Busch v. Richardson, et al., C.A. No. 2017-0868-AGB (Del. Ch. Nov. 14, 2018) (Bouchard, C.)
In this memorandum opinion, the Court of Chancery rejected a stockholder-plaintiff’s request to apply the Zapata analysis—ordinarily applicable in evaluating a special litigation committee’s motion to dismiss derivative litigation—to a board’s decision to refuse the stockholder’s pre-suit demand. The plaintiff argued that certain affirmative misrepresentations by the company misled him into making a pre-suit demand as opposed to filing a complaint and alleging demand futility. Although the Court determined that it would be inequitable under these circumstances to hold the plaintiff to his concession of board independence and disinterestedness attendant to his making a pre-suit demand, the Court stated that the proper standard was the demand futility framework, which would put the plaintiff in the position he would have been in had he filed a complaint without first making a demand, and not the Zapata framework, which only applies in a very narrow circumstance.
This case involved three transactions in which Richardson Electronics, Ltd. (the “Company”) repurchased shares of its stock in 2013 and 2014 from Edward J. Richardson (“Richardson”), the Company’s Chairman and Chief Executive Officer, and from a charity that Richardson controlled (the “Transactions”). Steven H. Busch (“Busch”), a stockholder of the Company, obtained books and records from the Company to evaluate the Transactions. In connection with that process, counsel for the Company made certain representations to Busch’s counsel suggesting that the Board had no role in or knowledge of the Transactions at the time they were executed. Based on that belief, Busch elected to make a pre-suit demand on the Board (the “Demand”) instead of filing a complaint and alleging that pre-suit demand was excused.
In response to the Demand, the Board formed a special committee (the “Special Committee”), which consisted of three of the Company’s five directors and did not include Richardson. Three of the Company’s five directors, including two members of the Special Committee, were not directors at the time that the 2013 Transactions occurred, but all five of the directors were on the Board at the time of the 2014 Transaction. The Special Committee retained counsel, which investigated the Demand and drafted a report (the “Report”). The Report noted that Company counsel’s representation to Busch regarding the Board’s involvement in the Transactions was inaccurate. Despite this finding, the Report recommended that the Board reject the Demand, opining that there was no basis on which to pursue an action against any director or officer relating to the Transactions. The Board adopted the Special Committee’s recommendation and informed Busch of its decision to reject the Demand.
Busch obtained a copy of the Report through a books and records request and filed his complaint, asserting a breach of fiduciary duty claim against the five current members of the Board for, among other things, failing to take action to recover damages as a result of the Transactions. The defendants moved to dismiss the complaint under Court of Chancery Rule 23.1.
Busch argued that his complaint should not be dismissed under the demand refusal framework announced in the Delaware Supreme Court’s Spiegel v. Buntrock decision. Under Spiegel, a stockholder who makes a pre-suit demand tacitly concedes the independence of the board to respond to the demand, meaning that the board’s decision to refuse the demand is protected by the business judgment rule. The Court rejected Busch’s argument because Busch failed to plead any particularized allegations sufficient to rebut the presumption of the business judgment rule that attached to the Board’s decision to refuse the Demand.
Busch argued in the alternative that the Court should not apply the Spiegel demand refusal analysis and that he should not be deemed to have conceded the independence of a majority of the Board by virtue of making his Demand because he was “actively misled” into believing that the Board played no role in approving the Transactions. Busch further argued that the Company’s misrepresentations caused him to make a pre-suit demand instead of filing a complaint and alleging that demand was excused. Busch urged the Court to adopt a “Zapata-type review” of the Special Committee’s independence as a consequence of these “affirmative misrepresentations.”
Although it recognized that the Spiegel demand refusal standard has been strictly applied when a stockholder makes a pre-suit demand, the Court nonetheless stated that it would be inequitable to hold Busch to the concession of independence and disinterestedness attendant to his making the Demand if the Company in fact misled him into making the Demand when he otherwise would have filed a complaint and alleged demand futility. The Court observed that it was possible based on the allegations in the complaint that Busch had been misled into believing that the Board had no knowledge of or involvement in the Transactions, but that it was not necessary to resolve this factual question.
Specifically, the Court of Chancery stated that the Supreme Court has made clear, including in Spiegel, that Zapata applies only when a derivative suit is brought, demand is excused, and the company then attempts to cleanse the conflicts by creating a special litigation committee, which moves to dismiss the derivative suit. In that narrow circumstance, the trial court inquires into the independence and good faith of the committee and its conclusions and applies the trial court’s own business judgment to determine whether the committee’s motion to dismiss the derivative litigation should be granted. Busch presented no contrary authority. For these reasons, the Court rejected Busch’s request to extend Zapata to apply to this case.
The Court went on to state that, if Busch was permitted to withdraw his concession of Board independence and disinterestedness attendant to his making the Demand, the proper standard to apply would be the demand futility framework, whereby Busch would be treated as if he had filed the complaint without ever having made the Demand. However, the Court stated that Busch could not satisfy the demand futility standard because his complaint contained no particularized allegations creating a reasonable doubt that a majority of the Board could have properly exercised their independent and disinterested business judgment in responding to the Demand.