United Food and Commercial Workers Union and Participating Food Industry Employers Tri-State Pension Fund v. Zuckerberg, et al., C.A. No. 2018-0671 (Del. Ch. Oct. 26, 2020) (Laster, V.C.)
In this opinion, the Court of Chancery dismissed plaintiff’s claim that the board of directors of Facebook, Inc. (“Facebook”) breached its fiduciary duties in connection with a stock reclassification proposal that would have allowed Facebook founder Mark Zuckerberg to retain voting control of Facebook even after donating a significant portion of his shares to charitable causes. The Court reached that decision because plaintiff had not adequately pled that its failure to make a demand on Facebook’s board was excused. In that analysis, the Court explained at length the shortcomings of the seminal Aronson v. Lewis (“Aronson”) decision, going so far as to question whether “the time has come to move on from” Aronson’s demand futility test. After extolling the flexibility of Rales v. Blasband (“Rales”) and its ability to serve “as the general demand futility test,” the Court applied Rales to conclude that at the time litigation was filed, a majority of Facebook’s directors were independent and disinterested for purposes of considering a potential demand.
Plaintiff’s suit arose from a proposed stock reclassification that would have allowed Zuckerberg to satisfy his “Giving Pledge” of donating nearly all of his wealth during his lifetime without having to give up his voting control of Facebook. Following board and stockholder approval of the reclassification, certain stockholders sought to prevent the reclassification from closing. Before trial in prior litigation directly challenging the reclassification proposal, at Zuckerberg’s request, Facebook’s board agreed to withdraw the proposal, though the legal expenses of pursuing that litigation and subsequent attorneys’ fees totaled more than $80 million. Plaintiff then, in this separate derivative action, brought suit claiming that the board of directors of Facebook breached its fiduciary duties in approving the stock reclassification proposal, failing to recover the money expended defending the proposal, and engaging in actions that caused Facebook reputational damage.
Because plaintiff did not make a pre-suit demand, the Court considered whether demand was futile. Before considering which demand futility test would apply, the Court explained that “Delaware’s evolving jurisprudence” had “dismantled the logic of Aronson” and that “[v]iewed on its own terms, Aronson is no longer a functional test.” The Court further explained that, following the Delaware Supreme Court’s decision in In re Cornerstone Therapeutics Inc. Stockholder Litigation, 115 A.2d 1173 (Del. 2015), Aronson’s first prong remained viable, “but only because the requirements for satisfying the first prong of Aronson also create a pleading-stage inference that exculpation [pursuant to a Section 102(b)(7) provision] will be unavailable to directors comprising a majority of the [b]oard[,]” and Aronson’s second prong remained viable “only in the unlikely event that a corporation lacks a Section 102(b)(7) provision, or to the extent that the particularized factual allegations portray a transaction that is so extreme as to suggest bad faith.”
The Court concluded that Rales was better suited as the general demand futility test, as it “refocus[ed] on the decision regarding the litigation demand, rather than the decision being challenged.” The Court explained that Rales was able to account for a number of situations that Aronson would not be able to address, such as the potential conflicts faced by a director who had abstained at the time of the voting on the reclassification but remained on the board of directors at the time litigation was filed and by a director who joined the Facebook board of directors following the approval of the reclassification but before the filing of the litigation. In applying Rales, the Court considered, for each director subject to the analysis and based on the subject of the demand, whether such director (i) received a “material personal benefit from the alleged misconduct,” (ii) faced “a substantial likelihood of liability on any of the claims,” and (iii) lacked “independence from someone who received a material personal benefit from the alleged misconduct” or “who would face a substantial likelihood of liability on any of the claims.” For purposes of considering “substantial likelihood of liability,” the test also considered the “operative standard of review” and “the potential availability of exculpation.”
The Court then interpreted plaintiff’s framing of the demand futility argument as whether the board of directors of Facebook could have independently and in a disinterested manner determined whether to “embark on litigation over the [r]eclassification.” Based on the allegations in the complaint, the Court made “pro-plaintiff assumptions” that three out of the nine directors could not be disinterested and independent with respect to plaintiff’s demand due to, in the case of Zuckerberg, the material benefit he could receive in the reclassification, or, in the case of Sheryl Sandberg and Marc Andreessen, their lack of independence from Zuckerberg. The Court then applied the aforementioned test to five out of the six remaining directors. The Court determined that the five directors did not face a “substantial likelihood of liability,” would not receive a “material personal benefit from the alleged misconduct” and were independent from those receiving a “material personal benefit” or facing “a substantial likelihood of liability.” Therefore, the Court concluded that demand was not excused and dismissed plaintiff’s claim.