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Chancery Finds Request for “Corrective Action” to be a Litigation Demand, Dismisses Derivative Claims for Failure to Plead Wrongful Refusal

Solak v. Welch, et al., C.A. No. 2018-0810-KSJM (Del. Ch. Oct. 30, 2019).

Under the Delaware Supreme Court’s decision in Spiegel v. Buntrock, 571 A.2d 767 (Del. 1990), a stockholder who makes a demand upon the board to address potential wrongdoing concedes that the board may properly decide whether to cause the corporation to bring suit.  That concession makes it more difficult to satisfy pleading standards in a later derivative suit.  In this recent decision, the Court of Chancery reviewed the law in this area and concluded that – despite a disclaimer to the contrary – the plaintiff’s pre-suit letter was a litigation demand.

The letter “suggest[ed] … corrective action” for alleged excessive director compensation.  It warned that the company was “more susceptible than ever to shareholder challenges” in this area.  It requested remedial measures, including setting limits for overall compensation.  It stated that, absent a satisfactory response, the plaintiff would consider “all available shareholder remedies.”  On the specific issue of whether it was a litigation demand, however, a footnote disclaimed “nothing contained herein shall be construed as a pre-suit litigation demand…”

Reviewing the letter, the Court reasoned that the “footnote disclaimer does not obviate the Court’s review of the [l]etter’s substance…” – because a plaintiff is not permitted to “cover all the bases” by demanding remedial actions while also purporting to reserve the right argue that a demand would be futile.  Instead, the Court evaluates the “substance of the communication objectively” to assess whether it gives notice of potential wrongdoing sufficient to allow the corporation to take corrective action.  No specific request that the corporation bring suit is required.  In addition, the remedies the plaintiff suggested “resemble therapeutic benefits commonly achieved in derivative lawsuits challenging non-employee director compensation.”  The Court also observed the letter was “nearly a carbon copy” of the plaintiff’s subsequent complaint, which also was prepared to provide notice of wrongdoing. 

The plaintiff’s complaint failed to allege wrongful refusal; it did not mention the demand letter or the company’s response.  The latter indicated that the board, with the help of counsel, had conducted an investigation, including review of pertinent documents and interviews.  The company’s response also provided merits-based reasons for not taking further action, and cited additional supporting considerations.  Accordingly, the Court granted the defendants’ motions to dismiss for failure to plead wrongful refusal.