United Food and Commercial Workers Union v. Zuckerberg

IN THE SUPREME COURT OF THE STATE OF DELAWARE
UNITED FOOD AND § No. 404, 2020
COMMERCIAL WORKERS UNION §
AND PARTICIPATING FOOD § Court Below – Court of Chancery
INDUSTRY EMPLOYERS TRI- § of the State of Delaware
STATE PENSION FUND, §
§ No. 2018-0671-JTL
Plaintiff-Below, §
Appellant, §
§
v. §
§
MARK ZUCKERBERG, MARC §
ANDREESSEN, PETER THIEL, §
REED HASTINGS, ERSKINE B. §
BOWLES, and SUSAN D. §
DESMOND-HELLMANN, §
§
Defendants-Below, §
Appellees §
§
and §
§
FACEBOOK, INC., §
§
Nominal Defendant-Below, §
Appellee. §
Submitted: June 30, 2021
Decided: September 23, 2021
Before SEITZ, Chief Justice; VALIHURA, VAUGHN, TRAYNOR, and
MONTGOMERY-REEVES, Justices, constituting the Court en banc.
Upon appeal from the Court of Chancery. AFFIRMED.
P. Bradford deLeeuw, Esquire, DELEEUW LAW LLC, Wilmington, Delaware;
Robert C. Schubert, Esquire, Willem F. Jonckheer, Esquire (argued), SCHUBERT
JONCKHEER & KOLBE LLP, San Francisco, California; James E. Miller, Esquire,
SHEPHERD FINKELMAN MILLER & SHAH, LLP, Chester, Connecticut; Attorneys for
Appellant United Food and Commercial Workers Union and Participating Food Industry
Employers Tri-State Pension Fund.
Kevin R. Shannon, Esquire, Berton W. Ashman, Jr., Esquire, Tyler J. Leavengood, Esquire,
POTTER ANDERSON & CORROON LLP, Wilmington, Delaware; William Savitt,
Esquire (argued), Ryan A. McLeod, Esquire, Anitha Reddy, Esquire, Kevin M. Jonke,
Esquire, WACHTELL, LIPTON, ROSEN & KATZ, New York, New York; Attorneys for
Appellees Marc L. Andreessen, Erskine B. Bowles, Susan D. Desmond-Hellman, Reed
Hasting, and Peter Thiel.
Raymond J. DiCamillo, Esquire, Kevin M. Gallagher, Esquire, RICHARDS, LAYTON &
FINGER, P.A., Wilmington, Delaware; George M. Garvey, Esquire, Laura Lin, Esquire,
MUNGER, TOLLES & OLSON LLP, Los Angeles, California; Attorneys for Appellee
Mark Zuckerberg.
David E. Ross, Esquire, Garrett B. Moritz, Esquire, R. Garrett Rice, Esquire, ROSS
ARONSTAM & MORITZ LLP, Wilmington, Delaware; Attorneys for Appellee
Facebook, Inc.
2
MONTGOMERY-REEVES, Justice:
In 2016, the board of directors of Facebook, Inc. (“Facebook”) voted in favor of a
stock reclassification (the “Reclassification”) that would allow Mark Zuckerberg—
Facebook’s controller, chairman, and chief executive officer—to sell most of his Facebook
stock while maintaining voting control of the company. Zuckerberg proposed the
Reclassification to allow him and his wife to fulfill a pledge to donate most of their wealth
to philanthropic causes. With Zuckerberg casting the deciding votes, Facebook’s
stockholders approved the Reclassification.
Not long after, numerous stockholders filed lawsuits in the Court of Chancery,
alleging that Facebook’s board of directors violated their fiduciary duties by negotiating and
approving a purportedly one-sided deal that put Zuckerberg’s interests ahead of the
company’s interests. The trial court consolidated more than a dozen of these lawsuits into a
single class action. At Zuckerberg’s request and shortly before trial, Facebook withdrew the
Reclassification and mooted the fiduciary-duty class action. Facebook spent more than
$20 million defending against the class action and paid plaintiffs’ counsel more than
$68 million in attorneys’ fees under the corporate benefit doctrine.
