Delaware Court Of Chancery Dismisses Derivative Claims Challenging Stock Sale Allegedly Based On Adverse Nonpublic Information For Failure To Plead Demand Futility
On December 15, 2021, Vice Chancellor Lori W. Will of the Delaware Court of Chancery dismissed stockholder derivative claims for breaches of fiduciary duty asserted on behalf The Kraft Heinz Company (the “Company”) against an investment firm (the “Investment Firm”) that had previously held 24.2% of the Company’s shares, as well as against certain alleged dual fiduciaries of the two entities. In re Kraft Heinz Company Derivative Litigation, C.A. No. 2019-0587-LWW (Del. Ch. Dec. 15, 2021). Plaintiffs alleged that defendants sold $1.2 billion in Company stock on the basis of nonpublic information that the Company was expected to miss its full-year earnings target by $700 million. The Court held that plaintiffs failed to establish demand futility because the complaint did not raise a reasonable doubt that a majority of the Company’s board members lacked independence from defendants.
The Company was formed by the merger of two predecessors in 2015, one of which had been owned jointly by the Investment Firm and another firm (the “Co-Investor”). The Investment Firm and the Co-Investor, which held 24.2% and 26.8% of the Company’s shares respectively, were each entitled under the merger agreement to three designees on the Company’s eleven-member board. Pursuant to a shareholder’s agreement, the Investment Firm and the Co-Investor were obligated to vote their shares in favor and prohibited from taking any action to facilitate the removal, of each other’s board nominees. In August 2018, the Investment Firm sold 7% of its stake. The Company announced poor financial results followed by stock price declines in November 2018 and February 2019.
The Court explained, that “as with every stockholder derivative action, plaintiffs must adhere to Court of Chancery Rule 23.1 by making a demand on the board of directors [in advance of filing the derivative suit] or demonstrating that a demand would have been futile.” According to the Court, defendants conceded that the three directors affiliated with the Investment Firm could not exercise impartial judgment and plaintiffs conceded that two other directors were independent and disinterested.
The Court thus applied the three-part test for demand futility recently established by United Food & Commercial Workers Union v. Zuckerberg, 2021 WL 4344361 (Del. Sept. 23, 2021), with respect to the remaining directors. Focusing on the independence-from-interested-parties (third) prong of Zuckerberg—because none of the six directors obtained a material personal benefit (prong one) or faced a substantial likelihood of liability (prong two)—the Court found that the complaint failed to plead demand futility as to at least four, rendering a majority of the board independent.
The Court rejected plaintiffs’ contention that the Investment Firm, on its own or in conjunction with the Co-Investor, was a controlling stockholder in a manner that would “strip the directors of the presumption of independence.” The Court concluded that plaintiffs failed to plead “particularized facts” to suggest that specific directors were “beholden” to the Investment Firm as a controlling stockholder. The Court also found insufficient allegations that one director’s private foundation had invested 12% of its investment portfolio in an Investment Firm fund and that he chaired a non-profit that receives donations from an entity controlled by the Investment Firm. Similarly, the Court rejected plaintiffs’ “transitive theory of independence” involving allegations that two directors had close personal relationships with the Co-Investor’s CEO/chairman, who allegedly had a “close friendship” with one of the defendants. As to the fourth director, the Court held that his compensation from the Company as a director—and previously as a consultant—did not “create a reasonable basis to doubt” his impartiality. The Court also explained that his status as a non-independent director for Nasdaq-listing purposes was “qualitatively different from” demand-futility independence.