Under Delaware law, it is well established that in order to bring a derivative suit, a stockholder of a corporation must either (i) make a demand upon the board to take action; or (ii) plead demand futility.  Ct. Ch. R. 23.1.  Derivative lawsuits are often brought against corporate directors and management for claims of breach of fiduciary duty, corporate mismanagement, self-dealing, etc.

Does the demand requirement apply to a stockholder’s claim for breach of contract of a stockholder approved plan?

The answer, under Delaware case law, is presently unclear.  In the recent Delaware Supreme Court decision of Friedman, et al. v. Khosrowshahi, et al., No. 442, 2014 (Del. Mar. 6, 2015), the Court affirmed the Court of Chancery’s decision to dismiss the complaint for failure to properly make a demand upon the board or to plead demand futility.  However, Chief Justice Leo E. Strine, Jr. noted:

What was not before the Chancellor was the question of whether a stockholder plaintiff must plead demand excusal if her claim for relief is a breach of a stockholder approved plan as a contract, and she seeks recovery under contract law. That question is one that this Court has not decided and on which Court of Chancery decisions arguably conflict. (Slip op. at 3).

The Delaware Supreme Court cited to the conflicting decisions of Allen v. El Paso Pipeline GP Co., 90 A.3d 1097, 1108 n.6 (Del. Ch. 2014) and Pfeiffer v. Leedle, 2013 WL 5988416, at *5 (Del. Ch. Nov. 8, 2013).  The Court of Chancery in Allen stated:

[W]hen a board violates contractual limits on its authority, that decision is not a business judgment to which deferential fiduciary duty review applies, rendering demand futile under the second prong of Aronson. In my view, the same reasoning demonstrates that the claim is not derivative at all.”)

See also Ryan v. Gifford, 918 A.2d 341, 354 (Del. Ch. 2007) (holding that demand was excused because the board lacked discretion to “contravene the terms of” stockholder-approved stock option plans).

On the other hand, Pfeiffer provides that: “The business judgment rule will not be rebutted, and thus demand will not be excused, when a plaintiff alleges only that a board of directors failed to follow the terms of a stock incentive plan. Such allegations pertain to the substance of the board’s decision and fail to address the critical question of how the board reached the result that it did.”

Stay tuned for further developments in Delaware case law addressing whether a stockholder must make a demand upon a board or plead demand excusal under Court of Chancery Rule 23.1 for breach of a stockholder approved plan under contract law.

If you would like to speak to a litigator in Fox Rothschild’s Delaware office, please reach out to Sid Liebesman (302) 622-4237 or Seth Niederman (302) 622-4238.