found that a letter from the stockholders (the “Letter”) to the Board constituted a pre-suit litigation demand that had been rejected by the Board, and as a result, Plaintiffs’ claim was not entitled to proceed derivatively under Delaware law. {Hard Return}

The defendants were the directors and CEO of the Company (“Defendants”). The plaintiffs were stockholders of the Company, Mancine Dahle and Alexandra Smiley (together, “Plaintiffs”).  In October 2016, the Company completed a spinoff and the Board revised its own compensation program, without stockholder approval.  Two years later, in October 2018, Plaintiffs’ counsel sent the Letter to the Board requesting corrective action to address the allegedly excessive director compensation and related policies and practices. The Letter stated that the Board salaries, “in excess of $300,000 each,” represented an amount more than two times the average for companies with similar market caps.  It also included an explicit statement that nothing contained in the Letter should be construed as a pre-suit litigation demand under Rule 23.1. On receipt of the Letter, the Board conducted an investigation and provided Plaintiffs a response recounting its responsive actions, which included interviews with an independent compensation consultant. The Board’s response letter stated that the Board unanimously resolved that it was in the best interest of the Company not to make any changes to the compensation program.

In its analysis, the Court noted that Rule 23.1 provides stockholders with only two options with respect to derivative actions: (i) make a pre-suit demand on a board of directors, or (ii) plead with particularity why such demand would be futile and should be excused. If a stockholder makes a pre-suit demand, it “tacitly concedes” that a board’s decision with respect thereto is subject to the business judgment rule.

As a starting point, the Court looked to its recent precedent in which the Court found a letter prepared by Plaintiff’s counsel for different parties with respect to another company constituted a pre-suit demand. In the present case, the Court noted that the Letter was nearly a carbon copy of the other letter, down to the topic of director compensation, and so the Court applied the reasoning from that case to its analysis.

The Court looked to three separate factors to find that the Letter constituted a pre-suit demand.  First, the Court applied the applicable test for a pre-suit demand: a pre-suit demand must communicate (i) the identity of the alleged wrongdoers, (ii) the wrongdoing they allegedly perpetrated and resultant injury to the corporation, and (iii) the legal action the shareholder wants the board to take on the corporation’s behalf.  The Court focused on the third prong of the test and clarified that a pre-suit communication need not expressly demand litigation in order to constitute a demand under Rule 23.1. Here, the Court found that the Letter’s “strong overtures of litigation” and warning language with respect to shareholder remedies satisfied the third element of the test.  Second, the Court found that the duplicate nature of the Letter and the letter in the other case suggested that the Letter served the notice function of a pre-suit demand.  Third, the Court noted that the Letter sought benefits commonly achieved in derivative lawsuits challenging non-employee director compensation, thus making it more likely the Board would recognize the Letter as a demand.  Accordingly, the Court found that the Letter constituted a pre-suit demand.

The Court next determined that, given that Plaintiffs were found to have delivered a pre-suit demand, the Board’s response was subject to the business judgment rule and Plaintiffs’ claim did not overcome the higher pleading standard with respect thereto.  Under Rule 23.1, once a demand has been delivered, the claim must to allege with particularity that the Board acted with gross negligence or bad faith in refusing the demand in order to overcome the business judgment rule. Here, Plaintiff’s complaint did not make such an argument, and thus the complaint was dismissed. Finally, the Court considered whether there was a public policy argument against considering the Letter to be a demand. Plaintiffs argued that if the Court ruled an ambiguous stockholder communication to be a demand, it might have a chilling effect that discourages stockholders from attempting to resolve issues outside of the courts. Here, the Court found that Plaintiffs made a “conscious attempt” to craft communication to spur the Board to action as if it were demand, while simultaneously aiming to skirt the consequences of such a demand through “clever draftsmanship.” Thus, the Court was not willing to grant “plaintiff-friendly deference” to the Letter as an ambiguous communication.

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