Topic: Chancery Court Rule 23.1

Board’s Lack of Independence from Interested Director Excuses Stockholder Demand as Futile

By: Christopher B. Tillson and J. Tyler Moser

In Sciabacucchi v. Liberty Broadband Corp., et al., C.A. No. 11418-VCG (Del. Ch. July 26, 2018), the Delaware Court of Chancery denied in part a motion to dismiss brought by defendants Liberty Broadband Corporation (“Liberty”), Liberty’s largest stockholder, and the board of directors of Charter Communications, Inc. (“Charter,” and collectively “Defendants”), for failure to plead demand futility.  The Court ruled that the Plaintiff, a stockholder of Charter, pleaded sufficient facts to support a reasonable inference that the influence of Liberty’s largest stockholder would prevent the Charter board of directors from exercising independent and disinterested business judgment when considering a demand to bring a lawsuit on behalf of the corporation.

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Chancery Court Denies Motion to Dismiss a Breach of Contract Claim Based on Language in Limited Partnership Agreement

By: Scott E. Waxman and Stephanie S. Liu

In Ms. Mary Giddings Wenske, et al. v. Blue Bell Creameries, Inc., et al., the Delaware Chancery Court denied Defendants’ motion to dismiss a breach of contract claim, finding that Plaintiffs had pled a set of facts that allow a reasonable inference that Defendants breached the standards set forth in its partnership agreement.

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Court of Chancery Dismisses Derivative Suit for Failure to Demonstrate Demand Futility because Plaintiff Failed to Allege Particularized Facts

By: Charles Carter and Caitlin Velasco

In Steinberg on behalf of Hortonworks, Inc. v. Bearden, C.A. No. 2017-0286-AGB (Del. Ch. May 30, 2018), the Delaware Court of Chancery granted the defendants’ motion to dismiss the stockholder plaintiff’s derivative claims for breach of fiduciary duties under Court of Chancery Rule 23.1, because the plaintiff failed to make a pre-suit demand or demonstrate that doing so would be futile. The Court found that the plaintiff failed to plead particularized facts sufficient to raise reasonable doubt that a majority of the directors on the Hortonworks, Inc. board could have exercised their independent and disinterested business judgment in responding to a pre-suit demand. Read More

Chancery Court Allows Complaint Alleging Waste of Corporate Assets to Move Forward to Discovery as a Result of Extreme Facts

By Annette Becker and Rashida Stevens

In R.A. Feuer on behalf of CBS Corporation v. Sumner M. Redstone (C.A. No. 12575-CB (Del. Ch. April 19, 2018)), R. A. Feuer (“Plaintiff”), a stockholder of CBS Corporation (“CBS”) brought a derivative suit against the directors of CBS Corporation (“Board”) alleging corporate waste, bad faith, and unjust enrichment for compensation in excess of $13 million dollars paid to Sumner Redstone, the controlling stockholder, former executive chairman and chairman emeritus of CBS (“Redstone”).  The payments were made under an extreme set of circumstances that resulted in the claims partially surviving a Rule 23.1 motion to dismiss for failure to make a pre-suit demand on the board and a 12(b)(6) motion to dismiss for failure to state a claim upon which relief could be granted. Read More

MULTI-BILLION DOLLAR INVESTMENT MANAGER AND DIRECTORS REMAIN AT RISK

By: Kevin Stichter and Samira Torshizi

In Cumming v. Edens, et al., C.A. No. 13007-VCS (Del. Ch. Feb. 20, 2018), the Court of Chancery denied a motion to dismiss a derivative suit for breach of fiduciary duties brought by a stockholder of New Senior Investment Group, Inc. (“New Senior”) against New Senior’s board of directors (the “Board”) and related parties in connection with New Senior’s $640 million acquisition of Holiday Acquisition Holdings LLC (“Holiday”). The Court made clear that compliance with Section 144 does not necessarily provide a safe harbor against claims for breach of fiduciary duty and invoke business judgment review of an interested transaction. Because the complaint alleged with specificity “that the Board acted out of self-interest or with allegiance to interest other than the stockholders,” the court applied the entire fairness standard of review and concluded that the transaction was not fair to New Senior stockholders. Read More

