CLIENT ALERT: Delaware Supreme Court Relaxes Inquiry into Director Independence in Demand Futility Context
Sandys v. Pincus, No. 157, 2016 (Del. Dec. 5, 2016).
In this en banc majority opinion, the Delaware Supreme Court signaled that, at least in the context of a demand futility analysis involving a corporation with a controlling stockholder, the Delaware courts may take a more relaxed view of a plaintiff’s burden to plead particularized facts demonstrating that a demand on a board would have been futile. Justice Karen L. Valihura disagreed with the majority and issued a dissenting opinion.
At issue below in the Court of Chancery was the defendants’ motion to dismiss plaintiff’s derivative claims under Court of Chancery Rule 23.1 given plaintiff’s failure to make a pre-suit demand on the board. The underlying breach of fiduciary duty claims involved allegations that certain managers and directors of Zynga, Inc. (“Zynga”), including its controlling stockholder, breached their fiduciary duties in connection with a sale of stock in a secondary offering before an earnings announcement. Applying the standard articulated in Rales v. Blasband, the Court of Chancery found that demand was not excused because five of Zynga’s nine directors were independent, and therefore granted defendants’ motion to dismiss. On appeal, the Delaware Supreme Court reversed and determined that a majority of the Zynga board could not impartially consider the stockholder demand.
Writing for the majority (the “Majority”), Chief Justice Leo E. Strine, Jr. first admonished the plaintiff for failing to use his pre-suit books and records demand to investigate the independence of the board. The Majority similarly criticized the plaintiff for failing to use the internet as one of the “tools at hand” to discover information about the relationships of the directors. Although cautioning that reliance on the internet as a source of information should be used with care, the Majority nonetheless stated that “we can take judicial notice that internet searches can generate articles in reputable newspapers and journals, postings on official company web sites, and information on university websites that can be the source of reliable information.”
Turning to the independence of the Zynga board members, the Majority disagreed with the Court of Chancery’s findings of independence with respect to three of the directors. First, the Majority found that Ellen Siminoff, who along with her husband co-owned a private plane with Mark J. Pincus (a Zynga director and its controlling stockholder), was not independent. Despite deficiencies in plaintiff’s factual pleadings, which were exacerbated by plaintiff’s failures to use the “tools at hand”, the Majority held that a reasonable inference could be drawn that, among other things, co-ownership of a private plane “signaled an extremely close, personal bond between Pincus and Siminoff, and between their families” affecting Siminoff’s independence, and that Siminoff would not be able to act impartially when evaluating “a suit implicating a very close friend with whom she and her husband co-own a private plane.”
The Majority then found that two other Zynga directors, William Gordon and John Doerr, were not independent for pleading stage purposes. The Majority reached this conclusion because Gordon and Doerr are partners at Kleiner Perkins Caufield & Byers (“Kleiner Perkins”), which controls approximately 9.2% of Zynga’s equity, and also holds investments both in a company co-founded by Pincus’ wife and a company whose board included a Zynga director and another partner at Kleiner Perkins. The Majority also was persuaded by the Zynga board’s determination, as set forth in Zynga’s SEC filings, that Gordon and Doerr did not qualify as independent directors under the NASDAQ Listing Rules. Although the plaintiff failed to plead the reason why the board made this determination, the Majority determined that a reasonable doubt existed under Rales as to whether Gordon and Doerr were independent, and therefore concluded that a majority of the Zynga board was unable to consider plaintiff’s demand impartially.
The Majority opinion in Pincus signals a shift in the long-standing proposition that directors are presumed independent for purposes of the demand futility analysis absent particularized facts pled by plaintiffs. It is important to point out, however, that the underlying facts of the case involved the presence of a controlling stockholder; and, therefore, it is unclear to what extent the case would be applicable to other situations. The Pincus opinion also appears to endorse the use of the internet as one of the “tools at hand” available to a plaintiff in crafting the pleadings. Finally, the opinion suggests that it is at least of some relevance to the demand futility analysis whether a board has determined that a director is independent for purposes of stock exchange listing requirements, even where there is an absence of well-plead factual allegations regarding the reasons for that determination.
Justice Valihura dissented from the Majority, taking issue with plaintiff’s failure to use its books and records request to inquire into the board’s independence, and finding that the plaintiff did not satisfy his burden to plead facts with particularity that showed that the demand on the board would have been futile, focusing in particular on the lack of pleadings regarding the materiality of the relationships of the board members.