Delaware Supreme Court Clarifies The Standards For Demand Futility

• Published date: 02 November 2021
• Subject Matter: Corporate/Commercial Law, Litigation, Mediation & Arbitration, Corporate and Company Law, Directors and Officers, Class Actions, Trials & Appeals & Compensation, Shareholders
• Law Firm: Sidley Austin LLP
• Author: Ms Heather Benzmiller Sultanian

A pair of opinions released by the Delaware Supreme Court in a single week have revisited longstanding precedent governing shareholder suits that claim corporate wrongdoing. As discussed in a companion post on this blog, the first of those opinions, Brookfield Asset Management Inc. v. Rosson, restricted the ability of shareholders to bring direct claims under certain circumstances, instead forcing them to pursue more procedurally challenging derivative suits. In the second case, United Food & Commercial Workers Union & Participating Food Industry Employers Tri-State Pension Fund v. Zuckerberg, the Delaware Supreme Court adopted a new three-part demand-futility test that clarifies the standard shareholders must meet to file such derivative suits, without first taking their complaints to the company's board of directors.

Background

United Food arose from a vote by Facebook's board of directors in 2016 to pursue a stock reclassification plan that would allow CEO Mark Zuckerberg to sell most of his Facebook stock ' which Zuckerberg planned to do to fulfill the "Giving Pledge," under which he had committed to giving the majority of his wealth to philanthropic causes ' while still maintaining voting control over the company. Days after Facebook announced the reclassification plan, several investors filed class action suits to block the plan, alleging that it was a self-interested deal that put Zuckerberg's interests ahead of Facebook's in violation of the board of directors' fiduciary duties. Shortly before trial was scheduled to begin, Facebook abandoned the reclassification plan and mooted the pending litigation.

Thereafter, a pension fund filed a derivative suit seeking to recover the more than $90 million Facebook spent in defending and settling the class action relating to the withdrawn reclassification plan, including a $68 million fee to the plaintiffs' attorneys and more than $20 million in defense litigation fees and expenses. The pension fund did not make a litigation demand on Facebook's board. Instead, it alleged that any demand would have been futile because Facebook's board conducted "sham" independent deliberations regarding the reclassification plan that were not a valid exercise of business judgment, and the majority of directors were biased toward and beholden to Zuckerberg.

On the defendants' motion to dismiss the complaint, the Court of Chancery concluded that the pension fund was not justified in sidestepping the board of directors and suing...