Solak v. Welch, C.A. No. 2018-0810-KSJM (Del. Ch. Oct. 30, 2019) (McCormick, V.C.)
In this memorandum opinion, the Delaware Court of Chancery dismissed a stockholder’s (“Plaintiff”) derivative complaint after finding that a letter sent to a board of directors by Plaintiff’s counsel, which sought remedial board action regarding director compensation, qualified as a pre-suit demand under Court of Chancery Rule 23.1 (“Rule 23.1”), and that Plaintiff, despite receiving the board’s refusal, failed to allege wrongful demand refusal.
Rule 23.1 requires a stockholder to first demand action by the board of directors before the stockholder brings a derivative action unless that stockholder instead chooses to allege demand futility and, in connection therewith, pleads with particularity the reasons it would have been futile to make a pre-suit demand on the board. Under Delaware law, a stockholder who makes a pre-suit demand cannot later argue that demand is excused, and “tacitly concedes” the board’s ability to properly consider the demand.
Here, the parties dispute whether Plaintiff actually made a pre-suit demand on the Board. Citing the Delaware Court of Chancery’s decision in Yaw v. Talley, the Court noted that a pre-suit communication qualifies as a demand pursuant to Rule 23.1 if it provides “(i) the identity of the alleged wrongdoers, (ii) the wrongdoing they allegedly perpetrated and the resultant injury to the corporation, and (iii) the legal action the [stockholder] wants the board to take on the corporation’s behalf.”
The parties dispute centered on whether the letter satisfied the third criterion of Yaw. Plaintiff argued that the letter could not be a pre-suit demand under Rule 23.1 because it did not expressly demand that the board initiate litigation. The Court noted that Delaware law considers “pre-suit communications that do not expressly demand litigation [as] sufficient to constitute pre-suit demand.” The Court also noted that, although avoiding express demands that the board take legal action, the letter clearly articulated “the need for ‘immediate remedial measures’” and proposed remedial actions for the board to implement. Further, the letter warned that Plaintiff would “consider all available” stockholder remedies absent a response by the board within thirty days. Despite Plaintiff’s assertion that the letter was not a demand, the Court found the “strong overtures of litigation” were evidence to the contrary and, thus, satisfied the third criterion of Yaw. In reaching that conclusion, the Court also observed that the letter read like a complaint and, in fact, not only alleged the same wrongdoing using similar expressions as in the letter but also adopted the letter’s manner of describing the alleged wrongdoing.
In reaching its decision, the Court rejected Plaintiff’s argument that the Court should not review the substance of the letter because it included a footnote disclaimer stating that “nothing contained herein shall be construed as a pre-suit demand under” Rule 23.1. The Court noted Delaware law’s refusal to sanction the practice of both making a demand and pleading demand futility as a way to “cover all the bases,” finding that Plaintiff could not simply state “this is not a demand” in the pre-suit letter as a means to avoid a judicial determination that pre-suit demand was made.
Finally, the Court found that Plaintiff failed to adequately plead wrongful refusal of its demand because Plaintiff did not allege with particularity any facts supporting an inference that the board committed gross negligence or acted in bad faith in reaching its refusal decision. In response to the letter, the board, with assistance of counsel, investigated the allegations by reviewing public and confidential corporate documents and interviewing the chairman of the compensation committee along with the committee’s independent consultant. The Court found that Plaintiff did not address these actions or the board’s response to the letter explaining the underlying substantive reasons for the board’s refusal decision, or allege how the board’s response was wrongful. Because the business judgment rule is the “operative standard” in assessing a board’s refusal to file a lawsuit upon demand by a stockholder and Plaintiff failed to allege particularized facts that showed the board wrongfully refused the pre-suit demand, the Complaint failed. For these reasons, the Court granted the motion to dismiss.