Derivative Actions

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Recently, in the decision of Feuer v. Redstone, (Del. Ch. Apr. 19, 2018), the Delaware Court of Chancery considered a motion to dismiss brought in response to a derivative complaint against certain directors of CBS Corporation for excessive compensation paid to media titan, Sumner Redstone, at a time when plaintiff alleged he could no longer render meaningful services to the company.  The derivative plaintiff complained that his receipt of millions in salary from his “at will” employment since 2014 resulted in corporate waste and breaches of the director defendants’ fiduciary duties.

The derivative plaintiff challenged several different payments made to Mr. Redstone, including bonuses and annual salary payments received as executive chairman, and later income received as chairman emeritus.  The complaint alleged that Mr. Redstone, a nonagenarian, was suffering from diminished health and no longer could contribute to the company.

The defendants moved to dismiss pursuant to Rule 23.1 for failure to plead demand futility.  The Court applied the Rales test for determining demand futility, given that plaintiff did not challenge specific decisions by the company’s board of directors.  Plaintiff did not challenge the independence of the directors, but argued that they could not disinterestedly consider a demand because of the potential for personal liability against them, in that, as plaintiff alleged, the payments were not made in good faith, and constituted “waste”.

In denying in part defendants’ motion to dismiss, Chancellor Bouchard found that based upon the “extreme factual scenario” alleged in the complaint, i.e. that millions were paid to an individual who could not provide services to the company, plaintiff successfully plead demand futility as to at least a portion of the contested transfers.  Accordingly, the motion to dismiss was denied in part.

Carl D. Neff is a lawyer with the law firm of Fox Rothschild LLP.  Carl is admitted in the State of Delaware and regularly practices before the Delaware Court of Chancery, with an emphasis on shareholder disputes.  You can reach Carl at (302) 622-4272 or at cneff@foxrothschild.com.

When a derivative lawsuit is brought on behalf of a company, the derivative plaintiff will often times attempt to argue that demand upon the board would be “futile” in order to excuse the demand requirement under Delaware Court of Chancery Rule 23.1.  The reason is that when a demand is in fact made upon the board, the propriety of the board’s refusal of the demand is governed by the “business judgment rule” — which is very unfavorable to the demanding shareholder, and generally leads to the dismissal of the claim.

In order to properly plead demand futility, a derivative plaintiff must allege with particularity that the board members are not disinterested in the subject matter of the demand.  This is almost certainly the case when the demand would ask directors to sue themselves. In order to allege demand futility, a stockholder must meet the heightened pleading standards under Delaware Court of Chancery Rule 23.1.

One way in which to assert that demand is excused is under the progeny of either Aronson or Rales, by asserting that a majority of the Board faces a substantial likelihood of liability for breaching the duty of loyalty by causing the company to violate law. This issue was addressed recently in the Delaware Court of Chancery decision of Wilkin v. Narachi, C.A. No. 12412-VCMR (Del. Ch. Feb. 28, 2018).  There, Vice Chancellor Montgomery-Reeves wrote that: “[B]ecause sophisticated and well-advised individuals do not customarily confess knowing violations of law, a plaintiff following this route effectively must plead facts and circumstances sufficient for a court to infer that the directors knowingly violated positive law.”  (Slip. op. at 27).

Wilkin addressed whether failure to follow not the law, but “best practices”, resulted in demand excusal in a derivative suit.  There, Plaintiff argued that demand should be excused because seven of the eight directors on the board knowingly and/or intentionally caused the Company to violate regulations and breach its confidentiality obligations. In rejecting Plaintiff’s demand futility argument, Vice Chancellor Montgomery-Reeves stated:

A review of Plaintiff’s allegations shows the main deficiency in the entirety of Plaintiff’s demand futility analysis. Plaintiff attempts to plead knowing and intentional violations of the law without any violation of the law. Instead, Plaintiff paints a picture of directors who, at worst, failed to follow best practices. But, a failure to follow best practices does not create a substantial likelihood of liability.

Accordingly, the Court granted Defendants’ motion to dismiss Plaintiff’s derivative complaint.

