Tuesday, June 29, 2021

Failure to plead demand futility cancels suit over Danaher’s board diversity

By John M. Jascob, J.D., LL.M.

The federal district court in Washington, D.C. has dismissed a shareholder derivative suit alleging that directors of Danaher Corporation breached their fiduciary duty of loyalty and violated the proxy provisions of the Exchange Act by falsely representing that the company promoted diversity despite the absence of any African American members on its board. Judge Trevor McFadden, a Trump appointee, ruled that the plaintiffs failed to allege demand futility with particularity under Delaware law because they did not show that the defendant directors faced a substantial likelihood of personal liability on any of the claims. Accordingly, the court granted the defendants’ motion to dismiss (In re Danaher Corporation Shareholder Derivative Litigation, June 28, 2021, McFadden, T.).

A Delaware corporation with its principal offices in Washington, D.C., Danaher is a Fortune 500 company that manufactures and markets medical, industrial and commercial products, with activities in approximately 60 countries. Despite acknowledging that Danaher has received "multiple awards and recognitions for diversity," including being recognized on Forbes’ list of the Top 200 Best Employers for Diversity in 2018 and 2019, the plaintiff shareholders contended that Danaher's directors falsely represented that the company promotes diversity because there are no black directors on Danaher’s board. As summarized by the court, "Under the Shareholders’ theory, African American representation is the sine qua non of diversity; other racial, ethnic, gender, religious, and socioeconomic backgrounds do not count."

In filing their derivative action against 10 members of Danaher’s 12-member board, the plaintiffs raised three claims: (1) breach of the directors’ fiduciary duty under the Delaware General Corporation Law; (2) unjust enrichment; and (3) violation of Exchange Act Section 14(a) and Rule 14a-9 governing proxy solicitations. Among other things, the shareholders sought damages and an order directing Danaher to: (1) replace three of its current directors with two African Americans and one other racial minority; (2) invest $150 million in economic and social justice programs; and (3) fill 15 percent of all new positions in the U.S. with African Americans.

Demand futility. The directors then moved to dismiss, arguing that the shareholders failed to either make a demand on the board to bring the suit or to plead with particularity that a demand would have been futile. Applying the Rales test used by the Delaware courts to determine whether a complaint properly alleges demand futility where the subject of the derivative suit is not a business decision of the board, the court stated that the main issue concerned whether the directors were conflicted, or "interested," such that the board could not have properly exercised its independent and disinterested business judgment in responding to the demand.

The plaintiffs argued that the Danaher directors were interested because they each faced a substantial likelihood of liability. The court observed that the parties disagreed whether the Caremark standard for director oversight liability applied to the plaintiffs' duty of loyalty claim, with the plaintiffs claiming that their fiduciary duty claim was more properly analyzed as alleging violations of the board’s obligation to communicate honestly with shareholders. Under either standard, however, the court held that the plaintiffs failed to show demand futility because they did not allege with particularity that the challenged statements were false.

The court reasoned that the statements about the diversity of Danaher’s workforce—such as "[a] diverse and inclusive workforce strengthens Danaher and ensures the best team continues to win"—said nothing about the diversity of the company’s board. Moreover, the proxy statements cited by the shareholders conveyed that the board had no strict diversity requirements. For example, the complaint cited statements in the proxy that "the Board does not have a formal or informal policy with respect to diversity" and that "[t]he Board does not make any particular weighting of diversity or any other characteristic in evaluating nominees and directors." While the plaintiffs complained that Danaher's proxy statements conveyed an "explicit absence of intention" to build a diverse board, the court questioned how anyone could be misled, given these "explicit" statements.

The shareholders fared no better with regard to statements that could be read as applying to the board as well as the workforce. "That there are no African Americans on Danaher’s Board does not inherently mean that the Board is not diverse," the court stated, observing that Danaher’s board could be racially diverse in other ways and that other types of diversity exist besides racial diversity. Accordingly, the court rejected what it described as the plaintiffs’ "cramped and archaic understanding of diversity."

And even if the complaint properly alleged false statements, the court continued, it lacked well-pleaded allegations that each defendant was involved with the statements or acted with scienter. Allegations that the directors intentionally or recklessly caused Danaher to disseminate materially misleading and inaccurate information to shareholders were not particularized enough to excuse demand, the court ruled, while the board’s failure to nominate any African Americans to the board did not mean that the alleged statements were false. "Without specific allegations for each Director, the Court cannot find that they face a substantial likelihood of liability," Judge McFadden stated.

The court also rejected the plaintiffs’ argument that demand would have been futile with regard to their claim under Exchange Act Section 14(a). The plaintiffs contended that statements regarding diversity were an "essential link" in Danaher shareholders following the company’s recommendation to re-elect the defendants to the board and approve their executive pay packages. The court explained, however, that federal courts have regularly dismissed Section 14(a) claims based on the election of directors because the losses to the company are indirect. "Under the Shareholders’ theory, the election itself did not harm the company—the Directors’ failure to nominate an African American director did. The proxy statements thus could not have been an ‘an essential link in the accomplishment of the transaction’ that caused harm," the court concluded.

The case is No. 20-cv-02445 (consolidated with No. 20-cv02846).