Shabbouei v. Potdevin, et. al., No. 2018-0847-JRS (Del. Ch. Apr. 2, 2020) (Slights, V.C.)
In this memorandum opinion, the Court of Chancery granted a motion to dismiss derivative claims against the board of directors of lululemon because the plaintiff failed to adequately plead demand futility under Court of Chancery Rule 23.1. In so ruling, the Court applied the two-prong Aronson standard and held that the plaintiff failed to plead with the required particularity that the board was self-interested in the separation agreement it entered into with its CEO, or that its decision to enter into the separation agreement (rather than fire the CEO for cause) was not a product of valid business judgment.
Laurent Potdevin (“Potdevin”) served as the CEO of lululemon athletica inc. (“lululemon”) from 2014 to 2018 under an employment agreement that authorized the lululemon board to terminate him with or without cause. During his tenure, Potdevin allegedly “created a toxic culture at lululemon and engaged in a pattern and practice of harassment and sexual favoritism while CEO.” He also allegedly gave preferential treatment to his girlfriend, a lululemon designer. In response to two vaguely described “incidents,” the lululemon board conducted several informal, un-minuted meetings to discuss how to best address Potdevin’s misconduct. The board eventually hired outside counsel to investigate Potdevin’s misconduct. After receiving the report from the investigation, the board authorized one of its directors, Glenn Murphy, to negotiate the terms of a separation agreement with Potdevin, as the board believed a quiet, amicable separation was favorable to a public termination for cause. The board ultimately agreed to pay Potdevin $5 million in exchange for Potdevin releasing all claims against lululemon and departing quietly. On February 5, 2018, one week after receiving the investigation report, the board announced Potdevin’s resignation.
In April 2018, lululemon stockholder David Shabboeui (“Plaintiff”) served lululemon with an inspection demand under Section 220 of the Delaware General Corporation Law for the purpose of investigating wrongdoing surrounding Potdevin’s exit. Armed with lululemon’s Section 220 production, Plaintiff brought derivative claims against the lululemon board of directors alleging that the directors breached their fiduciary duties by approving Potdevin’s separation agreement and that the separation agreement constituted corporate waste. Plaintiff also brought a claim against Potdevin, alleging that Potdevin was unjustly enriched by the separation agreement. Plaintiff did not make a litigation demand upon the board of directors.
Defendants moved to dismiss the claims under Court of Chancery Rule 23.1, arguing that Plaintiff failed in his Complaint to “state with particularity” why he did not ask the board to pursue the claims. Plaintiff, in turn, attempted to place his claims within the demand futility paradigm by arguing that the board’s decision to enter the separation agreement was either (i) an interested transaction, (ii) not a product of valid business judgment, or (iii) constituted waste.
As an initial matter, the Court pointed out that Plaintiff’s allegations, specifically that the board failed to implement adequate controls, were “the makings of a Caremark claim.” But because Plaintiff disavowed any intent to plead a claim that the board failed to exercise appropriate oversight, the Court did not conduct an analysis under Caremark. The Court noted, however, that the board adequately responded to any “red flags” when it hired outside counsel to investigate Potdevin’s misconduct and thereafter determined to secure Potdevin’s departure without litigation or excessive negative publicity.
Instead, the Court addressed the Rule 23.1 pleading standard for demand futility, as articulated in Aronson v. Lewis, 473 A. 2d 805 (Del. 1984), because Plaintiff challenged an affirmative board decision. The two-prong Aronson standard requires a stockholder attempting to establish demand futility to plead particularized facts in support of a reasonable inference that either (i) a majority of the board is interested in the challenged decision, or (ii) the challenged decision was not a product of valid business judgment. The Court held that Plaintiff failed to satisfy either prong.
Under Aronson’s first prong, the Court held that Plaintiff failed to plead with particularity that a majority of the directors were “interested” in lululemon’s decision to enter into the separation agreement with Potdevin. Plaintiff argued that the board was interested in the separation agreement as a means to hide board-level oversight failures and avoid liability for those failures. The Court rejected this argument, characterized these allegations as conclusory, and explained that for Plaintiff’s argument to stick, Plaintiff would need to plead particularized facts supporting an inference that the separation agreement extinguished a “substantial likelihood” of board liability based on oversight failures—a claim that Plaintiff had disavowed. The Court also noted that the separation agreement did not extinguish any claims that Potdevin might have had against the board, as Plaintiff identified no such potential claims. Moreover, the Court reaffirmed the rule that a general release obtained on behalf of a board of directors in a settlement is not a basis to characterize the settlement as an “interested party transaction.”
Under Aronson’s second prong, the Court held that Plaintiff failed to meet its “heavy burden” and plead particularized facts in support of an inference that the board’s decision to enter into the separation agreement with Potdevin was not a product of valid business judgment. The Court first explained that because lululemon has an exculpatory charter provision, demand is excused only by pleading that a majority of the board breached the duty of loyalty or acted in bad faith. Applying the business judgment rule standard, the Court focused on the “process” employed by the board and found that Plaintiff had not even pled an exculpated claim for breach of the duty of care. Plaintiff argued that the board allowed Potdevin to decide his own fate and that the board rushed to enter the separation agreement after conducting only informal meetings (without minutes). The Court determined that neither of these alleged shortcomings supported an inference of gross negligence, let alone bad-faith conduct or a breach of the duty of loyalty. Specifically, the Court explained that the board only authorized Murphy to negotiate a peaceful separation with Potdevin; if Potdevin did not agree to go quietly, the Board would have taken a different action. Moreover, the Court explained that Plaintiff could not argue that the board took too long to address Potdevin’s conduct, but then also argue that it acted too quickly in entering into the separation agreement after receiving the investigation report. Notably, the Court did not take issue with the board’s decision to discuss Potdevin’s misconduct in informal, un-minuted meetings.
Finally, the Court held that Plaintiff did not adequately plead a claim for corporate waste. The Court explained that Plaintiff was required to plead that the separation agreement could not be attributed to any rational business purpose. Instead, as the Court explained, Plaintiff merely alleged that Potdevin could have been fired for cause, and that lululemon derived no value from entering into the separation agreement. The Court rejected this argument, pointing out that the separation agreement required Potdevin to release all claims against lululemon, allowed lululemon to secure a non-solicitation covenant from Potdevin, and prevented lululemon from exposure to negative publicity.