Board’s Failure to Adhere to Best Practices in Drug Clinical Trial Does Not Excuse Stockholder Demand as Futile

By:  Remsen Kinne and J. Tyler Moser

In Wilkin v. Narachi, et al., and Orexigen Therapeutics, Inc., Civil Action No. 12412-VCMR (Del. Ch. February 28, 2018), the Delaware Court of Chancery granted a motion to dismiss brought by defendants (“Defendants”), directors and officers of biopharmaceutical company Orexigen Therapeutics, Inc. (“Orexigen”), for failure to plead demand futility under Court of Chancery Rule 23.1.  The Court ruled that the plaintiff, a stockholder of Orexigen (“Plaintiff”), did not plead sufficient facts to show that a substantial likelihood of liability prevented the directors from exercising independent and disinterested business judgment when considering a demand to bring a lawsuit on behalf of the corporation.

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Chancery Court Dismisses Derivative Claim Over Board’s Defensive Measures Against a Takeover as Stockholder Failed to Plead Specific Facts

By Rem Kinne and Peter Soskin

In Ryan v. Armstrong, et al., C.A. No. 12717-VCG (Del. Ch. May 15, 2017), the Delaware Chancery Court dismissed the derivative action brought by a Plaintiff-shareholder (“Plaintiff”) against specified members of the board of directors (“Defendants”) of nominal defendant The Williams Companies (“Williams”).  Plaintiff brought his claim against the Defendants without first demanding that the board pursue an action following Williams’ decision to allegedly undertake defensive measures against a takeover.  The court granted Defendants’ motion to dismiss holding that Plaintiff failed to plead facts demonstrating that an exception to the demand requirement of Court of Chancery Rule 23.1 applied.

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Court of Chancery Dismisses Derivative Action Against Board of Directors of UPS for Failure to Monitor

By: Michelle McCreery Repp and Joshua Haft

The Court of Chancery granted a motion to dismiss a shareholder derivative action brought against the board of directors of UPS for breach of their fiduciary duty of loyalty in which it was alleged that the board failed to monitor UPS’s compliance with laws governing the transportation and delivery of cigarettes, resulting in the government seeking approximately $180 million in a pending enforcement action against UPS. In ruling on the motion, the Court held that the plaintiffs did not adequately plead facts to support their contention that making a demand on the board of directors to take corrective action or pursue the claim would be futile, which is a prerequisite to a shareholder derivative action.

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Derivative Claims of Improper Demand Refusal for Grossly Negligent Investigations and Bad Faith Must Be Adequately Pled

By: Megan Wotherspoon and Calvin Kennedy

The court found that a board of directors’ decision to refuse demand in connection with a stockholder derivative claim satisfies the business judgment rule if the board’s investigation is reasonable and the board acts in good faith.  By this opinion, the court granted the defendants’ motion to dismiss under Court of Chancery Rule 23.1 in light of plaintiff’s failure to adequately plead improper demand refusal.

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Chancery Court Dismisses Derivative Breach of Fiduciary Duty Claims as Improperly Pled and the Requests for Declaratory Judgment as Not Ripe

By: Annette Becker and Makda Goitom

In Chester County Employees’ Retirement Fund v. New Residential Investment Corp., No. 11058-VCMR (Del. Ch. Oct. 7, 2016), the Court of Chancery granted the motion to dismiss brought by defendants (the members of the board of directors of New Residential Corp. (“New Residential”), its manager, the manager’s owner, and its controlling stockholder: (i) for an improperly pled derivative claim (with leave to replead) brought against the defendants for breach of fiduciary duty by the plaintiff, a stockholder of New Residential, (ii) for plaintiff’s failure to sufficiently plead futility in demanding that the board of New Residential bring the derivative suit, and (iii) as to declaratory judgments sought by plaintiff with respect to the Defendants’ liability under certain documents as not being ripe (with leave to replead).

