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Court of Chancery Grants Special Litigation Committee’s Dismissal of 'Carvana' Derivative Action

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May 14, 2024
By: Albert Carroll
Delaware Business Court Insider

Boards of Delaware corporations control the company’s assets, which includes by default derivative claims for breach of fiduciary duty against the company’s directors and officers.  When derivative claims survive dismissal because demand is excused with respect to the full board, a powerful tool remains at the board’s disposal to reassert control and, in the right conditions, elect to dismiss the claims: a special litigation committee comprised of independent and disinterested directors. In re Carvana Stockholders Litigation, Consol. C.A. No. 2020-0415-KSJM (Del. Ch. Mar. 27, 2024) is another example of a board successfully employing this process to discontinue a derivative suit after directors weighed the pros and cons and made a good faith business judgment to dismiss.  


This action concerned a direct offering made by the online used car retailer, Carvana, in March 2020. That offering followed some disruption at the onset of the COVID-19 pandemic that prompted the board to seek a quick financing solution. The direct offering was capped at $600 million at a price of $45 per share, which represented an 8.2% discount to the stock’s unaffected trading price. The company’s controlling stockholders, Ernest Garcia II and Ernest Garcia III, participated in the offering for $50 million. The company rebounded in the months after the offering. By the end of 2020, the stock price closed at nearly $240 per share. And over several months in late 2020, Garcia II sold approximately $1 billion worth of his shares.  

Stockholder plaintiffs initiated a breach of fiduciary duty action in Delaware, alleging that the Garcias enriched themselves by forcing a rushed and unnecessary offering at a depressed price. The Delaware Court of Chancery denied an initial motion to dismiss by the defendants, finding that two of the company’s six directors lacked independence from the Garcias, with Garcia III also on the board and interested in the challenged transaction, thereby excusing demand on the full board. Afterwards, the Carvana board formed a two-member special litigation committee and took control of the claims. The SLC stayed the litigation and investigated the claims with the help of legal and financial advisors. Supported by a 170-page report, the SLC eventually determined that no wrongdoing occurred, that the costs of suit outweighed the likely benefit, and that dismissal therefore would be in the company’s best interests. The plaintiffs opposed dismissal. 

The Court of Chancery Finds the SLC Independent and Its Investigation and Conclusions Reasonable

The Court of Chancery evaluated the SLC’s motion to dismiss under the two-step standard for special litigation committees set-forth in Zapata v. Maldonado, 430 A.2d 779 (Del. 1981). Zapata first places the burden on a committee to establish its independence and that it, in good faith, undertook a reasonable investigation and had reasonable grounds for its conclusions. In the second step, Zapata requires the trial court to apply its own business judgment to determine if dismissal is in the company’s best interests. 

Applying Zapata, the court found that the Carvana SLC was independent, rejecting the plaintiffs’ numerous arguments to the contrary. First, the fact that management recommended the SLC’s chosen counsel did not impugn the SLC’s independence. Second, the committee members’ status as co-defendants in litigation alongside the Garcias also did not affect their independence because that concurrent litigation concerned actions post-dating and unrelated to the challenged offering. Third, the plaintiffs failed to show that the SLC members prejudged the investigation, either via their participation in the board’s approval of the offering or their support of or acquiescence in the failed motion to dismiss. As the court explained, a director’s approval of a challenged transaction does not alone establish the director’s inability to impartially consider related claims. And a director’s presence on a board when a motion to dismiss is filed does not create a disabling conflict unless the director “approved or participated in a substantive way in the decision to file the motion.” No such substantial participation was alleged here. Finally, apparently minor business dealings between one of the SLC members and Carvana or the Garcias did not rise to the level of compromising that director’s independence. 

The court also found that the SLC conducted a reasonable investigation in good faith. The SLC’s investigation persisted for seven months, involved the review of tens of thousands of documents, 16 witness interviews, and nine formal committee meetings. The committee appropriately relied in good faith on substantive investigatory work delegated to its advisers.  And the SLC members remained engaged in overseeing the process, including involvement in document production decisions and in counsel’s interviews of the key witness. The committee’s report also evidenced consideration of all aspects of the plaintiffs’ complaint, including Garcia II’s subsequent stock sales and the Garcias’ alleged nonratable benefit. The committee also established reasonable bases for its conclusions, with its lengthy report marshalling supporting evidence and relevant law. The plaintiffs’ various quibbles with the investigation process, scope, and conclusions were insufficient to raise a material question about the SLC’s reasonableness or good faith. Indeed, in reaching its conclusions, the court observed that the SLC’s work compared favorably to special litigation committee investigations upheld by the Court of Chancery in prior decisions. 

Finally, and supported by its rejection of the plaintiffs’ various attacks on the SLC’s process and conclusions, the court found that the SLC’s recommended dismissal, as required, fell “within a range of reasonable outcomes that a disinterested and independent decision maker for the corporation, not acting under any compulsion and with the benefit of the information then available, could reasonably accept.” Accordingly, the court granted the SLC’s motion and dismissed the action. 

Key Takeaway

Carvana reinforces Delaware’s deference to independent decision-makers and illustrates the utility of special litigation committees. As Carvana demonstrates, a fully empowered committee may choose to dismiss rather than settle, pursue, or delegate to the stockholder plaintiff the at-issue derivative claims. At bottom, the Zapata committee structure affords disinterested and independent directors the opportunity to act in the company’s best interests regarding a pending suit, considering all factors relevant to a good faith business judgment, and detached from the plaintiff-firm profit motives underlying most stockholder derivative litigation. 

Delaware Business Court Insider | May 15, 2024

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