Following the settlement, another Facebook stockholder—the United Food and
Commercial Workers Union and Participating Food Industry Employers Tri-State Pension
Fund (“Tri-State”)—filed a derivative complaint in the Court of Chancery. This new action
3
rehashed many of the allegations made in the prior class action but sought compensation for
the money Facebook spent in connection with the prior class action.
Tri-State did not make a litigation demand on Facebook’s board. Instead, Tri-State
pleaded that demand was futile because the board’s negotiation and approval of the
Reclassification was not a valid exercise of its business judgment and because a majority of
the directors were beholden to Zuckerberg. Facebook and the other defendants moved to
dismiss Tri-State’s complaint under Court of Chancery Rule 23.1, arguing that Tri-State did
not make demand or prove that demand was futile. Both sides agreed that the demand futility
test established in Aronson v. Lewis1 applied to Tri-State’s complaint.
In October 2020, the Court of Chancery dismissed Tri-State’s complaint under
Rule 23.1. The court held that exculpated care claims do not excuse demand under
Aronson’s second prong because they do not expose directors to a substantial likelihood of
liability. The court also held that the complaint failed to raise a reasonable doubt that a
majority of the demand board lacked independence from Zuckerberg. In reaching these
conclusions, the Court of Chancery applied a three-part test for demand futility that blended
the Aronson test with the test articulated in Rales v. Blasband.2
Tri-State has appealed the Court of Chancery’s judgment. For the reasons provided
below, this Court affirms the Court of Chancery’s judgment. The second prong of Aronson
1
473 A.2d 805 (Del. 1984).
2
634 A.2d 927 (Del. 1993).
4
focuses on whether the derivative claims would expose directors to a substantial likelihood
of liability. Exculpated claims do not satisfy that standard because they do not expose
directors to a substantial likelihood of liability. Further, the complaint does not plead with
particularity that a majority of the demand board lacked independence. Thus, the Court of
Chancery properly dismissed Tri-State’s complaint for failing to make a demand on the
board.
Additionally, this Opinion adopts the Court of Chancery’s three-part test for demand
futility. When the Court decided Aronson, raising a reasonable doubt that the business
judgment standard of review would apply exposed directors to a substantial likelihood of
liability for care violations. The General Assembly’s enactment of Section 102(b)(7) and
other developments in corporate law have weakened the connection between rebutting the
business judgment standard and exposing directors to a risk that would sterilize their
judgment with respect to a litigation demand. Further, the Aronson test has proved difficult
to apply in many contexts, such as where there is turnover on a corporation’s board. The
Court of Chancery’s refined articulation of the Aronson standard helps to address these
issues. Nonetheless, this refined standard is consistent with Aronson, Rales, and their
progeny. Thus, cases properly applying those holdings remain good law.
5
I. RELEVANT FACTS AND PROCEDURAL BACKGROUND
A. The Parties and Relevant Non-Parties
Appellee Facebook is a Delaware corporation with its principal place of business in
California.3 Facebook is the world’s largest social media and networking service and one of
the ten largest companies by market capitalization.4
Appellant Tri-State has continuously owned stock in Facebook since
September 2013.5
Appellee Mark Zuckerberg founded Facebook and has served as its chief executive
officer since July 2014.6 Zuckerberg controls a majority of Facebook’s voting power and
has been the chairman of Facebook’s board of directors since January 2012.7
Appellee Marc Andreessen has served as a Facebook director since June 2008.8
Andreessen was a member of the special committee that negotiated and recommended that
the full board approve the Reclassification.9 In addition to his work as a Facebook director,
Andreessen is a cofounder and general partner of the venture capital firm Andreessen
Horowitz.10
3
App. to Opening Br. 19 (hereinafter, “A_”).
4
A19-20.
5
A19.
6
A20.
7
Id.8
Id.9
Id.10
A51.