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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.

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CHANCERY COURT DISMISSES STOCKHOLDER DERIVATIVE SUIT ON BEHALF OF ZYNGA, INC. ON GROUNDS OF FAILURE TO DEMONSTRATE DEMAND FUTILITY APPLYING THE RALES TEST

By: Shoshannah D. Katz and Alexa M. Ekman

In Sandys v. Pincus et al., C.A. No. 9512-CB (Del. Ch. Feb. 29, 2016), the Delaware Court of Chancery systematically dismissed claims brought in a stockholder derivative suit on behalf of Zynga, Inc. (“Zynga”), regarding alleged breaches of fiduciary duties in connection with Zynga’s secondary offering of its common stock, due to the plaintiff’s failure to demonstrate that the procedurally required demand upon Zynga’s board of directors to initiate such litigation would have been futile. The court applied the Rales test to assess demand futility, which required the plaintiff to prove reasonable doubt that the board at the time the litigation commenced was able to properly exercise its independent and disinterested business judgement in responding to a demand to file suit, and in doing so extended the scenarios in which to apply the Rales test.

Following the initial public offering (“IPO”) of its Class A common stock at $10 per share in December 2011, Zynga launched a secondary offering in April 2012 for $12 per share, in which various executives of Zynga and four members of Zynga’s board of directors (the “Participating Board Members”) were selling stockholders. To allow such participation in the offering by the various executives and the Participating Board Members, the underwriters agreed to the early release of certain lock-up agreements entered into by such executives and directors in conjunction with the IPO, and the audit committee of Zynga’s board of directors approved exceptions to the trading window restrictions set forth in Zynga’s 10b5-1 trading plan that otherwise would prohibit such sales by these individuals at the time of the secondary offering.

The secondary offering, including the selling stockholder participation, was approved by Zynga’s board of directors; however, of the eight members at such time, only seven were present to vote. The four Participating Board Members voted for the secondary offering, constituting the majority vote required to proceed. At the time the complaint was filed, Zynga’s board had increased to nine members, comprised of six members who served on Zynga’s board at the time of the secondary offering (of which only two were Participating Board Members) and three additional members who had since been added to Zynga’s board.

On April 4, 2014, the plaintiff, a stockholder of Zynga at all relevant times, filed suit and asserted three claims: (1) against the Participating Board Members, alleging breach of fiduciary duties by misusing Zynga’s confidential information when they sold shares in the secondary offering while in possession of materially adverse, non-public information, (2) against Zynga’s board of directors at the time of the secondary offering, alleging breach of the fiduciary duty of loyalty for approving the secondary offering and exempting the Participating Board Members from the trading window restrictions set forth in Zynga’s 10b5-1 trading plan, and (3) against Zynga’s board of directors and various Zynga executives at the time of the secondary offering alleging breach of fiduciary duties by failing to put controls in place to ensure adequate public disclosures and to avoid material omissions in its public statements.

The plaintiff brought each of the claims derivatively on behalf of Zynga, invoking Court of Chancery Rule 23.1, which requires the plaintiff of a derivative stockholder suit to make a demand upon the board of directors to initiate such litigation or demonstrate that such a demand would be futile. As the plaintiff in Sandys v. Pincus did not make a demand on Zynga’s board to initiate litigation, to over come the defendants’ motion to dismiss, the plaintiff needed to instead demonstrate such demand would be futile. To prove demand futility, Delaware courts apply one of two tests. The first, articulated in Aronson v. Lewis, 473 A.2d 805, 814 (Del. 1984), requires the plaintiff to plead facts that create a reasonable doubt either that the directors are disinterested and independent, or that the challenged transaction was otherwise the product of a valid business judgment (the “Aronson test”). The Aronson test does not apply when the board that would be considering the demand did not make a business decision which is being challenged in the derivative suit. The second test, articulated in Rales v. Blasband, 634 A.2d 927, 933-34 (Del. 1993), requires the plaintiff to create reasonable doubt that the board could have properly exercised its independent and disinterested business judgment in responding to the demand at the time the complaint was filed (the “Rales test”).

