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Summaries and analysis of recent Delaware court decisions concerning business-related litigation.
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Showing 168 posts in Derivative Claims.
Delaware courts typically apply the McWane first-filed doctrine to stay a later-filed Delaware case in favor of a case already pending in another jurisdiction involving substantially the same parties and issues. In this instance, Alphabet, Inc., a Delaware corporation, and the director defendants, relying on McWane and forum non conveniens, sought to stay or dismiss a second-filed Delaware stockholder derivative action in favor of a first-filed action in California raising similar breach of fiduciary duty and failure of oversight claims. Both litigations arose from alleged workplace harassment at Google by officers and similar allegations against executives and directors of its parent, Alphabet. At oral argument, Vice Chancellor Glasscock, from the bench, rejected the forum non conveniens argument, and explained in this opinion “it is difficult to imagine a derivative litigation involving a Delaware corporation, and alleging breaches of fiduciary duty by corporate directors or officers of that Delaware corporation, that is nonetheless subject to dismissal on forum non conveniens grounds; if such an animal exists, it is absent from the menagerie before me here.” The Court also exercised its discretion to deny the stay motion because (i) the McWane first-filed rationale carries less weight in the context of derivative actions, where Delaware’s interest in promoting well-crafted derivative complaints is more important than filing speed; (ii) the proceedings to date in California were limited to disputes over consolidating related actions and appointing lead counsel; and (iii) Delaware has a higher interest than California in applying Delaware’s common law of corporations and fiduciary duty to the novel issues of corporate law involved in the litigation.
Recently, the Delaware Supreme Court held in In re Investors Bancorp, Inc. Stockholder Litigation, 177 A.3d 1208 (Del. 2017) that stockholder approval of director self-compensation plans will shift the standard of review from entire fairness to business judgment only where the stockholders approve a plan that does not involve future director discretion in setting the compensation amounts. In Stein, the Court of Chancery applies Investors Bancorp and declines to dismiss a disloyal compensation claim, notwithstanding that the terms of the challenged compensation plans sought to absolve the directors of self-dealing claims and even though the plaintiff attacked only the compensation amount, not the process by which it was determined. More ›
Chancery Addresses the Direct and Derivative Claim Distinction and Demand Futility in the LLC Context
Plaintiff sued Defendants, who were supposed to manage the parties’ limited liability company, directly and derivatively for breaching the LLC agreement, and derivatively for breaching their fiduciary duties. In this decision, the Court of Chancery denies Defendants’ motion to dismiss and addresses, among other things, the direct versus derivative claim distinction under the Tooley test and demand futility under the Aronson v. Lewis test in the LLC context. Here, the LLC managers were deemed interested because they stood on both sides of the challenged transactions—i.e., the allegations that they stole millions from the LLC for themselves, for their other companies, for one of their spouses, and for one of their spouses’ companies. Thus, demand was futile as to the derivative claims, which also adequately stated viable causes of action under less stringent Rule 12(b)(6) standards.
This derivative action arose out of Uber’s acquisition of a self-driving vehicle firm named Otto, which involved former Google employees. Google sued Otto and Uber for alleged intellectual property infringement, resulting in Uber settling the dispute for $245 million. The plaintiff sued Uber’s directors for the acquisition, claiming they should have known better than to rely on their CEO’s promotions of the deal and his representations regarding the company’s due diligence findings under the circumstances.
This decision grants the defendants’ motion to dismiss under Court of Chancery Rule 23.1 pre-suit demand-on-the-board grounds. Applying recognized legal principles for that analysis, the Court held that the complaint lacked the necessary particularized allegations showing that pre-suit demand on the board would have been futile. In this regard, the plaintiffs’ allegations and argument had focused on the directors’ failure to inform themselves of specific due diligence findings rather than relying on management’s discussions of those issues, citing management’s alleged history of causing the company to engage in other misconduct as a supposed “red flag.” According to the Court, however, plaintiff alleged at most an exculpated duty of care claim, not a breach of the duty of loyalty. Central to the Court’s reasoning was the absence of other known misconduct involving the type of misconduct at-issue in the acquisition—the misappropriation of intellectual property. According to the Court, a board’s alleged awareness of an executive’s supposed bad character “is not a sufficient red flag … to convert a plain vanilla duty of care allegation into a persuasive pleading of bad faith on the part of the directors.” Under Delaware law, “there is a vast difference between an inadequate or flawed effort to carry out fiduciary duties and a conscious disregard for those duties.”