Carl D. Neff is a lawyer with the law firm of Fox Rothschild LLP.  Carl is admitted in the State of Delaware and regularly practices before the Delaware Court of Chancery, with an emphasis on shareholder disputes.  You can reach Carl at (302) 622-4272 or at cneff@foxrothschild.com.

In the recent decision of Oklahoma Firefighters Pension & Retirement System v. Corbett, C.A. No. 12151-VCG (Del. Ch. Dec. 18, 2017), the Delaware Court of Chancery provided a scholarly review of Caremark claims.  In sum, the decision stands for the proposition that in order to survive a motion to dismiss, a plaintiff must plead sufficient facts demonstrating a deliberate violation of the law or a conscious indifference to wrongdoing.

It is worth noting that Caremark claims are notoriously difficult to prove.  The Court of Chancery has previously explained that a “Caremark claim is possibly the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment, and bad faith on the part of the corporation’s directors is a necessary condition to liability.”  Melbourne Municipal Firefighters’ Pension Trust Fund v. Jacobs, C.A. No. 10872-VCMR, slip op. at 19, (Del. Ch. Aug. 1, 2016) (citing  In re Caremark Int’l Inc. Deriv. Litig., 698 A.2d 959, 967 (Del. Ch. 1996)).

Carl D. Neff is a partner with the law firm of Fox Rothschild LLP.  Carl is admitted in the State of Delaware and regularly practices before the Delaware Court of Chancery, with an emphasis on shareholder disputes. You can reach Carl at (302) 622-4272 or at cneff@foxrothschild.com.

In the recent opinion by the Delaware Supreme Court of Chancery in City of Birmingham Retirement and Relief System v. Good, No. 16, 2017 (Del. Supr. Dec. 15, 2017), the High Court held that stockholder plaintiffs failed to adequately plead demand futility in the connection with Caremark claims asserted against the company’s board of directors.  The majority’s en banc opinion should be read by any practitioner seeking to understand the demand futility analysis under Delaware law.

The complaint was filed as a derivative action on behalf of Duke Energy Corporation (“Company”).  In May 2015, the Company pled guilty to nine misdemeanor criminal violations of the Federal Clean Water Act and paid a fine exceeding $100 million. The plaintiffs, stockholders of Duke Energy, filed a derivative suit in the Court of Chancery against certain of Duke Energy’s directors and officers.  Plaintiffs sought to hold the directors personally liable for the damages the Company suffered from the spill.

The High Court agreed with the Court of Chancery that the stockholder plaintiffs did not sufficiently allege that the directors faced a substantial likelihood of personal liability for a Caremark violation.  Instead, the Court found that the directors at most faced the risk of an exculpated breach of the duty of care. Thus, the stockholders were required to make a demand on the board to consider the claims before filing suit.  In granting the defendant directors’ motion to dismiss, the Court noted case law explaining that Delaware courts routinely reject conclusory allegations that because illegal behavior occurred, the board must have known that internal controls were been deficient.

Carl D. Neff is a partner with the law firm of Fox Rothschild LLP.  Carl is admitted in the State of Delaware and regularly practices before the Delaware Court of Chancery, with an emphasis on shareholder disputes. You can reach Carl at (302) 622-4272 or at cneff@foxrothschild.com.

Under Delaware law, if a shareholder requests that a company pursue litigation, the decision whether to pursue litigation on behalf of the company generally resides with the board as an exercise of its business judgment.  A stockholder lacks standing to bring suit on the company’s behalf unless the stockholder (i) has demanded that the directors pursue the corporate claim and the demand is wrongfully refused; or (ii) purports to initiate litigation on behalf of the company and alleges with particularity why pre-suit demand is excused as futile.

Under the Rales test, where a putative derivative plaintiff alleges demand futility, in order to avoid dismissal, the shareholder must point to particularized allegations in its complaint raising reasonable doubt that a majority of the board could impartially consider a demand to sue.  Rales v. Blasband, 634 A.2d 927, 934 (Del. 1993).