As demand futility is assessed claim by claim, the court addressed each of the three claims separately, first determining whether to apply the Aronson or Rales test. The court applied the Rales test for each claim. In doing so, the court analyzed whether the plaintiff created reasonable doubt that at least five of the nine directors of Zynga’s board at the time the complaint was filed were able to properly exercise his or her independent and disinterested business judgement in responding to a demand to file suit. According to the court, a director lacks independence when he or she is sufficiently beholden to someone interested in the litigation that he or she may be unable to consider the demand impartially. An interested director is one who receives from a corporate transaction a personal benefit not equally shared by the stockholders, such that he or she could face liability if the transaction were subjected to entire fairness scrutiny.

With respect to the first claim, the court applied the Rales test because the claim did not challenge a business decision of the board, but rather the Participating Board Members’ individual decisions to sell in the secondary offering. Applying the Rales test, the court concluded that of the members of Zynga’s board at the time the complaint was filed, only the two remaining directors that had sold shares and received a benefit, faced liability under the alleged claim. Thus, the remaining seven members were not interested directors. The court reviewed certain facts pled to ascertain whether the seven disinterested board members were beholden to the two remaining Participating Board Members, and found that facts such as friendship or co-ownership of an asset, each absent a bias nature, are insufficient to raise reasonable doubt as to independence. The court dismissed plaintiff’s first claim for failure to allege demand futility under the Rales test.

For the second claim, the court applied the Rales test because Zynga’s board composition had changed since the secondary offering, marking an expansion of the scenarios in which such test applies. In assessing whether Zynga’s board at the time the complaint was filed could impartially decide whether to pursue plaintiff’s second claim, the court stated that the mere fact that two board members are both partners in the same firm does not support the plaintiff’s theory that they would not want to initiate litigation against the other, as the plaintiff presented no evidence that they are beholden to one another or have a relationship aside from their partnership that would suggest otherwise. In addition, in response to plaintiff’s argument that non-selling directors of Zynga’s board at the time of the secondary offering are interested directors because of the litigation risk they would face in an entire fairness review applicable to such claim, the court stated that a plaintiff seeking monetary damages as a result of this claim must plead non-exculpated facts against a director who is protected by Section 102(b)(7) of the Delaware General Corporation Law. Since Zynga’s charter contains such exculpatory provision, plaintiff needed to demonstrate breaches of duty of loyalty, bad faith, or a conscious disregard for directorial duties. As the plaintiff failed to demonstrate such facts and thus to cast the required reasonable doubt, the court dismissed the claim.

Lastly, the court applied the Rales test to plaintiff’s third claim because the claim did not address a business decision of the board, but rather a violation of the board’s oversight duties. The court held that in the context of an alleged oversight violation, there is no transaction in which the directors may be interested. For directors to have a disabling interest, they must face a meaningful litigation risk with a substantial likelihood of personal liability for the violations. Due to the exculpatory provision in Zynga’s charter, its directors would not face likelihood of personal liability unless plaintiff pled exculpated facts. As no such exculpated facts were pled, the court dismissed this claim for failure to allege demand futility under the Rales test.

In sum, the court dismissed each of plaintiff’s claims due to plaintiff’s failure to demonstrate that a demand upon Zynga’s board to initiate litigation would have been futile, applying the Rales test for demand futility. Under the Rales test, plaintiff failed to prove reasonable doubt that Zynga’s board was able to properly exercise its independent and disinterested business judgement in responding to plaintiff’s demand to file suit.

Sandys v. Pincus et al.

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