6
Appellee Peter Thiel has served as a Facebook director since April 2005.11 Thiel
voted in favor of the Reclassification.12 In addition to his work as a Facebook director, Thiel
is a partner at the venture capital firm Founders Firm.13
Appellee Reed Hastings began serving as a Facebook director in June 2011 and was
still a director when Tri-State filed its complaint.14 Hastings voted in favor of the
Reclassification.15 In addition to his work as a Facebook director, Hastings founded and
serves as the chief executive officer and chairman of Netflix, Inc. (“Netflix”).16
Appellee Erskine B. Bowles began serving as a Facebook director in September 2011
and was still a director when Tri-State filed its complaint.17 Bowles was a member of the
special committee that negotiated and recommended that the full board approve the
Reclassification.18
Appellee Susan D. Desmond-Hellman began serving as a Facebook director in
March 2013 and was still a director when Tri-State filed its complaint.19 Desmond-Hellman
was the chair of the special committee that negotiated and recommended that the full board
11
A21.
12
Id.13
A57.
14
See id.15
Id.16
A60.
17
See id.18
Id.19
See id.7
approve the Reclassification.20 In addition to her work as a Facebook director, Desmond-
Hellman served as the chief executive officer of the Bill and Melinda Gates Foundation (the
“Gates Foundation”) during the events relevant to this appeal.21
Sheryl Sandberg has been Facebook’s chief operating officer since March 2018 and
has served as a Facebook director since January 2012.22
Kenneth I. Chenault began serving as a Facebook director in February 2018 and was
still a director when Tri-State filed its complaint.23 Chenault was not a director when
Facebook’s board voted in favor of the Reclassification in 2016.24
Jeffery Zients began serving as a Facebook director in May 2018 and was still a
director when Tri-State filed its complaint.25 Zients was not a director when Facebook’s
board voted in favor of the Reclassification in 2016.26
B. Zuckerberg Takes the Giving Pledge
According to the allegations in the complaint, in December 2010, Zuckerberg took
the Giving Pledge, a movement championed by Bill Gates and Warren Buffet that challenged
wealthy business leaders to donate a majority of their wealth to philanthropic causes.27
20
Id.21
A27.
22
A46.
23
See id.24
See A46; A41.
25
See A46.
26
See A46; A41.
27
A23.
8
Zuckerberg communicated widely that he had taken the pledge and intended to start his
philanthropy at an early age.28
In March 2015, Zuckerberg began working on an accelerated plan to complete the
Giving Pledge by making annual donations of $2 to $3 billion worth of Facebook stock.29
Zuckerberg asked Facebook’s general counsel to look into the plan.30 Facebook’s legal team
cautioned Zuckerberg that he could only sell a small portion of his stock—$3 to $4 billion
based on the market price—without dipping below majority voting control.31 To avoid this
problem, the general counsel suggested that Facebook could follow the “Google playbook”
and issue a new class of non-voting stock that Zuckerberg could sell without significantly
diminishing his voting power.32 The legal team recommended that the board form a special
committee of independent directors to review and approve the plan and noted that litigation
involving Google’s reclassification resulted in a $522 million settlement.33 Zuckerberg
instructed Facebook’s legal team to “start figuring out how to make this happen.”34
28
Id.29
A24.
30
Id.31
Id.32
Id.33
Id.34
Id.9
C. The Special Committee Approves the Reclassification
At an August 20, 2015 meeting of Facebook’s board, Zuckerberg formally proposed
that Facebook issue a new class of non-voting shares, which would allow him to sell a
substantial amount of stock without losing control of the company.35 Zuckerberg also
disclosed that he had hired Simpson Thacher & Bartlett LLP (“Simpson Thacher”) to give
him personal legal advice about “what creating a new class of stock might look like.”36
A couple of days later, Facebook established a special committee, which was
composed of three purportedly-independent directors: Andreessen, Bowles, and Desmond-
Hellman (the “Special Committee”).37 The board charged the Special Committee with
evaluating the Reclassification, considering alternatives, and making a recommendation to
the full board.38 The board also authorized the Special Committee to retain legal counsel,
financial advisors, and other experts.39
Facebook management recommended and the Special Committee hired Wachtell,
Lipton, Rosen & Katz (“Wachtell”) as the committee’s legal advisor.40 Before meeting with
the Special Committee, Wachtell called Zuckerberg’s contacts at Simpson Thacher to discuss
the potential terms of the Reclassification.41 Simpson Thacher rejected as non-starters
35
A26.
