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Zucker v. Andreessen, C.A. No. 6014-VCP (Del. Ch. June 21, 2012) (Parsons, V.C.)

June 21, 2012

In this memorandum opinion, the Court of Chancery granted nominal defendant Hewlett-Packard Co.’s motion to dismiss pursuant to Court of Chancery Rule 23.1 for plaintiff’s failure to make a pre-suit demand or to allege a basis to excuse demand.  Plaintiff, a shareholder of Hewlett-Packard Co. (“HP” or the “Company”), brought a derivative action, accusing certain HP directors of committing waste in connection with a severance package provided to HP’s former CEO, Mark Hurd.  Plaintiff also claimed that the directors breached their duty of care by failing to have a long-term CEO succession plan prepared in the event of an unexpected termination, such as that of Mr. Hurd.  The Court held that the complaint did not meet the standard set by Delaware precedent for demand excusal, and therefore dismissed both claims.

In August 2010, the HP board voted unanimously to terminate Mr. Hurd after an internal investigation of certain claims of sexual harassment and falsifying expense reports revealed a breach of the Company’s standards of business conduct.  The Board entered into a severance agreement that provided payments and benefits estimated by plaintiff to be worth over $40 million to Mr. Hurd.  In exchange for these benefits, Mr. Hurd agreed, among other things, to release any claims he ever had, then had, or may have in the future against the Company.  Upon Mr. Hurd’s termination in August 2010, the Board immediately appointed the Company’s CFO, Cathie Lesjak, as interim CEO and formed a search committee to find a permanent replacement. 

On November 24, 2010, plaintiff filed a shareholder derivative complaint, which was subsequently amended.  Plaintiff argued that entering into the severance agreement constituted corporate waste because the board was not required to provide any severance to Mr. Hurd and did not receive what plaintiff believed to be anything of value in return.  Plaintiff also claimed that the directors breached their duty of care by not adopting a long-term succession plan, forcing HP to hire Lesjak as a temporary CEO and thereby putting HP in “a crisis mode.”  In response, HP and the director defendants moved to dismissed, contending that demand was not excused as to either claim and the complaint should therefore be dismissed pursuant to Court of Chancery Rule 23.1. 

The Court explained that because plaintiff’s first claim challenging the severance agreement as waste concerned a discrete transaction of the board, it should be reviewed under the standard set by the Delaware Supreme Court in Aronson v. Lewis, 473 A.2d 805 (Del. 1984).  Under Aronson, the Court will find demand futility where “the particularized facts alleged create a reasonable doubt that: (1) the directors are disinterested and independent or (2) the challenged transaction was otherwise the product of a valid exercise of business judgment.”  Because plaintiff conceded that the HP directors had no interest in the severance agreement and were independent of Mr. Hurd, the only question in terms of demand excusal was whether plaintiff had satisfied Aronson’s second prong by alleging particularized facts that raise a reasonable doubt that the severance agreement was the product of a valid exercise of business judgment.  The Court explained that while “the discretion of directors in setting executive compensation is not unlimited . . . it is the essence of business judgment for a board to determine if a particular individual warrants large amounts of money, whether in the form of current salary or severance provisions.”  A finding of waste is inappropriate so long as there is some rational basis for directors to conclude that the amount and form of compensation is appropriate and likely to be beneficial to the corporation.  The Court held that the agreement did not constitute an “egregious or irrational” exchange of corporate assets partly because it could have been appropriately given to Mr. Hurd for his prior successful stewardship of the Company.  It additionally found that the severance agreement, on its face, memorialized an exchange in which at least some consideration ran to HP.  For these reasons, the Court held that plaintiff failed to satisfy his burden under Aronson to show demand futility as to his waste claim.   

As for plaintiff’s due care claim, because the claim challenged the board’s inaction in failing to adopt a succession plan, rather than any particular board action, the Court applied the separate test set by the Delaware Supreme Court in Rales v. Balsband, 634 A.2d 927 (Del. 1993).  The Court noted that for claims based on board inaction, it is impossible to perform the essential inquiry contemplated by Aronson because there is no “challenged transaction” to review.  The Court explained that to properly plead demand futility under Rales, a plaintiff must allege particularized facts that create a reasonable doubt that the board of directors could have properly exercised its independent and disinterested business judgment in responding to a demand.  Only defendant directors who face a substantial likelihood of personal liability are deemed interested for purposes of a Rales analysis.  In that regard, the threat of directors’ liability is significantly lessened where, as in this case, the corporate charter exculpated the directors from liability to the fullest extent authorized by Delaware law.  For the HP directors to suffer a disabling likelihood of personal liability, the alleged breach of the duty of care for failing to implement a succession plan would have to rise to the level of bad faith.

Plaintiff separately attempted to argue that the Board implicitly conceded demand futility by allegedly establishing a special litigation committee.  While the appointment of a special litigation committee is in some cases an acknowledgement of demand futility and that a shareholder’s lawsuit was therefore properly initiated as a derivative action, the Court concluded that “to find that a board of directors conceded the futility of demand, a derivative plaintiff must allege particularized facts that support a factual finding that the board made the concession.”  Plaintiff failed to make such allegations in his complaint.  The Court rejected plaintiff’s waiver argument, stating that the complaint contained no allegations that the HP board formed a special litigation committee and thereby evidenced an intent to concede demand futility.

The full opinion is available here