29 November 2021

Chancery Court Issues Rare Finding of Wrongful Refusal of Demand – Followed By A Reminder of Why Such Findings Are So Uncommon

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On October 29, 2021, the Delaware Court of Chancery issued a rare opinion holding that plaintiffs had succeeded in pleading that a board of directors wrongfully had refused their demand to pursue certain claims. Following short on its heels on November 8, 2021 was another decision illustrating why such opinions are so rare, and the high burden plaintiffs must meet in order adequately plead wrongful refusal.

In order to succeed on a complaint alleging that a litigation demand served on a board of directors was wrongfully refused, plaintiffs must satisfy burdens imposed by both the rigorous pleading standards of Chancery Court Rule 23.1 and the deference afforded to directors in responding to the demand under the business judgment rule. Thus, in order to succeed on a motion to dismiss, plaintiffs must plead, with particularity, facts creating a reasonable doubt that the Board’s decision with respect to the demand was entitled to the protection of the business judgment rule. This is a standard that Delaware courts have described as onerous, and one that few, if any, plaintiffs surmount.

A memorandum opinion issued by Vice Chancellor Will on October 29, 2021, joined the sparse rank of decisions permitting a complaint alleging demand refusal to proceed past the motion to dismiss stage. In that case, Drachmen v. Cukier, the court (after requesting that the parties submit supplemental briefing regarding demand refusal, following a round of briefing regarding demand futility) held that plaintiffs had surmounted the “high hurdle” of pleading that the demand plaintiffs had previously made on the board of BioDelivery Sciences International, Inc. had been wrongfully refused. The demand concerned the company’s decision to treat as approved by stockholders two amendments to the company’s charter that had not been approved by a majority of the votes entitled to vote, which plaintiffs argued was a violation of 8 Del. C. § 242(b). The board rejected the demand through counsel, stating that the demand was without merit because the amendments had been approved by a majority excluding broker non-votes, and declining to take the actions requested.

After plaintiffs filed their lawsuit alleging that the amendments were invalid, and almost a year after the demand was served, the company’s stockholders again voted on the amendments and approved them by the requisite majority, ratifying the amendments under 8 Del. C. § 204. However, plaintiffs continued to argue that the Board breached its fiduciary duties in refusing to take action in accordance with the demand.

The court found that plaintiffs had adequately alleged wrongful refusal. It held that the demand “pointed out a straightforward violation of Section 242(b)” and that the board’s decision to exclude broker non-votes from the tally additionally contradicted statements in the proxy regarding vote tabulation. The court accordingly found that, while facts ultimately may demonstrate that the board acted in good faith and was simply misinformed, based on the allegations and drawing all reasonable inferences in favor of the plaintiffs, the complaint raised a reasonable doubt that the demand was refused in good faith.

Standing in counterpoint to Drachman is another recent decision by Vice Chancellor Slights addressing demand refusal in In re Facebook, Inc. Derivative Litigation. The decision, issued on November 8, 2021, concerned plaintiff’s motion for reargument with respect to the court’s prior opinion, among other things, permitting a stay of the plaintiff’s demand-refused complaint pending resolution of a demand-futility complaint based upon similar allegations. In a footnote, Vice Chancellor Slights addressed plaintiff’s allegation that the board ignored his demand entirely, and accordingly that his complaint merited special treatment. The court noted that a board has no obligation to take any specific action to comply with a demand, and that in some circumstances even “ignoring” a demand may be permissible. Accordingly, the court held that plaintiff’s demand refusal complaint should be treated like any other, and must make particularized allegations which would raise a reasonable doubt that the Board’s decision to reject the demand was the product of a valid business judgment.

Coming directly on the heels of the court’s decision in Drachman, this note from Vice Chancellor Slights reinforces the high bar for would-be derivative plaintiffs who have made a demand prior to litigation. While plaintiffs in Drachman were among the few who have been able to satisfy the burden, the standard remains a difficult one, and courts will still permit directors wide latitude in exercising their business judgment in connection with consideration of a demand.