36
Id.37
Id.38
Id.39
Id.40
A27.
41
A29.
10
several features from the Google playbook, such as a stapling provision that would have
required Zuckerberg to sell a share of his voting stock each time that he sold a share of the
non-voting stock, and a true-up payment that would compensate Facebook’s other
stockholders for the dilution of their voting power.42 By the time Wachtell first met with the
Special Committee, the key contours of the Reclassification were already taking shape, and
the Special Committee anticipated that the Reclassification would occur. Thus, the Special
Committee focused on suggesting changes to the Reclassification rather than considering
alternatives or threatening to reject the plan.43
Following the recommendation of Bowles, the Special Committee hired Evercore
Group L.L.C. (“Evercore”) as its financial advisor.44 Evercore was founded by Roger
Altman, a personal friend of Bowles who had helped him with various political efforts.45
Evercore’s team leader observed that it had been hired “in the second inning” and that
negotiations were well underway before it began to advise the Special Committee on the
Reclassification.46
As the negotiations progressed, the Special Committee largely agreed to give
Zuckerberg the terms that he wanted and did not consider alternatives or demand meaningful
42
Id.; see United Food & Commercial Workers Union v. Zuckerberg, 250 A.3d 862, 871 (Del. Ch.
2020) (hereinafter, “Op. at__”).
43
Id.44
A30.
45
Id.46
Id.11
concessions.47 For example, the Special Committee did not ask Zuckerberg to revisit any of
the terms that Simpson Thacher identified as non-starters and did not try to place restrictions
on Zuckerberg’s ability to sell as much stock as he wanted, for whatever purpose, on any
timetable that he desired.48 Similarly, the Special Committee asked for only small
concessions from Zuckerberg, such as a sunset provision that was designed to discourage
Zuckerberg from leaving the company despite the absence of any demonstrable reason to
believe that Zuckerberg would step away from his existing Facebook duties.49
On November 9, 2015, Zuckerberg publicly reaffirmed the Giving Pledge.50 The
next day, Zuckerberg circulated a draft announcement within Facebook that would disclose
his intent to begin making large annual donations to complete the pledge.51 Zuckerberg
asked for feedback on the announcement from various people, including Desmond-
Hellman.52 Zuckerberg also informed Bowles and Andreessen of his planned
announcement.53 Bowles and Andreessen told Zuckerberg that they were “proud” of him
for taking the Giving Pledge and announcing his plan to begin donating his wealth to
philanthropic causes.54 Zuckerberg also told Warren Buffett, Bill Gates, and Melinda Gates
47
See A30-40.
48
A31-32.
49
A41.
50
A33.
51
Id.52
Id.53
Id.54
Id.12
of his planned announcement.55 Melinda Gates forwarded an email that she received from
Zuckerberg to Desmond-Hellman, adding a smiley-face emoji.56 At that time, Desmond-
Hellman was the chief executive officer of the Gates Foundation.57
A few weeks later, Zuckerberg published a post on his Facebook page announcing
that he planned to begin making large donations of his Facebook stock.58 The post noted
that Zuckerberg intended to “remain Facebook’s CEO for many, many years to come”59 and
did not mention that his plan hinged on the Special Committee’s approval of the
Reclassification.60 The Special Committee did not try to use the public announcement as
leverage to extract more concessions from Zuckerberg.61
Throughout the negotiations about the Reclassification, Andreessen engaged in
facially dubious back-channel communications with Zuckerberg about the Special
Committee’s deliberations.62 For example, during a March 2016 teleconference with the
Special Committee, Zuckerberg pushed for an eight-year leave of absence.63 Andreessen
sent Zuckerberg text messages during the meeting that provided live updates on which lines
55
Id.56
A34.
