Entire Context of Pleadings Must be Considered in Light Most Favorable to Plaintiff for Purposes of Pleading Demand Futility

As the Delaware Supreme Court noted in Delaware County Employees Retirement Fund v. Sanchez (2015 Del. LEXIS 472), pleading facts to support an inference of a non-disinterested director for purposes of demand futility is difficult.  However, because the allegations must be considered in the entire context and most favorably to the plaintiff under Rule 23.1, the Court of Chancery erred dismissing the complaint.

The case involved a transaction between a private company held by the family of defendant A.R. Sanchez, Jr. – Sanchez Resources, LLC (the “Private Company”), and a public company – Sanchez Energy Corporation (the “Public Company”), in which the Sanchez family constituted the largest stockholder.  The challenged transaction was a $78 million payment from the Public Company to the Private Company for (1) the buyout of private equity investor interests, (2) the acquisition of interests in certain Private Company properties, (3) the facilitation of the joint production of property, and (4) cash payment.  The Plaintiffs alleged the transaction resulted in gross overpayment and unfairly benefited the Private Company.

The Court of Chancery dismissed the complaint for failure to allege demand futility.  Plaintiffs appealed.  On appeal, the Parties agreed that two of the five directors were not disinterested – A.R. Sanchez, Jr., and his son A.R. Sanchez, III.  The remaining issue concerned the independence of director Alan Jackson, a longtime friend of A.R. Sanchez, Jr.

The complaint alleged two grounds for Jackson’s lack of independence: (1) the friendship of Jackson and A.R. Sanchez, Jr. which spanned five decades; and (2) the inference that Jackson’s personal wealth was largely attributable to A.R. Sanchez, Jr.  With respect to the first issue, other than the longtime friendship, the Plaintiffs only alleged a political campaign donation to Jackson from A.R. Sanchez, Jr.  With respect to the second issue, Plaintiffs alleged that IBC Insurance Agency, Ltd. (“IBC”), employed Jackson.  IBC also provided insurance services to both the Private and Public Company.  More importantly, IBC is a wholly owned subsidiary of International Bancshares Corporation, of which A.R. Sanchez is both the largest stockholder and a non-independent director, thus exercising significant influence over Jackson.  Finally, the complaint alleged that the $165,000 Jackson earned as a director of the Private Company constituted 30-40% of his income for that year.

The Supreme Court noted that the Chancery Court considered the Plaintiffs' allegations separately.  However, the law requires that all pleaded facts be considered in their full context and that all inferences be drawn in the plaintiff’s favor (FRCP 23.1).  Defendants attempted to analogize the case to Beam v. Stewart (845 A.2d 1040), but the Court distinguished the general social circle-friendship described in Beam from the long-lasting friendship here, coupled with the additional allegations relating to Jackson's financial interest.

Under the controlling test in Aronson v. Lewis (473 A.2d 805), the facts considered in Plaintiffs' favor, raised doubt to Jackson’s independence.  The Court reversed dismissal and remanded for further proceedings.

Federal Court Requires Derivative Plaintiff Seeking Voluntarily Dismissal to Provide Notice to Shareholders

A federal court made it more difficult for derivative plaintiffs and their lawyers to cheaply exit derivative lawsuits they brought but no longer wish to maintain.  In June 2013, the Delaware Chancery Court dismissed stockholder claims challenging the validity of a forum-selection bylaw adopted by Chevron’s directors (Boilermakers Local 154 Retirement Fund v. Chevron Corp, 73 A.3d 934). Before the decision, a parallel derivative suit Bushansky v. Armacost (2012 WL 3276937), was filed in federal court, but stayed pending the outcome of the Delaware suit. After the decision, the plaintiff in Bushanksy sought court authorization to voluntarily dismiss the suit without providing notice under Fed.R.Civ.P. 23.1(c). Rule 23.1(c) requires court approval and notice of dismissal to voluntarily dismiss a derivative action. There are three exceptions to the notice requirement: the claim is dismissed after litigation on the merits, the claim is moot, or absent class members would not be prejudiced without notice and the expense is unduly burdensome. Bushansky alleged all three exceptions and claimed that because he lacked standing, the court had no jurisdiction to order notice. He also argued that other shareholders were already on notice, excusing any requirement.

The court rejected the lack of standing claim. Standing is irrelevant to the purpose of the rule – discouraging secret settlements and affording absent shareholders the opportunity to continue a potentially meritorious claim, so the lack of standing did not affect notice. The Court then rejected Bushansky’s argument that the Delaware ruling precluded the claims in the instant action. He argued at the stay hearing that fiduciary duty claims in the federal suit were separate and the Court held that those issues were neither litigated nor moot. Next, the Court found the possibility of prejudice, based on statute of limitations concerns barring subsequent suits. Additionally, any concerns of cost were unfounded. Even if notice by mail or publication was unduly burdensome, other means existed. Finally, Bushansky’s argument for prior notice failed. His arguments did not address notice of dismissal, but rather demonstrated notice for the adoption of the bylaw and the decision of the Delaware suit.

The court ordered the parties to file a proposed notice plan. If no shareholder sought to intervene during the notice period, the plaintiff could then file a motion to voluntarily dismiss.

California Court of Appeal Dismisses Derivative Suit Against Yahoo Directors

The Court of Appeal for California's Sixth District upheld the dismissal of a purported shareholder derivative suit against the directors of Yahoo (http://www.metnews.com/sos.cgi?1013//H037762).  The shareholder plaintiff asserted that five of Yahoo's twelve directors had engaged in insider trading in violation of the California Corporations Code.  The Court first correctly applied Delaware law in decided whether a pre-suit demand by the shareholder plaintiff was excused.  The Court assumed for the sake of the appeal that the five directors who allegedly committed insider trading were not independent for purposes of whether demand was excused.  However, the shareholder could not plead specific facts sufficient to taint the independence of the remaining seven directors.  As is common in these cases, plaintiff asserted a hodgepodge of allegations against the other seven directors including that some also engaged in some insider trading, were beholden to their comrades, and failed to fix the problems at Yahoo or otherwise prevent the insider trading.  The case provides an excellent explanation and summary of Delaware law on demand futility and properly applied that law to dismiss the claims asserted.

Do Derivative Plaintiffs Have to Make a Books and Records Demand in Delaware?

The Delaware Supreme Court has long pressed shareholder plaintiffs in derivative suits to make a pre-suit books and records demand under 8 Delaware Code Secion 220.  In In re Freemont McMoRan Copper & Gold Derivative Litigation (http://www.delawarebusinesslitigation.com/uploads/file/Freeport%20McMoRan%20letter%20op%202%2014%202013.pdf), however, would-be derivative plaintiffs in the context of a merger and acquisition sought to stay a derivative action by other plaintiffs.  The basis of the stay request was that the would-be plaintiffs had made a books and records demand under Section 220.  They feared that the case brought by others without the benefit of the book and records, if unsuccessful, would preclude their later derivative suit.  The Chancery Court held that the case should proceed, reasoning that the merger was scheduled to close in a matter of weeks and that the expediency necessitated by that schedule outweighed the legitimate concern about obtaining the books and records and the possible res judicata effects of other plaintiffs proceeding without the books and records.  The Delaware Supreme Court this week declined to take up the matter.  The upshot seems to be that, in the face of an impending merger, the need for speed outweighs the need for plaintiffs to obtain pre-suit books and records.  If the derivative suit without the books and records fail yet the Section 220 demand uncovers additional facts, the Delaware courts will be keft with a messy issue of res judicata (and one the Delaware Supreme Court will speak on in the impending Allergan decision).