By Joanne Cursinella, J.D.
The Delaware Supreme Court adopted a chancery court standard establishing a new three-part test as the universal test for assessing whether demand should be excused as futile, finding as a result that demand was not excused on Facebook’s board in connection with an allegation of bias in the approval of a stock reclassification plan (United Food and Commercial Workers Union and Participating Food Industry Employers Tri-State Pension Fund v. Zuckerberg, September 23, 2021, Montgomery-Reeves, T.).
Reclassification. This action stems from a Facebook stock reclassification plan approved by the Facebook board of directors to facilitate a way for the founder, CEO, and chairman of the board, Mark Zuckerberg, to contribute to charity pursuant to a “Giving Pledge” without relinquishing control of the company. Eventually, a plan was approved by the board. Several suits were filed and settled as a result. Facebook stockholder Tri-State Pension Fund then filed a class action seeking to recoup the money Facebook spent defending and settling the reclassification. The complaint asserted a single count alleging that the “Director Defendants” breached their fiduciary duties of care and loyalty by improperly negotiating and approving the reclassification and claimed that demand was futile. The parties agreed that Aronson v. Lewis (473 A.2d 805 (Del. 1984)) applied to Tri-State’s complaint.
The Court of Chancery issued a memorandum opinion dismissing the complaint for failing to comply with Rule 23.1. The court held that demand was required because the complaint did not contain particularized allegations raising reasonable doubt that a majority of the demand board received a material personal benefit from the reclassification, faced a substantial likelihood of liability for approving the reclassification, or lacked independence from another interested party. Tri-State appealed and this court affirmed the lower court’s opinion.
New universal standard for demand futility review. The question before the court was whether demand was excused as futile. In the present action, Tri-State alleged that demand was excused as futile for several reasons, including that the board’s negotiation and approval of the reclassification was not a valid exercise of business judgment because their decision was not fully informed and that a majority of them lacked independence from Zuckerberg.
First, Tri-State argued that the Court of Chancery erred by holding that exculpated duty-of-care violations do not satisfy the second prong of the Aronson test. Second, Tri-State argued that its complaint contained particularized allegations establishing that a majority of the directors on the demand board were beholden to Zuckerberg.
In its analysis, the court found the three-part test for demand futility the Court of Chancery applied below is consistent with both Aronson and Rales v. Blasband (634 A.2d 927 (Del. 1993)), which were blended to devise the three-part test, and their progeny, and so adopted it as the universal standard. The three-part analysis is (i) whether the director received a material personal benefit from the alleged misconduct that is the subject of the litigation demand; (ii) whether the director would face a substantial likelihood of liability on any of the claims that are the subject of the litigation demand; and (iii) whether the director lacks independence from someone who received a material personal benefit from the alleged misconduct that is the subject of the litigation demand or who would face a substantial likelihood of liability on any of the claims that are the subject of the litigation demand.
And because the three-part test is consistent with and enhances Aronson, Rales, and subsequent cases, the court said it didn’t need to overrule Aronson to adopt this refined test, and that cases properly construing Aronson, Rales, and their progeny remain good law.
Applied here, the court found that Tri-State failed to raise a reasonable doubt that either any of the relevant defendants was beholden to Zuckerberg or made any allegation that would excuse demand, affirming the lower court’s decision.
The case is No. 404, 2020.