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In re The Dow Chemical Company Derivative Litigation, C.A. No. 4349-CC (Del. Ch. Jan. 11, 2010) (Chancellor Chandler)

January 11, 2011

In this memorandum opinion, Chancellor Chandler held that plaintiff stockholders had not plead particularized facts sufficient to show demand futility under Aronson and dismissed plaintiffs’ various derivative claims under Chancery Court Rule 23.1.

Plaintiffs, stockholders of the Dow Chemical Company (“Dow”), brought a derivative action against the Dow directors for breaches of fiduciary duties in relation to Dow’s acquisition of Rohm & Haas Company (“R&H”). Plaintiffs alleged that the directors breached their fiduciary duties by approving the transaction and misrepresenting the relationship between the transaction and a joint venture with a Kuwaiti company. Plaintiffs also asserted a Caremark claim for failure to supervise and prevent a litany of alleged wrongs, including bribery and insider trading.

In 2007, Dow entered into a memorandum of understanding in order to form a joint venture (“K-Dow”) with a Kuwaiti chemical company. Dow anticipated that the joint venture transaction, which was expected to close in late 2008, would provide $9 billion in cash payments to Dow. In July 2008, the Dow board unanimously approved a merger agreement pursuant to which Dow would acquire R&H. Because there were many other potential buyers and R&H was demanding deal certainty, Dow did not condition the closing of the merger transaction on financing. At the time it entered into the merger agreement with R&H, Dow had multiple sources of funding available to it aside from the potential cash payments resulting from the anticipated K-Dow transaction, and two Dow directors/officers made public statements that the R&H deal was not contingent upon the closing of the K-Dow joint venture. The economic downturn and tightening of the credit markets in the second half of 2008, however, depleted Dow’s cash reserves and ability to secure other credit to fund the R&H transaction. In addition, the Supreme Petroleum Council (“SPC”) of Kuwait rescinded its prior approval of the K-Dow joint venture amidst press reports insinuating that Dow had bribed the SPC. When Dow refused to close on the merger with R&H in January 2009, R&H filed suit in the Court of Chancery seeking specific performance, which lead to a settlement and closing of the merger on altered financial terms.

With respect to the fiduciary duty claims arising from the Dow board’s approval of the acquisition of R&H, the Court first analyzed whether demand was excused under the familiar Aronson test, considering whether there was reasonable doubt that either (1) a majority of the directors who approved the transaction in question were disinterested and independent, or (2) the transaction was the product of the board’s good faith, informed business judgment. As to part one of the Aronson test, the Court found that a majority of the directors were disinterested and independent. None of the directors stood on both sides of the transaction, and even though a number of the directors had varying personal and business relationships with the Chairman and Chief Executive Officer, he was not personally interested in the transaction. As the Court noted, under Brehm v. Eisner, “without an interested director the independence of the remaining directors need not be examined,” and therefore any beholdenness to the Chairman and Chief Executive Officer was irrelevant.

The Court likewise found that demand was not excused under the second prong of Aronson. First, the Court found that the complaint failed to allege that the board was not adequately informed in making the decision. Noting that the plaintiffs were focused on the substantive decision of the board to enter into the merger agreement without a financing condition and not the process the board followed, the Court stated that it “made clear in Citigroup that substantive second-guessing of the merits of a business decision, like what plaintiffs ask the Court to do here, is precisely the kind of inquiry that the business judgment rule prohibits.” Plaintiffs attempted to distinguish Citigroup by arguing that an exercise of business judgment relating to a transaction or series of transactions was different from the “bet the company” transformational transaction that was currently at issue. The Court refuted this argument, however, stating that Delaware law did not support such a distinction. The Court also found that the allegations in the complaint failed to raise a doubt that the board action was taken in good faith. The Court found plaintiffs had not made particularized allegations sufficient to find that the board had completely and “utterly failed” to even attempt to meet their duties, which is the standard required under Lyondell.

Next, the Court moved on to plaintiffs’ Caremark claim. The Court noted that a board’s unconscious failure to act was governed by Rales. Under Rales, the only demand futility issue is whether the board that would be addressing the demand can impartially consider its merits without being influenced by improper considerations. Directors who face a “substantial likelihood of personal liability” cannot make an impartial decision because they are deemed interested in the transaction. In considering the likelihood of personal liability, the Court noted that the plaintiffs’ claims were based on Caremark, which under Citigroup, requires a plaintiff to establish that “the directors demonstrated a conscious disregard” for their responsibilities. A showing of bad faith is a “necessary condition to director oversight liability.” The Court also noted that Dow had adopted a section 102(b)(7) provision in its charter, and thus the plaintiffs had the burden of “pleading particularized facts showing bad faith in order to establish a substantial likelihood of personal directorial liability.” Turning to the well-pled allegations of the complaint, the Court held that plaintiffs’ claims failed to allege facts to establish a substantial likelihood of director liability under Citigroup because: (i) plaintiffs did not allege that the board knew about, or had reason to suspect, bribery; and (ii) no misrepresentations occurred because the board’s statements that the R&H transaction were not contingent on the K-Dow joint venture were not misrepresentations at all, but merely statements about the timing of the two deals.

Lastly, Chancellor Chandler held that the plaintiffs’ remaining claims for insider trading and waste were waived because they were not addressed in their responsive brief. Accordingly, the Court dismissed all claims.

The full opinion is available here