In 2015, Facebook, Inc. (Facebook) founder and CEO Mark Zuckerberg took the Giving Pledge – a movement championed by Bill Gates and Warren Buffet that challenges wealthy business leaders to use a majority of their wealth for philanthropy. To effectuate this pledge, Zuckerberg determined to donate roughly US$2-3 billion of Facebook stock a year. Facebook’s general counsel warned Zuckerberg that he would lose voting control of Facebook if he sold US$3-4 billion of stock at the current market value. To solve this problem, Zuckerberg, in consultation with Facebook’s general counsel, sought to create a class of non-voting stock that Zuckerberg could sell while retaining control of Facebook. Zuckerberg proposed this stock reclassification plan to the board of directors on August 20, 2015, noting that shareholder litigation relating to Google’s reclassification of stock resulted in a US$522 million settlement.
The board created a special committee of three purportedly-independent directors to consider the proposal, analyze alternatives, and make a recommendation to the full board. The special committee agreed to nearly all of Zuckerberg’s proposals and asked for only minor concessions, many of which appeared not to be based on any legitimate concern (e.g., asking for provisions that would disincentivize Zuckerberg leaving Facebook early, which no one anticipated occurring). Moreover, one of the members of the special committee engaged in what the court called “facially dubious back-channel communications with Zuckerberg” throughout the negotiations over reclassification. On April 13, 2016, the special committee recommended that the full board approve the reclassification plan, which the board did.
On June 20, 2016, holders of a majority of Facebook’s stock (Zuckerberg alone would have been sufficient) voted in favor of the reclassification plan; however, more than three-quarters of the minority shareholders voted against the plan.
Several putative class actions were filed shortly after the board’s vote in favor of the reclassification plan. Facebook agreed not to proceed with the plan while the lawsuits were pending. About a week before the consolidated class action trial was set to begin in September 2017, Facebook and Zuckerberg announced that they were abandoning the reclassification plan and that Zuckerberg would find another way to fulfill the Giving Pledge.
Following this announcement, one of Facebook’s longstanding shareholders, the United Food and Commercial Workers Union and Participating Food Industry Employers Tri-State Pension Fund (Tri-State), filed a derivative lawsuit seeking to recoup the more than US$80 million that Facebook had paid defending the class action lawsuit. Tri-State did not make a pre-suit demand and alleged that such a demand was excused as futile under Delaware Court of Chancery Rule 23.1 because the reclassification vote was not a product of a valid exercise of business judgment, because the directors of Facebook faced a substantial likelihood of liability, and because the directors of Facebook lacked independence.
The Court of Chancery dismissed the case, finding that a pre-suit demand was not excused because (1) the directors were exculpated from breach of care claims and thus did not face a substantial likelihood of liability and (2) Tri-State failed to plausibly allege that the directors were not independent. Tri-State appealed.
The Delaware Supreme Court affirmed the Court of Chancery’s decision. In doing so, it made two key holdings. First, it held that “exculpated breach of care claims no longer pose a threat that neutralizes director discretion,” and that if a director is exculpated from duty of care claims, as Delaware statutory law now expressly permits, that director does not face a substantial likelihood of liability for a breach of care claim sufficient to support demand futility.
Second, the court adopted a new test for determining demand futility, which would apply regardless of whether the corporate board at the time a shareholder sought to bring suit was the same or different than the board that made the decision the shareholder sought to challenge. Under the new test, courts are instructed to examine: “(i) whether the director received a material personal benefit from the alleged misconduct that is the subject of the litigation demand; (ii) whether the director would face a substantial likelihood of liability on any of the claims that are the subject of the litigation demand; and (iii) whether the director lacks independence from someone who received a material personal benefit from the alleged misconduct that is 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.”
This decision reframes the test for determining whether a litigation demand on a corporate board is necessary or would be futile in light of now well-established changes to Delaware law that permit corporations to exculpate directors for breaches of care.