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Summaries and analysis of recent Delaware court decisions concerning business-related litigation.
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Chancery Finds “Constellation” of Personal and Professional Relations Between Directors and Controlling Stockholder Excuses Demand
A stockholder plaintiff seeking to bring a derivative claim on behalf of a corporation must first demand authorization from the board of directors or allege why making such a demand would be futile due to the board’s assumed partiality under the alleged facts and circumstances. One way of establishing demand futility is alleging with particularity significant personal or professional ties to an interested party, like a conflicted controlling stockholder. BGC Partners illustrates the type and degree of relationships that may excuse the pre-suit demand requirement and overcome a motion to dismiss under Court of Chancery Rule 23.1. This is a developing area of Delaware law, arguably involving a heightened sensitivity to the significance of personal relationships. As BGC Partners observes, the Delaware Supreme Court has reversed Court of Chancery findings of director independence in the demand futility context three times in the past four years.
In BGC Partners, utilizing related entities, a company’s controlling stockholder (Howard Lutnick of Cantor Fitzgerald and BGC Partners) caused the company to acquire another company he also controlled. Minority stockholders of the acquirer filed derivative claims against the controller, the related entities, and the board, alleging that the acquisition involved an overpayment for the target, where the controlling stockholder had a higher economic interest and would benefit from the overpayment. Defendants moved to dismiss under Court of Chancery 23.1 and 12(b)(6).
Applying the Aronson test for demand futility, the Court of Chancery found that plaintiffs’ allegations overcame the Rule 23.1 hurdle. Aronson asks whether the complaint’s particularized factual allegations create a reasonable doubt that: (1) the directors are disinterested and independent or (2) the challenged transaction was otherwise the product of a valid exercise of business judgment. Relying on established precedent, the Court declined to find that demand was excused under Aronson’s second prong based on the presence of a conflicted controlling stockholder in the transaction and the application of the entire fairness standard of review. As the Court explained, although a controller’s involvement is relevant to the Court’s assessment, it does not automatically excuse demand. However, the Court found that plaintiffs sufficiently alleged that the board lacked independence from the controlling stockholder based on a “constellation” of facts, excusing demand under Aronson’s first prong. Specifically, for the three outside directors who had supported the underlying transaction, plaintiffs alleged many years of professional relationships with the controlling stockholder, involving consistent unilateral appointment to boards of the stockholder’s various entities, and the consequent lucrative renumeration, as well as long-standing personal relationships, involving joint gala appearances, arrangements for a private museum tour, and extensive joint service involving a particular college. That lack of independence supported denying defendants’ motion to dismiss. Demand on the board was excused and plaintiffs stated a claim against the directors who approved the allegedly unfair transaction while beholden to the controlling stockholder.