Chancery Questions Utility of Aronson Test, Dismisses Derivative Suit of Facebook Stockholder for Failure To Allege Demand Futility

Morris James LLP

United Food and Comm. Workers Union v. Zuckerberg, C.A. No. 2018-0671-JTL (Del. Ch. Oct. 26, 2020)
In its recent decision in United Food and Comm. Workers Union v. Zuckerberg, the Court of Chancery discussed the legal tests to demonstrate demand futility in derivative actions under the seminal cases of Aronson and Rales. Reconciling longstanding and recent case law, the Court ruled that demand futility turns on whether at the time of filing of the complaint, the majority of a board of directors is disinterested, independent, and capable of impartially evaluating a litigation demand to bring suit on behalf of a company.

This derivative suit followed prior litigation that challenged a proposed, board-approved reclassification of Facebook stock that would have enabled Mark Zuckerberg to sell significant quantities of his stock without attendant stockholder voting rights to maintain his present level of control over Facebook. On the eve of trial in the prior litigation, Zuckerberg asked the Facebook board to withdraw the proposed reclassification. The plaintiff then filed derivative claims for breach of fiduciary duties, seeking damages in connection with the board’s approval of the stock reclassification. 

The Court held that plaintiff failed to adequately plead demand futility under Court of Chancery Rule 23.1. Conducting a director-by-director analysis of the Facebook board, the Court found that the nine-member board could impartially consider a litigation demand if at least a majority, or five members, could exercise independent and disinterested judgment regarding a litigation demand. Two members were outside directors, who had joined the board after the proposed reclassification had been approved, and plaintiff had failed to plead non-conclusory allegations that called into question their disinterest or independence. For three other members, their alleged business relationships with Facebook or personal relationships with Zuckerberg did not support any inference that they were unable to independently consider a litigation demand. Nor did plaintiff plead any facts that would support a pleading-stage inference that they had received personal benefits from the proposed reclassification or committed a non-exculpated breach of fiduciary duty, and thus could face personal liability in the derivative litigation, as a result of voting to approve the reclassification. 

In sum, the Court found that demand was not excused because a majority of the Facebook board was disinterested, independent, and capable of impartially considering a litigation demand regarding the board’s approval of the stock reclassification. Accordingly, the Court dismissed the complaint based on plaintiff’s failure to plead demand futility.   

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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