In the recent decision of Lenois v. Lawal, et al., C.A. No. 11963-VCMR (Del. Ch. Nov. 7, 2017), the Delaware Court of Chancery examined whether plaintiff stockholder adequately alleged demand futility.  This opinion demonstrates that merely because one officer or director may have acted in bad faith, does not excuse demand if the plaintiff is unable to plead particularized facts demonstrating that a majority of the board could not act impartially upon a stockholder demand.

In addition, this opinion illustrates that where a company’s charter contains an exculpatory provision under Section 102(b)(7) of the Delaware General Corporation Law, a plaintiff must plead facts showing that a majority of the board faces a risk of liability for claims that would not be exculpated, for example, claims for not acting in good faith or for violation of the duty of loyalty.

Carl D. Neff is a partner with the law firm of Fox Rothschild LLP.  Carl is admitted in the State of Delaware and regularly practices before the Delaware Court of Chancery, with an emphasis on shareholder disputes. You can reach Carl at (302) 622-4272 or at cneff@foxrothschild.com.

In Delaware, to assert a derivative action against company management, either a presuit demand must be made, or plaintiff must allege that demand would be futile because the board is not disinterested.   For derivative actions asserted by shareholder against a corporation or of an unincorporated association, Court of Chancery Rule 23.1 requires that the complaint “allege with particularity the efforts, if any, made by the plaintiff to obtain the action the plaintiff desires from the directors or comparable authority and the reasons for the plaintiff’s failure to obtain the action or for not making the effort.”  Ct. Ch. R. 23.1.

The Delaware Limited Liability Act similarly requires that a complaint must “set forth with particularity the effort, if any, of the plaintiff to secure initiation of the action by a manager or member or the reasons for not making the effort.”  6 Del. C. § 18-1003.  Thus, members of a Delaware LLC must likewise allege presuit demand, or demand futility.

An interesting question becomes whether this requirement applies to 50/50 “joint venture” limited liability companies, in which two 50/50 managing members have equal control over the company.  The recent decision of Dietrichson v. Knott, et al., C.A. No. 11965-VCMR (Del. Ch. Apr. 19, 2017) answers in the affirmative.  There, a managing member who held a 50% interest in the entity asserted claims against the other 50% owner for breach of fiduciary duty by paying himself an unauthorized salary and misappropriating the proceeds of an asset sale.  Plaintiff also brought claims for breach of the operating agreement and the implied covenant of good faith and fair dealing.

Vice Chancellor Montgomery-Reeves rejected plaintiff’s reliance upon El Paso Pipeline GP Co., L.L.C. v. Brinckerhoff,  152 A.3d 1248 (Del. 2016), in support of the proposition that the fiduciary duty claims were “dual-natured”, i.e., possessing both derivative and direct qualities.  The Court noted that in Brinckerhoff, the Delaware High Court stated that in “unique circumstances” it has recognized that certain claims have both direct and derivative aspects.  This namely occurs when the action involves a controlling stockholder and transactions “that resulted in an improper transfer of both economic value and voting power from the minority stockholders to the controlling stockholder.”  Brinckerhoff, 152 A.3d at 1262.

Because plaintiff did not allege any dilution of voting power in the case, the Court found that Brinckerhoff did not apply. And because plaintiff did not alleged demand futility or that demand was made and wrongfully refused, the derivative claims were dismissed.

Key Takeaway: In actions between two managing members of a 50/50 limited liability company, a common assumption is that any traditionally derivative claims, such as breach of fiduciary duty, would be direct given the bilateral composition of the LLC.  Such an assumption could be problematic and may lead to dismissal of such claims, if plaintiff fails to allege facts that a direct harm was likewise incurred, such as dilution of voting power.

Carl D. Neff is a partner with the law firm of Fox Rothschild LLP.  Carl is admitted in the State of Delaware and regularly practices before the Delaware Court of Chancery, with an emphasis on shareholder disputes. You can reach Carl at (302) 622-4272 or at cneff@foxrothschild.com.

The recent decision of Trusa v. Nepo, C.A. No. 12071-VCMR (Del. Ch. April 13, 2017), stands for the proposition that a creditor lacks standing to assert a derivative claim against a limited liability company.  In Trusa, the plaintiff creditor Steven B. Trusa brought a derivative action for breach of fiduciary duty and dissolution of Xion Management, LLC (“Xion” or “LLC”).  The creditor brought such claims, among other reasons, as a result of his assertion that he lent money to the LLC under false pretenses.  One of the managing members moves to dismiss the action for lack of standing, duplication, and failure to state a claim.

