Delaware Chancery Court reaffirms need for factual particularity in assessing demand futility and granted Defendants’ motion to dismiss

By: Jessica Pearlman and Mary Nicholas

In a letter opinion, Mark Gottlieb, et al., v. Jonathan Duskin, et al, Civil Action No. 2019-0639-MTZ (Del. Ch. November 20, 2020), the Delaware Court of Chancery granted Defendants’ motion to dismiss Plaintiff’s complaint in its entirety for failure to satisfy, with enough factual particularity, that a demand that the board of directors pursue the corporate claim would have been futile under Rule 23.1.

Plaintiff’s claim in this case arose from the rejection of a $0.80 per share offer for Christopher & Banks (“Company”) by the Company’s board of directors (“Board”) due to what Plaintiff Mark Gottlieb alleged was an underlying animosity between Defendant Jonathan Duskin, a director on the Board, and Justin Yoshimura, the offeror. Plaintiff alleged that in rejecting the offer, the directors breached their fiduciary duties of loyalty to the Company. On May 27, 2020 the court issued a partial ruling that Plaintiff had pled facts sufficient to trigger enhanced scrutiny under Unocal and that Plaintiff’s claims are derivative. To resolve the motion, the court had to determine, in the absence of a demand made by Plaintiff to the Board, whether demand would have been futile.

To assess validity of a derivative action the court relied on well-established law as to a director’s breach of duty of loyalty. A stockholder’s derivative claim may only proceed “if (i) the stockholder demanded that the directors pursue the corporate claim and they wrongfully refused to do so or (ii) demand is excused because directors are incapable of making an impartial decision regarding the litigation.” Plaintiff did not make a pre-suit demand. Therefore, the court applied the Rales and Aronson tests, with “significant analytical overlap”, to decide whether Plaintiff established, with enough particularity, that a pre-suit demand would have been futile because the directors were incapable of making an impartial decision.           

Under Rales, the more general and overarching test for futility, a plaintiff must prove that the Board, at the time litigation commenced, would not have exercised independent and disinterested business judgment in responding to the demand to file suit. The Aronson test is narrower and circumstance-specific, requiring plaintiffs to establish reasonable doubt that (1) the directors were disinterested and independent or (2) the challenged transaction was otherwise the product of a valid exercise of business judgment. The court in this case determined that both tests in effect ask the same question: “could the directors bring business judgment to bear on the demand?”

The court then analyzed the two prongs of Aronson to establish that Plaintiff failed to show futility under both prongs of the test.

Under the first prong of Aronson, the court found that Plaintiff offered no particularized factual allegation to establish that any director defendant other than Duskin was interested in the transaction. Instead, Plaintiff offered a conclusory entrenchment theory alleging that the Board fended off the bid to preserve their individual positions, but failed to show that any other member of the Board, let alone the needed majority of directors on the Board, had any ill will toward Yoshimura that would cause lack of independence with respect to the demand. 

Under the second prong of Aronson, the court found that Plaintiff offered no allegations that other directors had a non-corporate motive or that Duskin’s influence “was so powerful as to sterilize the other directors’ discretion.”

Mirroring Rales, the court found that entrenchment theory is insufficient to excuse a demand per se without particularized facts that the directors were motivated by entrenchment or other non-corporate considerations. Moreover, though the conduct may trigger the heightened scrutiny under Unocal, the court noted that a “bare-bones Unocal claim…does not amount to a per se determination that the transaction is inexplicable other than by bad faith.”

Defendants argued that the Board opted to stay the course in favor of a turnaround plan rather than accept the bid. The court further noted that even if the directors rejected the bid for entrenchment purposes, “the decision to reject the bid and stay the course on a turnaround plan is not so egregious as to be inexplicable other than by bad faith. To the contrary, staying the course could likely have had a legitimate business purpose.”

After applying the Rales and Aronson tests for demand futility, the court granted Defendants’ motion for summary judgment and dismissed Plaintiff’s complaint in its entirety for failure to demonstrate that a demand upon the Board to initiate litigation would have been futile. Under both tests, the facts pled by Plaintiff did not support any inference that the actions taken by the Board were inexplicable other than as bad faith and that the Board was unable to exercise independent and disinterested business judgment in response to a demand to file suit.

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