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Melbourne Municipal Firefighters’ Pension Trust Fund v. Jacobs, C.A. No. 10872-VCMR (Del. Ch. Aug. 1, 2016) (Montgomery-Reeves, V.C.), affirmed by order (Del. March 3, 2017)

August 1, 2016

In this memorandum opinion, the Delaware Court of Chancery dismissed, pursuant to Court of Chancery Rule 23.1, a stockholder’s Caremark claim brought derivatively on behalf Qaulcomm Incorporated (“Qualcomm” or the “Company”). The Court held that a pre-suit demand on Qualcomm’s board of directors (the “Board”) was not excused because the stockholder’s complaint failed to plead facts sufficient to infer that the Board faced a substantial likelihood of liability.

To sufficiently plead a Caremark claim, a plaintiff must allege (i) that the directors knew or should have known that the corporation was violating the law, (ii) that the directors acted in bad faith by failing to prevent or remedy the corporate conduct giving rise to such violation, and (iii) that such failure resulted in damage to the corporation. Plaintiffs often attempt to satisfy the foregoing elements by pleading that a board of directors was aware of “red flags” indicating corporate misconduct and acted in bad faith by consciously disregarding its duty to address such misconduct.

In this case, Melbourne Municipal Firefighters’ Pension Trust Fund (“Plaintiff”), a stockholder of Qualcomm, alleged (i) that as evidenced by certain red flags, including decisions issued by South Korean and Japanese regulatory authorities finding that Qualcomm had violated anti-competition laws, the Board was aware that certain of the Company’s business practices were illegal, (ii) that the Board acted in bad faith by failing to prevent or remedy such conduct, and (iii) that such inaction resulted in, among other things, Qualcomm being fined $975 million for violating Chinese antitrust law. Plaintiff did not make a pre-suit demand on the Board, arguing that such demand was excused as the Board faced a substantial likelihood of liability by reason of Plaintiff’s claim. The Board moved to dismiss the complaint under Rule 23.1.

Applying the Rales v. Blasband test for demand futility, the Court held that Plaintiff’s Caremark claim failed to plead facts sufficient to reasonably infer that a majority of the Board faced a substantial likelihood of personal liability. Assuming for the purposes of its analysis that the alleged red flags constituted corporate misconduct of which the Board was aware, the Court focused on whether the Board’s response to such red flags constituted bad faith. The Court noted that the Board (i) continuously monitored each of the red flags, (ii) repeatedly expressed (including in its public filings) its view that the Company’s business practices were not in violation of applicable law, (iii) elected to address claims to the contrary by focusing on educating industry participants and governmental officials as to why its business practices were legal, and (iv) was actively pursuing appeals of the South Korean and Japanese decisions.

Because the Board had assessed the purported red flags, concluded that Qualcomm’s business practices were legal, and was appealing the South Korean and Japanese decisions, the Court held that Plaintiff failed to demonstrate that the Board acted in bad faith. The Court noted, however, that in some instances, severe enough red flags could require directors to act to prevent or remedy the corporate misconduct, even if they believed that such conduct was legal. The Court observed, for example, that in In re Massey Energy Co. and Louisiana Municipal Police Employees Retirement System v. Pyott the plaintiffs plead bad faith inaction in response to illegal or criminal misconduct sufficient to plead a Caremark claim. However, as the Qualcomm Board had not caused the Company to plead guilty to any criminal charge related to its business practices, had not been advised by counsel that such practices were illegal, and  at all times believed that the Company’s conduct did not violate applicable anti-trust laws, the Court reasoned that the case was distinguishable from Massey and Pyott.

Accordingly, as a result of having failed to demonstrate the Board’s bad faith, the Court held that Plaintiff’s Caremark claim necessarily failed and, as a result, pre-suit demand was not excused, requiring dismissal of the complaint.  The Court’s decision was affirmed by order of the Delaware Supreme Court on March 3, 2017.

The full opinion is available here