Tag: Derivative Suit

Chancery Court Finds No Breach of Duty in Failed Corporate Inversion

By Joanna Diakos and Tom Sperber

In Kyle Ellis (AbbVie, Inc.) v. Richard A. Gonzalez, et al., the Delaware Chancery Court dismissed a derivative suit for failing to make a demand and to allege particularized facts demonstrating that demand would have been futile. Kyle Ellis (“Plaintiff”) alleged breaches of fiduciary duty by the CEO of AbbVie, Inc. (“AbbVie”), Richard A. Gonzalez (“Gonzalez”), and the individual members of AbbVie’s board of directors (“Director Defendants”) in connection with a proposed but ultimately abandoned corporate inversion between pharmaceutical giants AbbVie and Shire plc (“Shire”). The Court held that because AbbVie’s certificate of incorporation contained a Section 102(b)(7) exculpatory clause, Plaintiff had to allege that a majority of the board faced a substantial likelihood of liability for breaching the duty of loyalty in order for demand to be excused. Ultimately, Plaintiff failed to do that.

At all relevant times, Plaintiff was a minority stockholder of AbbVie, a Delaware corporation headquartered in Chicago, Illinois. Shire was an Island of Jersey biopharmaceutical company with its headquarters in Dublin, Ireland.

On July 18, 2014, AbbVie and Shire entered into an acquisition agreement. Pursuant to that agreement, AbbVie would acquire Shire for $54 billion worth of cash and stock of a new, wholly owned Jersey subsidiary (“New AbbVie”). Both AbbVie and Shire would then become wholly owned subsidiaries of New AbbVie, which would be headquartered in Ireland. Among other financial benefits that AbbVie stated when announcing the corporate inversion, the corporation cited tax savings from placing New AbbVie’s headquarters in Ireland rather than in the United States. On July 21, Gonzalez spoke at an investor conference. There, he reiterated the strategic rationales for the merger, stating that the avoidance of paying the higher US corporate tax rate was “clearly a benefit, but [] not the primary rationale.” On August 21, AbbVie filed a Form S-4 that outlined the strategic advantages of such a merger. Among nine other rationales for the transaction, the S-4 included the benefit of “the potential realization of tax and operational synergies by New AbbVie as a result of the Merger.”

On September 22, the Treasury Department announced that it would issue regulatory guidance that would eliminate some tax benefits that US-based corporations saw from merging with foreign companies through corporate inversions. One week later, AbbVie filed two Form 425s which included letters from Gonzalez and AbbVie Vice President Chris Turek. In their letters, Gonzalez and Turek assured employees of each company that the deal would close despite the Treasury Department’s announcement. On October 14, AbbVie announced that, in light of the regulatory shift, the board was reconsidering the merger. The next day, the board withdrew its recommendation and Shire’s stock price dropped substantially. AbbVie issued a press release on October 21 announcing the termination of the proposed merger and the payment of a $1.64 billion termination fee to Shire. Plaintiff’s complaint alleged that Gonzalez’s statements to investors in July as well as the letters included in the Form 425 filings in September amounted to breaches of fiduciary duty: Gonzalez’s statements had allegedly understated the importance of the inversion tax benefits in the decision to merge; and the Form 425 letters stated AbbVie’s intent to follow through with the merger, even though, according to Plaintiff, they had already abandoned that plan.

The defendants moved to dismiss Plaintiff’s complaint for failure to make a demand. Plaintiff argued demand-futility under the theory that the board could not impartially consider a demand because they faced a substantial likelihood of liability for the alleged material misrepresentations and omissions in the statements in question.

In finding that Plaintiff failed to sufficiently allege futility, the Court looked first to his allegation that the statements made to investors in July of 2014 were false or misleading. The Court cited Malone v. Brincat for the proposition that such a futility argument would require an allegation that the directors “deliberately misinform[ed] shareholders.” The Court identified that AbbVie’s charter’s exculpatory provision required Plaintiff to plead particularized facts that would lead to an inference that the board acted knowingly, intentionally, or in bad faith.

