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    Business Law Legal Research Blog

    CORPORATE LAW: Delaware’s New Universal Test for Demand Futility—A Game Changer?

    Posted by Charlene J. Hicks on Thu, Nov 18, 2021 @ 09:11 AM

    Charlene Hicks—Senior Attorney, National Legal Research Group

                Prior to bringing a shareholder derivative action, the complaining shareholders must normally make a detailed presuit demand on the corporation’s board of directors or show the court that such a demand would be futile. In United Food & Commercial Workers Union v. Zuckerberg, No. 404, 2020, 2021 WL 4344361 (Del. Sept. 23, 2021), the Delaware Supreme Court announced a new “universal test” for determining whether a shareholder demand should be excused as futile. This new test imposes more stringent pleading requirements on the derivative plaintiffs to show futility.

                In United Food, the complaining shareholders alleged that the members of Facebook, Inc.’s (now “Meta Platforms Inc.”) board of directors violated their fiduciary duties when they voted in favor of a stock reclassification that would have allowed Mark Zuckerberg, Facebook’s CEO, to sell most of his Facebook stock while still maintaining voting control. The Board’s vote eventually led to the company spending approximately $90 million to defend against a class action lawsuit. The complaining shareholders filed the derivative action in an attempt to recoup those litigation expenses.

                Prior to filing their derivative complaint, the United Food shareholders did not make a presuit demand on Facebook’s board. The derivative complaint instead alleged that demand was excused as futile. To support this allegation, the complaining shareholders asserted that the vote by the board members was not a valid exercise of business judgment and that a majority of the Facebook directors lacked independence from Mark Zuckerberg. Facebook and the individual board members moved to dismiss the derivative action on the ground that the derivative plaintiffs did not adequately allege demand futility.

                The Delaware Supreme Court agreed with Facebook and the board members. Id. at *17-21. In reaching this decision, the court applied a three-part test that was to be used “from this point forward . . . on a director-by-director basis when evaluating allegations of demand futility.” Id. at *17. First, the court should consider “whether the director received a material personal benefit from the alleged misconduct that is the subject of the litigation demand.” Id. Second, the court should ask “whether the director faces a substantial likelihood of liability on any of the claims that would be the subject of the litigation demand.” Id. Third, the court should consider “whether the director lacks independence from someone who received a material personal benefit from the alleged misconduct that would be the subject of the litigation demand or who would face a substantial likelihood of liability on any of the claims that are the subject of the litigation demand.” Id. “If the answer to any of the questions is ‘yes’ for at least half of the members of the demand board, then demand is excused as futile.” Id.

                The United Food court emphasized that this universal three-part test “refocuses the inquiry on the decision regarding the litigation demand, rather than the decision being challenged.” Id. at *16. In other words, in determining demand futility, the focus of consideration is on “whether the board should be deprived of its decisionmaking authority because there is reason to doubt that the directors would be able to bring their impartial business judgment to bear on a litigation demand.” Id. The derivative plaintiffs must plead with particularity facts showing that the directors’ impartial judgment has been compromised to such a degree that demand on the board would be futile. In the United Food case, the court ruled that the chancery court properly dismissed the derivative complaint because the shareholders failed to plead with the requisite particularity that a demand on Facebook’s board would be futile. Id. at *17-21.

                As a practical matter, the requirement that complaining shareholders clearly show that a majority of corporate board members lack the ability to impartially consider a demand sets a high standard. Thus, the new universal test may function as a barrier to shareholders’ ability to successfully file derivative complaints in the future.

    Topics: corporations, Charlene J. Hicks, impartial business judgment, shareholder dirivative action, presuit demand

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