Delaware Supreme Court Utilizes Holistic Analysis in Reversing Demand Futility Decision

In Delaware County Employees Retirement Fund v Sanchez et. al., 2015 WL 5766264 (Del., October 2, 2015), the Delaware Supreme Court reversed a decision by Vice Chancellor Glasscock granting defendants’ motion to dismiss because plaintiffs failed to meet their burden under Rule 23.1 to plead “particularized facts” showing demand futility. While not groundbreaking, the opinion is interesting because it reminded courts evaluating demand futility allegations to take a holistic approach that considers well plead allegations “in their totality and not in isolation from each other”. (Id., at *1). Although reiterating Rule 23.1’s “heightened burden” requiring a plaintiff to plead “particularized facts”, the opinion also emphasized that a court analyzing such “particularized facts” must draw “all reasonable inferences… in favor of the plaintiff in determining whether the plaintiff has met its burden under Aronson.” (Id., at *2). Utilizing that holistic approach, the Supreme Court found that a director’s close friendship over half a century with the interested party, coupled with the primary employment of the director (and his brother) as executives at a company over which the interested party exercised “substantial influence” was sufficient to raise a reasonable doubt regarding the director’s independence. (Id., at *1)

Sanchez involved a “complicated transaction” between a private company wholly owned by the Sanchez family and a public company in which the Sanchez family was the largest shareholder with a 15% block and for which the private company provided all of the management services. (Id.). Under the transaction terms, the public company paid $78 million to the private company in return for interests in certain properties with energy producing potential for joint production. (Id.). The private company then used the funds to buy out a private equity investor. Plaintiffs, stockholders in the public company, challenged the transaction as “unfair” claiming that it “grossly overvalued’ the properties and provided the private company with an “unduly favorable” royal stream (Id.).

The question before the Court was “whether the plaintiffs had pled particularized facts raising a pleading stage doubt” about the independence of the public company board. (Id., at *2) (emphasis added).   Disinterestedness was not an issue so the Court focused solely on the question of independence. Moreover, due to the makeup of the public company board, the parties agreed that demand was excused if plaintiffs could show that only one of the outside directors lacked independence. Utilizing the holistic approach, the Court found that the half a century friendship between one of the directors and the interested party coupled with the employment of that director (and his brother) by an insurance subsidiary of a corporation in which Sanchez was both the largest stockholder and a director was sufficient to raise a reasonable doubt as to the director’s independence.

Interestingly, the Court’s opinion did not discuss the extent to which Sanchez, as a shareholder and director of the holding company was able to control the actions of the subsidiary. While wholly owned, there is no substantive discussion of whether the subsidiary had a majority of independent directors or the extent to which Sanchez, as a director of the parent, could exercise control of the subsidiary board. Indeed, in a footnote, the Court brushed aside the Chancery Court’s analysis of the absence of such particularized allegations in favor of: (i) allegations that Sanchez was not an independent director of the holding company under the NASDAQ Marketplace Rules; and (ii) somewhat conclusory allegations that Sanchez could have caused the subsidiary company to terminate the director if he failed to do Sanchez’s bidding. (Id., at *4,n.25). Perhaps the Court found it unnecessary in light of other facts the Court did mention such as the materiality to the director of the fees he earned as a member of the public company board to the director’s total income (approximately 30-40%) and that the primary work both the director and his brother did at the insurance subsidiary was to provide insurance to the public and private companies, the absence of which presumably would have a material effect on their compensation. (Id., at *2).

In any event, the Court did take issue with what it perceived as the Chancery Court analyzing separately the friendship allegations and the business allegations and the Chancery Court holding that neither standing alone was sufficient to plead a lack of independence. (Id., at *3) (“[T]he Court of Chancery’s analysis seemed to consider the facts the plaintiffs pled about Jackson’s personal friendship with Sanchez and the facts they plead regarding his business relationships as entirely separate issues”.) The Court also rejected defendants’ reliance on Beam v Stewart, pointing out the absence of facts in that case regarding economic relations as well as distinguishing the 50 year relationship from the Beam allegations of “moving in the same social circles”. (Id., at *4). Rather, in looking at the particularized allegations in their entirety, the Court concluded that “the plaintiffs pled particularized facts, that when considered in the plaintiff-friendly manner required, create a reasonable doubt about [the director’s] independence.

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