Plaintiff’s theory was that despite Gonzalez’s claim that tax arbitrage was but one of many motivations, realizing tax benefits was the “sole, or at least primary, rationale for the merger.” Plaintiff points to AbbVie’s press release after the decision had been made to abandon the merger, which stated that the recommendation to merge was withdrawn after a detailed consideration of the impact of the new tax rules. The Court found this argument conclusory. In so finding, the Court stated that while the tax benefits may have been necessary to the deal, it does not follow that they were the primary motivation of AbbVie. Ultimately, the Court found that Plaintiff would have had to allege that “most of the value” of the deal came out of the tax break in order to meet the heightened pleading standard of Rule 23.1. The Court also found that Plaintiff failed to allege with particularity that the Director Defendants were involved in the July statements made by Gonzalez.

The Court also examined Plaintiff’s second allegation that statements in the Form 425 letters were misleading in that AbbVie expressed a continued interest in pursuing the merger when, in reality, plans to merge had been abandoned as soon as the Treasury Department made its announcement. In arguing that the Director Defendants could face liability for these letters, Plaintiff argued that they must have authorized or at least known about these letters. The Court found only conclusory allegations regarding the Director Defendants’ involvement.

In arguing that the letters were misleading, Plaintiff explained that the defendants intentionally failed to correct the false statements in order to avoid paying interest on the $1.6 billion termination fee for the time difference between when the board began reconsidering the deal and when it ultimately terminated it. The Court pointed out that the Complaint itself alleged that the fee would be triggered only if and when the board withdrew or modified its recommendation. This meant that the fee would have been triggered on October 15, rather than when the board started having doubts, making Plaintiff’s argument flawed. While the Court conceded that the statements made by Gonzalez and Turek may have caused a “misimpression” that the deal would still close, the Court found that Plaintiff’s remaining allegations that the statements were made in bad faith were conclusory.

In addition to the “substantial likelihood of liability” theory, Plaintiff advanced two alternative arguments for futility which the Court largely disregarded. Plaintiff alleged that some defendants served on the Audit Committee and, presumably, that would limit their ability to be impartial. The Court cited the “well-settled rule that mere membership on a board committee is insufficient to support a reasonable inference of disloyal conduct.” Plaintiff also contended that the company’s insurance policy did not provide coverage for actions that the company brings against its directors. In rejecting that argument, the Court pointed to the rejection of a similar argument made by the plaintiff in Decker v. Clausen, characterizing it as an assertion that the directors cannot be impartial if they are “suing themselves.”

As such, Plaintiff failed to adequately plead any of his claims to the extent required by Rule 23.1, resulting in the Court granting the defendants’ motion to dismiss with prejudice.

Kyle Ellis… v. Richard A. Gonzalez, et al., and AbbVie, Inc., nom. def…

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

Class Action Dismissed as Demand was Not Excused as Futile; Plaintiff Failed to Allege Facts Sufficient to Establish that a Majority of the Board Faced Substantial Likelihood of Liability for Non-Exculpated Claims

By: Annette Becker and Will Smith

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.

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IN MERGER-RELATED SUIT, ATTORNEY-CLIENT PRIVILEGE PREVAILED OVER GARNER CHALLENGE

By: Kevin Stichter and Nathan G. Harrill

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.

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Court of Chancery Dismisses all Claims Brought by Minority Stockholder

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.

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Chancery Court Holds More than Red Flags Required to Allege Demand Futility in a Derivative Suit

By:  Annette Becker and Will Smith

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.

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Chancery Court Dismisses Inseparable Fraud Claim Based on Derivative Claims That Former Shareholders Lacked Standing To Maintain

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.

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Failure to Make Demand to the Board of Directors Dooms 50% Owner’s Breach of Fiduciary Duty Claims Against Co-Owner

By: Michelle McCreery Repp and Benjamin Kendall

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.

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Chancery Court Blocks Former Judge From Serving On LLC Special Litigation Committees

By: Scott E. Waxman and Trevor M. Gates

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.

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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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