Delaware Supreme Court Clarifies the Standards for Demand Futility

A pair of opinions released by the Delaware Supreme Court in a single week have revisited longstanding precedent governing shareholder suits that claim corporate wrongdoing. As discussed in a companion post on this blog, the first of those opinions, Brookfield Asset Management Inc. v. Rosson, restricted the ability of shareholders to bring direct claims under certain circumstances, instead forcing them to pursue more procedurally challenging derivative suits. In the second case, United Food & Commercial Workers Union & Participating Food Industry Employers Tri-State Pension Fund v. Zuckerberg, the Delaware Supreme Court adopted a new three-part demand-futility test that clarifies the standard shareholders must meet to file such derivative suits, without first taking their complaints to the company’s board of directors.


United Food arose from a vote by Facebook’s board of directors in 2016 to pursue a stock reclassification plan that would allow CEO Mark Zuckerberg to sell most of his Facebook stock — which Zuckerberg planned to do to fulfill the “Giving Pledge,” under which he had committed to giving the majority of his wealth to philanthropic causes — while still maintaining voting control over the company. Days after Facebook announced the reclassification plan, several investors filed class action suits to block the plan, alleging that it was a self-interested deal that put Zuckerberg’s interests ahead of Facebook’s in violation of the board of directors’ fiduciary duties. Shortly before trial was scheduled to begin, Facebook abandoned the reclassification plan and mooted the pending litigation.

Thereafter, a pension fund filed a derivative suit seeking to recover the more than $90 million Facebook spent in defending and settling the class action relating to the withdrawn reclassification plan, including a $68 million fee to the plaintiffs’ attorneys and more than $20 million in defense litigation fees and expenses. The pension fund did not make a litigation demand on Facebook’s board. Instead, it alleged that any demand would have been futile because Facebook’s board conducted “sham” independent deliberations regarding the reclassification plan that were not a valid exercise of business judgment, and the majority of directors were biased toward and beholden to Zuckerberg.

On the defendants’ motion to dismiss the complaint, the Court of Chancery concluded that the pension fund was not justified in sidestepping the board of directors and suing Facebook directly because it had not adequately alleged that a demand on Facebook’s board would have been futile. On appeal, the Delaware Supreme Court affirmed the dismissal of the case, and took the opportunity to modernize the decades-old demand-futility standards articulated in a pair of prior decisions: Aronson v. Lewis, 473 A.2d 805 (Del. 1984), and Rales v. Blasband, 634 A.2d 927 (Del. 1993).

The Demand-Futility Standard

As a general matter, shareholder derivative suits represent a fundamental encroachment on the managerial authority and discretion of a company’s board of directors. Before stockholders are permitted to upset the ordinary balance and file a derivative suit on behalf of the company, they must either make a demand on the company’s board of directors — which would afford the board the opportunity to address the complaint and control any litigation pursued on the company’s behalf — or prove that such a demand would be futile. The Delaware Supreme Court has noted that the demand requirement is a critical “doctrinal check” that should be excused only where there is reason to doubt that the board could exercise impartial business judgment.

In Delaware, demand futility has long been governed by Aronson and Rales. The Aronson test excuses the demand as futile if the allegations raise a reasonable doubt that “the directors are disinterested and independent” or that “the challenged transaction was otherwise the product of a valid business judgment.” 473 A.2d at 814. The Rales test excuses the demand if the allegations create a reasonable doubt that a majority of the board in place at the time of the demand “could have properly exercised its independent and disinterested business judgment in responding to a demand.” 634 A.2d at 934.

The Delaware Supreme Court has now for the first time combined the demand-futility principles announced in Aronson and Rales, and embraced a new three-part test. Under this test, which is applied on a director-by-director basis, demand will be excused as futile if any of the prongs of the test is true for at least half of the members of the “demand board” (i.e., the board in place at the time of the litigation demand): (i) the director received a material personal benefit from the alleged misconduct, (ii) the director would face a substantial likelihood of liability on the claims that are the subject of the demand, or (iii) the direct lacks independence from another person who received a material personal benefit from the alleged misconduct or would face a substantial likelihood of liability on the claims that are the subject of the demand.

Notably, the new three-part test effectively abandons the second prong of the Aronson test, which excused demand when the directors were not entitled to business judgment deference for the transaction underlying the litigation. Under that prong, business judgment deference was used as a proxy for board members’ personal liability risk — that is, if the board was not entitled to deference for the underlying business decision out of which the litigation arose, Aronson assumed that directors were at risk of personal liability and could not be relied upon to make an independent decision. However, two years after Aronson was decided, Delaware enacted Section 102(b)(7), a provision of the Delaware Code that permits corporations to shield directors from money damages for breaching their fiduciary duties. Such “exculpatory provisions” dramatically reduced director liability risk from lawsuits, and consequently eroded the core premise of the second prong of the Aronson test. The new combined standard announced in United Food addresses this evolution in the law, and ensures that shareholders are excused from the demand requirement only if the directors on the demand board are unable to exercise their business judgment to conduct litigation on behalf of the corporation free of any influence that “sterilizes” their discretion.

Applying its new three-part test to Facebook’s demand board, the Court concluded that the pension fund failed to adequately allege that a majority of board members had a material personal interest or would face a substantial likelihood of liability from the subject of the litigation demand, as the complaint alleged only a breach of fiduciary duties that was exculpated under the broad scope of Facebook’s Section 102(b)(7) provision. Nor did the allegations establish that a majority of the directors lacked independence from Zuckerberg. Accordingly, the Court concluded that the pension fund failed to adequately allege that a litigation demand to the board would have been futile, and affirmed dismissal of the complaint.


It is too soon to tell whether the Delaware Supreme Court’s refinement of the demand-futility standard in the United Food decision will have a significant practical impact on the success of shareholder derivative suits. However, in the wake of this decision, companies facing derivative claims have greater clarity regarding the standard plaintiffs must meet, and can develop better-informed litigation strategies in response.

This post is as of the posting date stated above. Sidley Austin LLP assumes no duty to update this post or post about any subsequent developments having a bearing on this post.