Under Delaware law, stockholders who wish to pursue a derivative claim on the corporation’s behalf face an important decision—whether to make a pre-suit demand on the board to handle the suit itself, or bring the suit oneself and plead that the board cannot disinterestedly and independently consider a pre-suit demand under the circumstances. Neither path is easy. More ›
Under the Delaware Supreme Court’s Gentile decision, a claim may be dual-natured, meaning partially derivative on behalf of the corporation and partially direct on behalf of the stockholder. One allure for plaintiffs of successfully pleading a dual-natured claim is avoiding the pre-suit demand-on-the-board requirements for purely derivative claims. So it is not uncommon for plaintiffs to try to plead and argue into Gentile. But Gentile has been limited to claims involving deals with a controlling stockholder that unfairly dilute the other stockholders of both economic and voting rights. The Delaware Supreme Court recently clarified that in its El Paso decision. And Delaware courts have been cautious in applying Gentile of late. More ›
A derivative complaint that meets the demand requirements of Rule 23.1 may be subject to later dismissal at the request of a properly formed and functioning special committee under the Zapata decision. Of course, such a request is subject to special scrutiny by the Court. This decision holds that Zapata does not apply in other contexts, such as when a plaintiff has been misled into making a pre-suit demand under the mistaken belief the Board was capable of making a Zapata-like decision.
This is an interesting decision for many reasons. It includes a comprehensive analysis of when demand on a board is not excused, when ignoring a forum selection clause constitutes prejudice sufficient to invoke a laches defense and why a named plaintiff cannot also be the attorney on the complaint. Perhaps its more lasting impact will be its holding that when directors are exculpated by a 102(b)(7) defense there cannot be an aiding and abetting claim against a third party who facilitated the actions alleged to be a breach of fiduciary duty.
In this decision, the Delaware Federal District Court applied the Delaware tests for deciding if demand is excused by the facts alleged in a derivative complaint. In dismissing the complaint, the Court held that simply pleading the Board should have known of business problems is not enough to excuse demand. The decision also notes several other defects in the complaint.
This is the rare decision that declines to approve the settlement of a derivative suit. The Court rejected the settlement because the proposed terms required the corporation, as a nominal defendant, to release breach of fiduciary duty claims against the director defendants in return for which those directors would agree to make disclosures already required by law. The Court viewed that agreeing to do what you had to do anyway as providing no real consideration for the release of the claims. This result illustrates the scrutiny the Court of Chancery applies to such settlements that affect corporate and stockholder rights.
When something bad occurs in a business, it now seems inevitable that the directors may be sued. The most popular form of suit now seems to be a securities claim based on a failure to have disclosed the danger the entity faced that has now come home to do it harm. This decision shows why securities claims are in fashion for those events. For as it points out, there is not liability under Delaware corporate law for simply failing to prevent harm to the corporation. Something more is needed to show the directors acted in bad faith, such as a red flag warning of the need to act to prevent the harm. Thus, the decision dismissed a complaint that only alleged the directors did not do as much as might have been done to prevent the bad events from harming their entity.
Court of Chancery Clarifies Nature of Dilution Claims in Charter-Liberty Broadband Equity Issuance and Allows Derivative Challenge to Proceed
This is the second notable decision arising out of litigation involving Charter Communication’s equity issuance to its largest stockholder, Liberty Broadband, in connection with other transactions. More ›
Several Court of Chancery decisions discuss the appropriateness of staying a derivative action pending a related securities laws action. Doing so relieves a company from the tension of having to defend against allegations of wrongdoing carried out by its directors or officers while at the same time a stockholder is seeking to prove those same claims against its directors and officers on its behalf. A stay also has the advantage of allowing the existence and size of any damages to be firmly established. This is another decision to add to that line of authority.
The pre-suit demand on the board requirement for derivative litigation usually is not excused solely by a sufficiently pled disclosure violation. Rather, as held in this decision and recently in Steinberg v. Bearden, 2018 WL 2434558 (Del. Ch. May 30, 2018), to excuse demand on an independent, disinterested, and duty-of-care-exculpated board on the basis that the directors face a substantial risk of liability for a disclosure violation, the complaint must sufficiently plead the disclosure violation was the product of bad faith. Absent sufficient non-conclusory facts on this point, the complaint will be dismissed.
This is an interesting decision for its discussion of when pre-suit demand on the board is not excused for a derivative complaint alleging the directors made improper disclosures to stockholders. Applying the well-known Rales test for demand futility, the Court’s focus here was on the absence of particularized allegations from which it was reasonable to infer that a majority of the directors deliberately caused the corporation to issue certain allegedly misleading statements. When that is the case in a suit relying on a bad faith claim, the board doesn’t face a substantial threat of personal liability capable of excusing demand.