Source: https://www.jdsupra.com/legalnews/delaware-supreme-court-examines-24892/
Timestamp: 2019-04-21 09:03:18+00:00

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Delaware law provides important tools for directors to maintain control of derivative lawsuits.1 One such tool is the “demand requirement” embodied in Court of Chancery Rule 23.1, which requires that before a stockholder acts on behalf of the corporation, the stockholder must either demand that the board take action or establish that demand would be futile. The seminal opinion of the Delaware Supreme Court in Aronson v. Lewis established the test used by Delaware courts in determining whether a plaintiff stockholder’s demand would have been futile: Has the plaintiff stockholder seeking to proceed with a claim on behalf of the company pleaded particularized facts creating a “reasonable doubt” that either (1) the directors are disinterested and independent, or (2) the challenged transaction was otherwise the product of a valid exercise of business judgment? 473 A.2d 805, 814 (Del. 1984).
In two recent opinions — Sandys v. Pincus, 152 A.3d 124 (Del. 2016) and Delaware County Employees Retirement Fund v. Sanchez, 124 A.3d 1017 (Del. 2015) — the Delaware Supreme Court applied the Aronson test for demand futility under Rule 23.1. These two opinions, along with other recent cases, illuminate certain guideposts under Delaware law for assessing director independence and disinterestedness. As then-Chief Justice Leo E. Strine, Jr. observed in Sanchez, however, it remains true that “[d]etermining whether a plaintiff has pled facts supporting an inference that a director cannot act independently of an interested director for purposes of demand excusal under Aronson can be difficult.” Sanchez, 124 A.3d at 1019.
In Sandys, a Zynga stockholder brought derivative claims for breach of fiduciary duty against certain directors and officers of the company who sold shares in a secondary stock offering in April 2012. Shortly after the secondary offering, the company’s per-share trading price fell dramatically. The plaintiff alleged that the directors and officers traded improperly on the basis of their inside knowledge of the company’s declining performance. At the time the complaint was filed, the board was comprised of nine directors, only two of whom had sold shares in the secondary offering. The Court of Chancery held that the plaintiff had failed to allege facts that would create a reasonable doubt as to the ability of a majority of the board to act independently for purposes of considering a derivative demand, and it therefore dismissed the complaint.
In Sanchez, the Delaware Supreme Court reversed a finding of the Court of Chancery that a director was independent for purposes of analyzing demand excusal under Rule 23.1. 124 A.3d 1017 (Del. 2015). The Supreme Court held that “it is important that the trial court consider all the particularized facts pled by the plaintiffs about the relationships between the director and the interested party in their totality and not in isolation from each other.” Specifically, the court found one director lacked independence because of the alleged facts that the director (1) was the interested director’s “close personal friend of a half century,” (2) “derives his primary employment from a company over which [the interested director] has substantial control” and “has a brother in the same position.” In so ruling, the court noted that plaintiffs’ allegation of friendship went beyond “the kind of thin social-circle friendship” that was at issue in Beam v. Stewart, where the court rejected a challenge to directors’ independence that was based on the allegation that the directors “moved in the same social circles, attended the same weddings, developed business relationships before joining the board, and described each other as ‘friends.’” Id. at 1022 (quoting Beam, 845 A.2d 1040, 1051 (Del. 2004)).
Director independence is commonly understood in the context of stock exchange listing requirements, and while those standards are, in some ways, analogous to the analysis under Delaware law, they are not co-extensive. Sandys, 152 A.3d at 131 (Del. 2016). For example, in Sandys, while the Delaware Supreme Court considered a director’s independence designation under the stock exchange listing requirements in determining independence under Delaware law, it explained that the two inquiries “do not perfectly marry,” and stock exchange listing requirements are “relevant under Delaware law,” though not dispositive. Id. In particular, the analysis under Rule 23.1 is specific to the transaction or board decision the stockholder plaintiff is challenging. There are several other Delaware opinions that address the independence of a director for Rule 23.1 demand excusal purposes that demonstrate the fact-intensive nature of the inquiry, which does not easily lend itself to any bright-line rules.
a third director was a partner in a private equity firm that had invested in several start-ups affiliated with the controlling stockholder, because the court found that the alleged conflict of interest did “not provide continuous ongoing revenue to” the private equity firm or present an opportunity for the firm to profit from the challenged transaction at issue in the case.
In another case, the Court of Chancery examined whether a director could impartially consider a demand to challenge a services agreement entered into between the company and its alleged controlling entity. Teamsters Union 25 Health Services & Insurance Plan v. Baiera, 119 A.3d 44, 59 (Del. Ch. 2015). The court found that the director was independent despite allegations that the director had been an executive of the controlling entity or the controlling entity’s parent for 16 years, had been CEO of the controlling entity’s affiliate and had been elected to the board of the company shortly after leaving employment with the controlling entity’s affiliate.
the other had provided outside legal services to and later served as in-house counsel at another company at which the compensation committee member had been a senior vice president, and (like the compensation committee member) had joined the company’s board as a nominee of the same other company where they had both previously worked.
a board of another company previously determined that the third director was “too connected” with the controlling stockholder to play a significant role in the merger negotiation between that other company and a company owned by the controlling stockholder.
the fourth director’s family owned a minority stake of an entity that was majority owned by the company and had several family members who were employees of the same entity; and the fifth director personally participated in the decisions to approve the services agreements, even after indications of problems had arisen, and, although retiring from the board since approving the services agreements, immediately returned to the board after the services agreements were terminated by other directors.
two other directors each were appointed to the board by the control group, were appointed to several other boards of other companies by the control group and had expectations of future dealings with the control group because all are in the same business of restructuring distressed companies.
These opinions continue the development of Delaware law in assessing whether a director is sufficiently disinterested and independent to consider a demand impartially, and thereby whether a stockholder may pursue a claim derivatively on the corporation’s behalf. Taken together, they suggest that Delaware courts will examine the totality of a plaintiff stockholder’s factual allegations in each situation to evaluate whether a director’s personal or business relationships “give rise to human motivations compromising the participants’ ability to act impartially toward each other on a matter of material importance.” Sandys, 152 A.3d at 126. The number of derivative lawsuit filings appears to be increasing, and in many instances, are preceded by a Section 220 demand on the company for books and records to support such a filing. Boards encountering this circumstance should carefully consider, along with their advisers, whether these rulings implicate their ability to maintain control over the corporation’s claims under Rule 23.1.
1 Whether a claim is direct or derivative under Delaware law turns on whether it was the corporation or the suing stockholder, individually, who suffered the alleged harm and who would receive the benefit of the recovery or other remedy. See Tooley v. Donaldson, Lufkin & Jenrette, Inc., 845 A.2d 1031, 1036 (Del. 2004).
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