Of the. Supreme Court tightens futility of claim test in derivative lawsuits

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(Reuters) – It’s been a tough week for long-standing precedents – and for shareholders alleging corporate wrongdoing – in the Delaware Supreme Court.

Monday at Brookfield Asset Management Inc. v. Rosson, the judges explicitly quashed a 15-year-old case that allowed shareholders to sue majority shareholders directly for diluting the value of their shares. Rather, under the new ruling, plaintiffs’ lawyers face more procedurally difficult derivative lawsuits.

Then on Thursday, the Supreme Court passed a new test that will make it harder for shareholders in derivative lawsuits to show that board members cannot be trusted to decide whether or not to sue on behalf of the company. . The opinion of the Supreme Court in United Food and Commercial Workers Union and Participating Food Industry Employers Tristate Pension Fund v. Mark Zuckerberg did not exactly reverse court precedent in the 1984s Aronson vs. Lewis, which, as I will explain, allowed shareholders to sue derivatives by accusing board members of approving tainted transactions.

But the ruling effectively closed a path Aronson had provided to plaintiff attorneys suing company boards over conflicting deals. Aronson may still be good law, but it’s not very good for shareholders after Thursday’s decision.

The Zuckerberg case, as you have surely guessed, is a derivative legal action by shareholders against members of the Facebook board who approved a stock reclassification plan in 2016 designed to allow the founder, CEO and majority shareholder of Facebook to sell shares to fund his charitable foundation while preserving his voting rights.

Facebook then abandoned the plan after a series of shareholder lawsuits – but not before spending more than $ 90 million defending the reclassification, then paying lawyers for plaintiffs whose litigation led to its abandonment. The Tri-State Fund derivative lawsuit alleged that Facebook’s board members breached their duties of diligence and loyalty in supporting Zuckerberg’s aborted re-employment plan.

As you know, shareholders can only sue on behalf of the company if they can prove that the board cannot or will not act on its own. Lawyers for the Tri-State fund have claimed that, according to the 1984 Aronson test, it would have been futile to ask Facebook administrators to take legal action over the reclassification plan.

The Aronson test applies when the majority of the directors who would assess a shareholder application were members of the board of directors at the time of the disputed transaction. Aronson offered two avenues for shareholders to establish the futility of the claim: they could prove that a majority of the board was in conflict, or they could show that the transaction was too problematic to qualify for deference in business judgment. Tri-state shareholders have argued that the two routes led to the futility of demand in the Facebook affair.

Vice Chancellor Travis Laster rejected Tri-State’s arguments in a decision last October which cast doubt on Aronson’s viability.

Laster’s key point was that a change in Delaware’s corporate code undermined the rationale for the 1984 ruling. The Aronson court, he said, used deference for business judgment as a sort of proxy for the personal liability risk of board members, believing that if the board was not entitled to deference for the underlying transaction, the directors were at a higher risk and therefore could not be relied on. to make an independent decision as to whether the company has a cause of action.

But two years after Aronson’s decision, Laster said, Delaware enacted a provision that allows corporations to protect directors from damages for breach of their fiduciary duties. These so-called exculpatory provisions have clearly reduced the risk of directors’ liability in the event of lawsuits arising from transactions tainted with error. So, as Laster recounted, Delaware began to question whether it was still reasonable to base the futility of the claim on the standard of review of the underlying agreements if board members did not face damages.

Laster said the answer was no: “Aronson is broken as of right because subsequent jurisprudential developments rendered unviable the basic premise upon which Aronson depends,” he wrote.

Laster proposed an alternative three-part test for the futility of demand which he said harmonizes Aronson and a successor case, the 1993s. Rales vs. Blasband. The courts should determine whether the director gained personal advantage from the misconduct alleged by the shareholders; whether the members of the board of directors were at substantial risk of liability for shareholder claims; and if the director is dependent on someone – probably a majority shareholder – who benefited from the transaction in question. If the answer is yes for the majority of the board, the shareholders can proceed.

The Delaware Supreme Court agreed with Laster that the exculpatory provisions eroded Aronson’s core logic. The court, in a unanimous opinion drafted by Justice Tamika Montgomery-Reeves, categorically ruled that claims covered by such provisions cannot be the cause of the futility of the claim.

“When the Aronson decision was rendered, raising a reasonable doubt that the directors breached their duty of care exposed them to a substantial likelihood of liability and protracted litigation, raising doubts as to their ability to review demand impartially, “Montgomery-Reeves wrote. “The terrain has changed since and claims for neglect of care are no longer a threat that neutralizes the discretion of directors.”

In light of that ruling, the Supreme Court said it was adopting Laster’s three-part test for the futility of the claim. Laster’s test, Montgomery-Reeves said, mixed up the precedents of Aronson and Rales to answer the crucial question of whether directors can be trusted to act in the best interests of the company.

The gist of the analysis, she writes, “is to assess whether the board should be deprived of its decision-making power because there is reason to doubt that the directors would be able to exercise their impartial business judgment. on a contentious request. “

Laster’s “fine-tuned” test will answer that question, the court said – and it doesn’t even require judges to overturn Aronson because, in Thursday’s opinion, he “makes Aronson, Rales and their offspring better.”

Neither tri-state attorney Willem Jonckheer of Schubert Jonckheer & Kolbe nor Facebook board attorney William Savitt of Wachtell, Lipton, Rosen & Katz responded to my email questions.

Delaware court keeper Kyle Compton Wagner of the Chancery Daily said in a alert on Zuckerberg’s decision that this is the most important week for shareholder derivative litigation since he started publishing. I suspect that shareholders will feel the consequences for a long time.

Read more:

Of the. Supreme Court drops risky precedent over direct shareholder claims

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The opinions expressed are those of the author. They do not reflect the views of Reuters News, which, under the principles of trust, is committed to respecting integrity, independence and freedom from bias.


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