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Recent Cases Emphasize the Holistic Evaluation of Director Independence in the Demand Futility Context

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November 12, 2019
Albert J. Carroll and Matthew F. Lintner
Delaware Business Court Insider

A derivative claim for harm befalling a corporation belongs to the corporation itself. Under the state’s board-centric model of corporate governance, Delaware law empowers the board of directors to control such claims, provided the directors are sufficiently impartial on the subject. A shareholder plaintiff therefore must either make a pre-suit demand on the board to take action concerning the prospective derivative claim or plead with particularity that a pre-suit demand would be futile, i.e., a majority of the board is interested or lacks independence on the claim’s subject.

Delaware law has long recognized that significant personal or professional ties to a party who would be a defendant in the prospective derivative claim, like a conflicted controlling stockholder, is grounds for finding a director lacks independence. Recent decisions from the Delaware Supreme Court provide a useful road map for this area of the law, as recognized in one of the latest Delaware Court of Chancery decisions addressing the issue: In re BGC Partners Derivative Litigation, Consol. C.A. No. 2018-0722-AGB (Del. Ch. Sept. 30, 2019).

Background

BGC Partners involved billionaire businessman Howard Lutnick, the controlling shareholder of the global financial services firm Cantor Fitzgerald, and also of BGC Partners (the company). The action concerned BCG Partners’ acquisition of another company also controlled by Lutnick, Berkeley Point Financial LLC. Minority stockholders of BGP Partners filed derivative claims for breach of fiduciary duty against Lutnick and the board of directors arising out of the transaction, alleging that the company overpaid, benefiting Lutnick given his greater economic interest in Berkeley Point. The defendants moved to dismiss the claims, including on demand-required grounds under Court of Chancery Rules 23.1.

Chancery Finds a Lack of Independence

The Court of Chancery declined to grant dismissal on the basis that a demand was required, finding plaintiffs sufficiently pleaded that a majority of the board was interested or lacked independence from Lutnick. Since the claim challenged affirmative board action, the court’s review of the allegations was governed by the demand-futility test articulated in Aronson v. Lewis, 473 A.2d 805 (Del. 1984). The Aronson test asks whether the complaint’s particularized factual allegations create a reasonable doubt that: the directors are disinterested and independent, or the challenged transaction was otherwise the product of a valid exercise of business judgment.

Applying that test, the court first declined to hold that demand was excused simply because a conflicted controlling stockholder was involved in the challenged transaction, triggering the entire fairness standard of review. As the court explained, while Delaware law is “more suspicious” when the interested fiduciary is a controlling stockholder, a conflicted controller’s involvement does not automatically excuse demand under the second prong of Aronson.  Instead, a controlling stockholder’s presence and influence “is an important factor that should be considered in the director-based focus of the demand futility inquiry under the first prong of Aronson, particularly on the issue of independence.”

Turning to the director-based analysis required under the first prong of Aronson, Lutnick concededly was interested and, according to the court, the plaintiffs sufficiently alleged that three of the company’s four other directors lacked independence from him. As the court explained, when assessing independence, Delaware law does not “ignore the social nature of humans or that they are motivated by things other than money, such as love, friendship and collegiality.” Mere assertions of a close relationship are insufficient. But when a plaintiff pleads specific facts about the relationship’s length and closeness, all reasonable inferences will be drawn in the plaintiff’s favor, considering the allegations in totality. “In short, a plaintiff must allege a ‘constellation of facts that, taken together, create a reasonable doubt about [the director]’s ability to objectively consider a demand.’”

The court went on to observe that director independence in the demand futility context is a recently refined area of the law. As the court articulated, on three occasions over the past four years the Delaware Supreme Court has reversed Court of Chancery findings of director independence under a de novo standard of review. The court briefly examined the decisions in Delaware County Employees Retirement Fund v. Sanchez, 124 A.3d 1017 (Del. 2015), Sandys v. Pincus, 152 A.3d 124 (Del. 2016), and Marchand v. Barnhill, 212 A.3d 805 (Del. 2019), finding they “reinforce the importance of considering a plaintiff’s factual allegations holistically and affording the plaintiff all reasonable inferences.”

Applying that guidance to this case, the court found the requisite constellation of facts creating reasonable doubt about the impartiality of the three relevant directors who had supported the transaction, citing long-standing personal and professional relationships between Lutnick and those individuals. The first director had ties to Lutnick dating back 20 years, with consistent lucrative appointments to boards of Cantor-affiliated entities, and significant social interactions, including joint gala appearances and arrangements for a private tour at a prominent museum for family members. The second director had ties to Lutnick dating back 10 years, with similar lucrative appointments to boards of Cantor-affiliated entities, and significant ties involving Haverford College, Lutnick’s alma mater and a favorite recipient of his largess. The third director also had ties to Lutnick dating back 10 years, with similar lucrative appointments to boards of Cantor-affiliated entities, and significant ties involving Haverford College. With a majority of the five-member board either interested or lacking independence, pre-suit demand by the plaintiffs would have been futile. Accordingly, dismissal under Rule 23.1 was unwarranted.

Key Takeaway

BGC Partners illustrates the type and degree of relationships that may excuse the pre-suit demand requirement while exemplifying the realistic and holistic view employed by Delaware courts concerning the significance of personal and professional relationships when assessing director independence in the demand futility context.

Delaware Business Court Insider, November 6, 2019

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