Delaware Supreme Court Decision Creates New Paradigm for Derivative Claims

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On September 23, the Delaware Supreme Court issued a decision replacing the long-standing Aronson test for demand futility and instead adopts and affirms a new universal Rales-like test applied below by Vice Chancellor Laster as follows: 

From this point forward, courts should ask the following three questions on a director-by-director basis when evaluating allegations of demand futility:

  1. Did the director receive a material personal benefit from the alleged misconduct that is the subject of the litigation demand?
  2. Does the director face a substantial likelihood of liability on any of the claims that would be the subject of the litigation demand?
  3. Does the director lack independence from someone who received a material personal benefit from the alleged misconduct that would be the subject of the litigation demand or who would face a substantial likelihood of liability on any of the claims that are the subject of the litigation demand?

If the answer to any of the questions is “yes” for at least half of the members of the demand board, then demand is excused as futile. It is no longer necessary to determine whether the Aronson test or the Rales test governs a complaint’s demand-futility allegations.

As the Court explained: “This approach treat[s] Rales as the general demand futility test, while drawing upon Aronson-like principles when evaluating whether particular directors face a substantial likelihood of liability as a result of having participated in the decision to approve the [transaction].” Rales is more flexible and arguably broader than Aronson, focusing on the decision regarding the litigation demand rather than the transaction being challenged.

Substantively, this is not a major departure from existing principles and the Court made clear that cases applying Aronson and Rales remain good law. However, the re-articulated test is a new paradigm for derivative claims that will likely make its way to other courts around the country over time (as Aronson did in many states).

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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