Vice Chancellor Montgomery-Reeves granted the motion to dismiss in its entirety.  The Court held that under the plain language of the Delaware Limited Liability Act, only members and assignees can assert derivative claims on behalf of a limited liability company.  The Court rejected Trusa’s argument that the power of attorney provision in the loan agreement granted creditor a contractual right to assert derivative claims, as the clause only permitted Trusa to pursue remedies as provided in the Agreement.

The Court also rejected Trusa’s demands for dissolution and fraud.  Only a member or manager may seek dissolution of a limited liability company under the Delaware LLC Act’s dissolution statute, 6 Del. C. § 18-802.  Moreover, the Court found that the extreme remedy of “equitable dissolution” did not apply.  Finally, the Court rejected the creditor’s attempts to raise fraud in a breach of contract claim.

Notably, the Court rejected Trusa’s argument that because the LLC’s Certification of Formation was automatically cancelled under Section 18-203 of the LLC Act, he should be permitted to seek appointment of a receiver under Section 18-805 of the LLC Act.  But as Vice Chancellor Montgomery-Reeves held:  “a creditor may only seek the appointment of a trustee or receiver [under Section 18-805] when a certificate of cancellation is filed after the dissolution and winding up of the company, not where the certificate of formation has been canceled by operation of law for want of a registered agent.” (emphasis in original).  The Court declined Trusa’s invitation to “read any cancellation method under Section 18-203(a) as triggering the rights granted to creditors in Section 18-805….”

Key Takeaway: Creditors will be denied standing to assert derivative claims to recover damages.  The preferred course is to prepare for such contingencies in the loan documents.  In addition, a creditor must wait until a certificate of cancellation is filed in order to seek appointment of a receiver under Section 18-805 of the LLC Act.

Carl D. Neff is a partner with the law firm of Fox Rothschild LLP.  Carl is admitted in the State of Delaware and regularly practices before the Delaware Court of Chancery, with an emphasis on shareholder disputes. You can reach Carl at (302) 622-4272 or at cneff@foxrothschild.com.

Whether a claim against company management is direct or derivative is not infrequently disputed in litigation before the Delaware Court of Chancery.  This determination becomes important in many contexts, including whether it was necessary for plaintiff to make a pre-suit demand upon the board, whether derivative claims of a company have been assigned to a receiver, or whether such claims have previously been settled in a prior litigation.

In the recent decision of Sehoy Energy LP, et al. v. Haven Real Estate Group, LLC, et al., C.A. No. 12387-VCG (Del. Ch. Apr. 17, 2017), the Court of Chancery examined the nature of the asserted claims due to the filing of bankruptcy of the entity for whom company management served.  There, investors in a partnership commenced suit against a general partner and its principal, asserting that they breached the partnership agreement, induced plaintiffs to invest capital into the partnership, and breached their fiduciary duties by making decisions based upon self-interest.

After suit was commenced, the partnership, a non-party to the case, filed for bankruptcy.  Plaintiff investors then filed a motion seeking a determination that their claims against the general partner and its principal should not be stayed by the bankruptcy.  Defendants argued that the automatic stay applied to the action.

In considering the investors’ motion, Vice Chancellor Glasscock noted that if the action filed against the general partner was derivative in nature, then it would be stayed under the Bankruptcy Code because it would be an asset of the debtor’s estate.  On the other hand, if the claims are direct, then they are not property of the partnership’s estate, and the Chancery litigation can move forward.

The Court found that certain of the investors’ claims were largely direct, and granted their motion.  Relying upon the well-known Delaware Supreme Court decision of Tooley v. Donaldson, Lufkin & Jenrette, Inc. to determine whether the claims were derivative or direct, the Court examined “(1) who suffered the alleged harm (the corporation or the suing stockholders, individually); and (2) who would receive the benefit of any recovery or other remedy (the corporation or the stockholders, individually)?” 845 A.2d 1031, 1033 (Del. 2004).  The Court found that the investors’ contract claims, breach of fiduciary duty claims, and fraud claims were all direct.  Plaintiffs were willing to agree to forebear certain other claims while the automatic stay remains in effect.

