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
In Lenois, et al. v. Lawal, et al., and Erin Energy Corporation, C.A. No. 11963-VCMR (Del. Ch. November 7, 2017), plaintiff Robert Lenois (“Plaintiff”) on behalf of himself and other stockholders brought a class action for breach of fiduciary duty against controllers and the board of directors of Erin Energy Corporation (“Erin”) for approving what was claimed to be an unfair transaction. The Delaware Court of Chancery dismissed the class action suit under Court of Chancery Rule 23.1, holding that the directors were protected by an exculpatory charter, and Plaintiff failed to meet the heightened pleading standard for demand futility set by the second prong of Aronson v. Lewis, 473 A.2d 805 (Del. 1984). Although Plaintiff pled with particularity that one director acted in bad faith, the complaint did not allege facts sufficient to establish that a majority of the board faced a substantial likelihood of liability for non-exculpated claims.
In Salberg v. Genworth Financial, Inc., C.A. No. 2017-0018-JRS (Del. Ch. July 27, 2017), the Delaware Court of Chancery denied the demand by the plaintiff stockholders (the “Stockholders”) for books and records from defendant Genworth Financial, Inc. (“Genworth”) under Section 220 of the Delaware General Corporation Law. Genworth asserted the attorney-client privilege and the Stockholders sought to invoke the “celebrated” Garner fiduciary exception. While the § 220 demand was made in the context of a pending merger, influential to the ruling was the fact that the requested books and records were relevant to a separate derivative action among the same parties. Although most of the Garner “good cause” factors weighed in favor of an exception to the privilege, the court held that the unique facts and circumstances surrounding the Stockholders’ demand barred them from accessing privileged information that was shielded from discovery in the derivative suit.
By Shoshannah Katz and Tom Sperber
In Francis M. Ford (VMware Inc.) v. VMware Inc. C.A. No. 11714-VCL (Del. Ch. May 2, 2017), the Delaware Court of Chancery granted defendants’ motion to dismiss the plaintiff’s complaint in full for failing to state a claim upon which relief can be granted. Francis M. Ford (“Plaintiff”) alleged breaches of fiduciary duty against VMware Inc. (“VMware”), EMC Corp. (“EMC”), Denali Holding Co. (“Denali”), Dell Inc. (“Dell”), Universal Acquisition Co. (“Universal”), and several directors of these companies. Plaintiff was a minority stockholder of VMware prior to a merger between EMC, VMware’s controlling stockholder, and Denali that closed in September 2016. The Court held that Plaintiff failed to allege that the parties to the merger breached any fiduciary duties to the VMware stockholders or that the parties otherwise bound VMware to unfair terms. The Court also found that the restructuring of VMware prior to the merger was subject to the business judgment rule, and that Plaintiff failed to sufficiently plead that Denali’s issuance of a tracking stock reflecting the performance of VMware’s stock price was a misappropriation or a wrongful dilution.
In In re Qualcomm Inc. FCPA Stockholder Derivative Litigation, C.A. No. 11152-VCMR (Del. Ch. June 16, 2017), the Delaware Court of Chancery granted a motion to dismiss brought by defendants for failure to state a claim and for failure to make demand or to allege demand futility with sufficient facts, dismissing the plaintiff-stockholders’ derivative action on Court of Chancery Rule 23.1 grounds. The court held that the plaintiffs failed to support the inference that the board acted in bad faith pursuant to a Caremark claim for breach of fiduciary duties and found that the plaintiffs’ proffered documentary evidence suggested that the defendant-directors had yielded to—rather than charged after—red flags raised about the Qualcomm’s compliance with federal anti-bribery laws.
By Scott E. Waxman and Russell E. Deutsch
In In re Massey Energy Company Derivative And Class Action Litigation, C.A. No. 5430-CB (Del. Ch. May 4, 2017), the Chancery Court dismissed both the direct class action claim for “inseparable fraud” and the derivative claim brought by the former shareholders of Massey Energy (“Massey” or the “Corporation”) against the former directors and officers of Massey for breaching their fiduciary duties by causing Massey to operate in willful disregard of safety regulations. The court dismissed the derivative claim holding that the plaintiffs were not continuous shareholders, and therefore lacked standing to bring a derivative claim after Massey merged into Alpha Natural Resources, Inc. (Alpha) in June of 2011. The court dismissed the plaintiffs’ direct claim for “inseparable fraud” claim holding that, though pled as a direct claim, it was, in fact, also a derivative claim that the plaintiffs’ lacked the standing to maintain.
In Dietrichson v. Knott, C.A. No. 11965-VCMR (Del. Ch. Apr. 19, 2017), the Chancery Court dismissed the entire complaint brought by one member of a limited liability company against another member for paying himself an unauthorized salary and misappropriating the proceeds of a sale of the company’s assets, concluding that the claims made were derivative rather than direct stockholder claims. The Court also held that plaintiff’s claims were not “dual-natured” (i.e., having both direct and derivative aspects), because the plaintiff failed to plead that the transaction resulted in both an improper transfer of economic value and voting power from the minority equity holders to the controlling equity holder.
In Obeid v. Hogan, No. CV 11900-VCL (Del. Ch. June 10, 2016), the Delaware Court of Chancery prevented a former federal judge from serving as the sole member of parallel special litigation committees formed to assess derivative actions because he was not a director or manager of the respective limited liability companies (“LLCs”). In reaching this decision, the court followed corporate precedent in interpreting an LLC agreement because of the LLC’s “corporate-style governance structure.” The court concluded an LLC board of directors could therefore delegate authority to a committee to take control of a derivative action, under certain circumstances, but that authority could not be delegated to a non-director/non-member in this instance.
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.
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.