Delaware Court Of Chancery Dismisses Derivative Action, Finding Demand Unexcused Because Plaintiff Did Not Plead Non-Exculpated Claims Against A Majority Of Directors
On November 7, 2017, Vice Chancellor Tamika Montgomery-Reeves of the Delaware Court of Chancery granted a motion to dismiss a derivative and putative class action brought by a minority stockholder of Erin Energy Corporation (“Erin”), challenging a series of transactions involving Erin, Allied Energy PLC (“Allied”)—an entity affiliated with Kase Lukman Lawal, Erin’s chairman, CEO, and controlling stockholder—and another party, Public Investment Corporation Limited (“PIC”). Lenois v. Lawal, C.A. No. 11963 (Del. Ch. Nov. 7, 2017). Plaintiff alleged that the CEO—who together with an affiliated entity (Allied’s parent company) controlled nearly 60% of Erin’s shares—effectively stood on all sides of the challenged transactions and negotiated in his own self-interest. Plaintiff asserted derivative claims for breach of fiduciary duty against the CEO and the remaining directors. The Court found that plaintiff adequately pleaded that the CEO acted in bad faith, but dismissed the derivative claims because the complaint “failed to plead non-exculpated claims against a majority of the Erin Board” and, thus, demand on the board was not excused.
Erin, an oil and gas exploration company, entered the challenged transactions in 2014, when it was on the brink of insolvency, as follows: (a) PIC invested $270 million in exchange for Erin stock; and (b) in exchange for certain Allied oil mining rights and a commitment to fund certain costs, Erin provided to Allied $170 million, a $50 million convertible subordinated note, certain future payments, and Erin stock. Plaintiff alleged that the CEO initiated and controlled the deal process, while acting as a controller of Erin, the owner of Allied, and the effective sole negotiator between Erin and PIC. Erin’s seven-member board appointed a three-director special committee and ultimately approved the transactions, certain aspects of which were also approved by a stockholder vote, with the support of approximately 64% of the minority-held shares.
Asserting derivative breach of fiduciary duty claims against the directors for approving the transactions, plaintiff alleged that Erin substantially overpaid for the Allied assets. Plaintiff also asserted direct breach of fiduciary duty claims against the board for alleged disclosure violations in the transaction proxy. According to the Court, plaintiff and defendants agreed that the futility of a demand on the board to pursue the derivative claims was subject to assessment under the second prong of Aronson v. Lewis, 473 A.2d 805, 814 (Del. 1984), which requires a plaintiff to allege “particularized facts sufficient to raise a reasonable doubt that … ‘the challenged transaction was … the product of a valid exercise of business judgment.’”
After an extensive review of prior case law, the Court held that where—as here—directors are protected from duty of care claims by an exculpatory charter provision pursuant to 8 Del. C. § 102(b)(7), “a plaintiff must allege that a majority of the board faces a substantial likelihood of liability for non-exculpated claims in order to raise a reason to doubt that the challenged decision was a valid exercise of business judgment under the second prong of Aronson” (emphasis added). The Court explained, “[t]he purpose of the demand futility analysis … is to determine whether the board tasked with considering demand could bring its business judgment to bear” and “[t]he Court removes the demand decision from the board where the complaint pleads facts as to individual directors showing that a majority of them cannot consider demand impartially.” Therefore, plaintiff was required to plead “with particularity sufficient allegations to create a reasonable doubt that the Board … act[ed] honestly and in good faith to advance corporate interests when negotiating and approving the [t]ransactions at issue.”
Here, the Court found that “demand is not excused as futile because [p]laintiff fails to plead non-exculpated claims against Erin’s director defendants (other than [the CEO]).” Among other things, the Court pointed to the appointment of a special committee, which hired an investment banker and legal counsel, and resisted attempts by the CEO to dictate the process, by “pushing back on deal terms.” The Court also highlighted that the “special committee sought approval from the entire Board other than the controller …[,] issued a proxy statement to stockholders, and received stockholder approval for the increase in shares outstanding necessary to finance the [t]ransactions.” Therefore, the Court dismissed the derivative claims.
The Court also dismissed the purportedly “direct” claims asserted against the directors for breaches of the duty of disclosure related to alleged misrepresentations and omissions in the transaction proxy. The Court explained that, under In re J.P. Morgan Chase & Co. Shareholder Litigation, 906 A.2d 766 (Del. 2006), damages claims by a stockholder “are disallowed when those damages would be ‘identical to the damages that would flow to [the company] as a consequence of … [the] underlying derivative [ ] claim.’”