On September 23, 2021, in a decision authored by Justice Tamika Montgomery-Reeves, the Delaware Supreme Court sitting en banc
affirmed the dismissal of a derivative complaint filed by a stockholder of Facebook, Inc. (the “Company”) against the CEO, who is also the founder, controlling stockholder and chairman of the board, as well as certain other directors. United Food and Commercial Workers Union and Participating Food Industry Employers Tri-State Pension Fund v. Zuckerberg, et al.
, No. 404, 2020 (Del. Sept. 23, 2021). Plaintiff asserted that the directors breached their fiduciary duties by improperly approving a stock reclassification allegedly for the benefit of the CEO, which though ultimately abandoned resulted in litigation and settlement costs. The Court concluded that the Delaware Court of Chancery properly dismissed plaintiff’s complaint for failing to make a pre-suit demand on the board. In so holding, the Court adopted a refined test for demand futility and also determined that exculpated claims cannot excuse demand because they do not entail a substantial likelihood of liability.
Plaintiff sought to recoup the money the Company spent defending and settling a class action that had challenged the board’s decision to issue a new class of non-voting shares in order to enable the CEO to fulfill a “Giving Pledge” to donate much of his wealth to philanthropic causes without significantly diminishing his voting power. The prior suit was dismissed as moot following the board’s decision to abandon the stock reclassification—at the CEO’s request—as trial approached. But the Company spent more than $90 million defending and settling the class action.
Under prior case law, demand futility was typically assessed under one of two tests. Pursuant to Aronson v. Lewis
, 473 A.2d 805 (Del. 1984), demand is excused if the complaint raises a “reasonable doubt that (1) the directors are disinterested and independent[,] [or] (2) the challenged transaction was otherwise the product of a valid business judgment.” The Aronson
test applied where the complaint challenged a decision made by the same board that would consider the litigation demand. As explained by the Court, in “all other circumstances,” the test articulated in Rales v. Blasband
, 634 A.2d 927 (Del. 1993), applied. Under Rales
, demand is excused if the complaint demonstrates a “reasonable doubt that, as of the time the complaint is filed, a majority of the demand board could have properly exercised its independent and disinterested business judgment in responding to a demand.”
The parties agreed that the Aronson
test applied in this case. Plaintiff argued that demand was excused because “the board’s negotiation and approval of the [r]eclassification would not be protected by the business judgment rule because [t]heir approval was not fully informed” and also because a majority of the directors lacked independence from the CEO.
The Court of Chancery held that the complaint failed to plead with particularity facts establishing demand futility. The Company’s charter contains a clause authorized under Section 102(b)(7) of the Delaware General Corporation Law that insulates directors for breaches of the duty of care. The Court of Chancery held that exculpated care claims do not excuse demand and the complaint also failed to raise a reasonable doubt that a majority of the demand board lacked independence from the CEO.
The Delaware Supreme Court affirmed. It explained that “[e]xculpated claims do not satisfy [the] standard because they do not expose directors to a substantial likelihood of liability.” Relying on the language of Aronson
, plaintiff argued that demand is excused “whenever the complaint raises a reasonable doubt that the challenged transaction was a valid exercise of business judgment, regardless of whether the directors face a substantial likelihood of liability for approving the challenged transaction.” But the Court explained that the assessment is intended to focus on whether the directors on the demand board face a substantial likelihood of liability—rather than on the standard of review—and an exculpated claim does not “pose a threat that neutralizes director discretion” to impartially consider the demand.
In light of this lack of clarity under the language of Aronson
and because the Aronson/Rales
framework does not neatly address circumstances where—as here—some directors at the time of litigation participated in the challenged transaction and others are new, the Court of Chancery applied a refined articulation of the demand-futility test. On appeal, the Delaware Supreme Court adopted this three-part test as the “universal test for assessing whether demand should be excused as futile” and directed courts to ask the following three questions on a director-by-director basis:
(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 faces a substantial likelihood of liability on any of the claims that would be 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 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.
The Court held that if the answer is “yes” for at least half the members of the demand board, then demand is excused. The Court noted, however, that Aronson
, and their progeny remain “good law” because the refined standard is consistent with those cases.
The Court also found that the Court of Chancery correctly determined that the complaint did not raise a reasonable doubt as to independence from the CEO. Nine directors were on the demand board. Plaintiff conceded that two who joined the board after the reclassification was approved and later abandoned were sufficiently independent. Defendants did not argue that the CEO and two other directors could have impartially considered a demand. The Court found that the complaint did not sufficiently plead a lack of independence as to three others (and did not need to consider the fourth). In this regard, the Court explained, for example, that allegations of the following are not enough: (i) personal friendship; (ii) a bias in favor of founders maintaining control; and (iii) a track record of donating to similar philanthropic causes.