Background

The plaintiff, a longtime and substantial stockholder owning a 36% equity interest, was entitled to designate one director on the company’s five-person board. That stockholder’s director sought books and records and thereafter the plaintiff brought this action against the company’s chief executive officer and chief technology officer, who also were members of the board. The complaint at issue challenges misconduct in connection with unilateral increases in CEO compensation, accounting irregularities, and financial disclosures regarding loans and down round financing. The five-person board in place at the time of the amended complaint when the plaintiff first asserted derivative claims consisted of one disinterested and two interested directors. The court dismissed the action because the plaintiff failed to allege particularized facts sufficient to show that the two other directors could not impartially evaluate the allegations of the complaint.

• Court Finds Plaintiff Failed to Allege Particularized Facts Showing a Majority of the Directors Was Disabled From Considering a Demand

The plaintiff argued that demand was futile based on two non-defendant directors being beholden to the CEO. Were that so, then in combination with the defendant directors, three out of the five directors would be unable to act disinterestedly in evaluating a demand. The plaintiff could not allege a substantial risk of personal liability because the directors were subject to exculpation under Section 102(b)(7) of the DGCL. That meant that they only could be subject to a substantial risk of liability if the plaintiff alleged specific facts that the directors acted disloyally in the transactions at issue, benefited personally from those transactions or were beholden to an interested party and hence unable to act independently in assessing a demand.  The plaintiff alleged no facts that either of the two directors benefited from the transactions tje plaintiff challenged. The court rejected the plaintiff’s argument that the mere fact that a director approved the transactions at issue or that a defendant appointed a director to the board sufficed to taint independence. The plaintiff alleged no additional disqualifying facts, such as material social or financial relationships with the CEO. Finally, the court held that the mere fact that the CEO appointed one of the directors to the board 16 months after he had fired another director who had disagreed with the CEO did not demonstrate that the director was beholden to the CEO. In so holding, the court distinguished the totality of the facts from other cases where the termination of a director was part of the mix of facts that demonstrated a lack of independence due to fear of retaliation.

• A Court Will Not Allow a Derivative Action to Proceed if Plaintiff Cannot Allege Particularized Facts That a Majority of the Board Is Unable Impartially to Consider a Demand

A Delaware court requires particularized factual allegations that the judgment of a majority of the Board is sterilized from impartially considering a demand to allow a plaintiff to proceed with a derivative action based on demand futility. If a plaintiff cannot allege a financial interest in the challenged transactions, a substantial risk of personal liability or lack of independence from an interested or disloyal fiduciary, then the court will dismiss the action under Rule 23.1 of the Court of Chancery rules. The mere fact that an interested party elects or appoints a director to the board, without more, does not suffice. The Harrison case reflects the Court of Chancery’s application of well-settled principles in assessing the adequacy of plaintiff’s factual allegations to rebut the presumption that directors act independently and in the best interests of the company and its stockholders.

Delaware Business Court Insider | April 10, 2024