The Court also declined to stay the action in the interest of judicial economy.  Defendants asserted that wasteful overlap would occur between the action and the bankruptcy proceeding.  However, because the parties indicated that no derivative claims would be brought before the bankruptcy court, there would be no likelihood of two separate courts entertaining two lawsuits based upon the same underlying dispute.  Moreover, the Court noted that the elements and remedies surrounding the fraud and nondisclosure claims would be different than corporate mismanagement claims.  Thus, Vice Chancellor Glasscock declined to stay the action in the interest of judicial economy.

Key takeaway: This is an important read for any party involved in litigation, in which a related non-party files for bankruptcy.  In such a situation, Sehoy Energy provides a helpful roadmap in determining whether the pending Chancery action should be stayed or can proceed.

Carl D. Neff is a partner with the law firm of Fox Rothschild LLP.  Carl is admitted in the State of Delaware and regularly practices before the Delaware Court of Chancery, with an emphasis on shareholder disputes. You can reach Carl at (302) 622-4272 or at cneff@foxrothschild.com.

In 2016, beginning with In Re Trulia Inc. Stockholder Litigation, C.A. No. 10020-CB (Del. Ch. Jan. 22, 2016) (see blog post here), the Court of Chancery has issued a wave of decisions analyzing the granting of fees in the context of disclosures.  In Trulia, the Court of Chancery set forth the standard that disclosure-only settlements will only be approved if the supplemental disclosures address a “plainly material” misrepresentation or omission, and the releases provided to D&Os are narrowly circumscribed.

Notably, in Trulia, the Court explained that the “plainly material” standard for supplemental disclosures does not apply to a mootness fee award.  This rationale was subsequently followed in Louisiana Municipal Employees’ Retirement System v. Black, C.A. No. 9410-VCN (Del. Ch. Feb. 19, 2016) (see blog post here) (noting that Trulia does not require a ‘plainly material’ inquiry in the mootness fee award context).

The recent Court of Chancery opinion of In re Xoom Corporation Stockholder Litigation, C.A. No. 11263-VCG (Del. Ch. Aug. 4, 2016) clarified the standard for supplemental disclosures on a mootness fee application.  Vice Chancellor Glasscock ruled that a mootness fee “can be awarded if the disclosure provides some benefit to stockholders, whether or not material to the vote. In other words, a helpful disclosure may support a fee award in this context.”

Carl D. Neff is a partner with the law firm of Fox Rothschild LLP.  Carl is admitted in the State of Delaware and regularly practices before the Delaware Court of Chancery, with an emphasis on shareholder disputes. You can reach Carl at (302) 622-4272 or at cneff@foxrothschild.com.

In the recent decision of Melbourne Municipal Firefighters’ Pension Trust Fund v. Jacobs, C.A. No. 10872-VCMR (Del. Ch. Aug. 1, 2016), Vice Chancellor Montgomery-Reeves dismissed Caremark claims brought against certain directors (“Directors”) of Qualcomm, Incorporated (“Qualcomm” or “Company”).  Plaintiffs alleged that the Directors failed to take action to prevent antitrust violations from occurring, despite being aware of U.S. antitrust violations of the Company.

By way of background, it is worth noting that Caremark claims are notoriously difficult to prove.  In the decision, the Court of Chancery explained that a “Caremark claim is possibly the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment, and bad faith on the part of the corporation’s directors is a necessary condition to liability.”

In granting the motion to dismiss Plaintiffs’ claim, the Court found that the complaint did not adequately plead facts giving rise to bad faith on the part of the board.  The Court made clear that simply alleging that the board made a “wrong” decision in response to red flags was insufficient to plead bad faith.

Carl D. Neff is a partner with the law firm of Fox Rothschild LLP.  Carl is admitted in the State of Delaware and regularly practices before the Delaware Court of Chancery, with an emphasis on shareholder disputes. You can reach Carl at (302) 622-4272 or at cneff@foxrothschild.com.