57
A27.
58
A34.
59
Id.60
Id.61
Id.62
A36-40.
63
A38.
13
of argument were working64 and which were not.65 When confronted with these text
messages later on, Desmond-Hellmann agreed that it appeared Andreessen had been
“coaching” Zuckerberg through the negotiations.66
On April 13, 2016, the Special Committee recommend that the full board approve the
Reclassification.67 The next day, Facebook’s full board accepted the Special Committee’s
recommendation and voted to approve the Reclassification.68 Zuckerberg and Sandberg
abstained from voting on the Reclassification.69
D. Facebook Settles a Class Action Challenging the Reclassification
On April 27, 2016, Facebook revealed the Reclassification to the public.70 The
announcement was timed to coincide with the company’s best-ever quarterly earnings
report.71 Evercore’s project leader, Altman, sent Desmond-Hellmann an email remarking,
“Anytime [Facebook] announces earnings like that, no one will care about an equity
recapitalization.”72
On April 29, 2016, the first class action was filed in the Court of Chancery challenging
the Reclassification.73 Several more similar complaints were filed, and in May 2016 the
64
See, e.g., id. (“NOW WE’RE COOKING WITH GAS.”).
65
See, e.g., id. (“This line of argument is not helping . . . .”).
66
Id.67
A41.
68
Id.69
A41 n.4.
70
A42.
71
Id.72
A43.
73
Id.14
Court of Chancery consolidated thirteen cases into a single class action (the “Reclassification
Class Action”).74
On June 20, 2016, Facebook held its annual stockholders meeting.75 Among other
things, the stockholders were asked to vote on the Reclassification.76 Zuckerberg voted all
of his stock in favor of the plan.77 Including Zuckerberg’s votes, a majority of Facebook’s
stockholders approved the Reclassification.78 More than three-quarters of the minority
stockholders voted against the Reclassification.79
On June 24, 2016, Facebook agreed that it would not go forward with the
Reclassification while the Reclassification Class Action was pending.80 The Court of
Chancery certified the Reclassification Class Action in April 2017 and tentatively scheduled
the trial for September 26, 2017.81 About a week before the trial was scheduled to begin,
Zuckerberg asked the board to abandon the Reclassification.82 The board agreed, and the
next day Facebook filed a Form 8-K with the Securities and Exchange Commission
disclosing that the company had abandoned the Reclassification and mooted the Class
74
Id.75
Id.76
Id.77
Id.78
Id.79
Id.80
Id.81
Id.82
Id.15
Action.83 The Form-8K also disclosed that despite abandoning the Reclassification,
Zuckerberg planned to sell a substantial number of shares over the coming 18 months.84
In a companion Facebook post, Zuckerberg explained that he “knew [the
Reclassification] was going to be complicated and [that] it wasn’t a perfect solution.” The
post continued, “Today I think we have a better one” that would allow Zuckerberg and his
wife to “fully fund [our] philanthropy and retain voting control of Facebook for 20 years or
more.”85 The post also clarified that this new plan would not “change [our] plans to give
away 99% of our Facebook shares during our lives. In fact, we now plan to accelerate our
work and sell more of those shares sooner.”86 By January 3, 2019, Zuckerberg had sold
about $5.6 billion worth of Facebook stock without the Reclassification.
E. Tri-State Files a Class Action Seeking to Recoup the Money that
Facebook Spent Defending and Settling the Reclassification Class Action
Facebook spent about $21.8 million defending the Reclassification Class Action,
including more than $17 million on attorneys’ fees. Additionally, Facebook paid $68.7
million to the plaintiff’s attorneys in the Reclassification Class Action to settle a claim under
the corporate benefit doctrine.87
83
A43-44.
84
A44.
85
Id.86
Id.87
A45.
16
On September 12, 2018, Tri-State filed a derivative action in the Court of Chancery
seeking to recoup the money that Facebook spent defending and settling the Reclassification
Class Action.88 The complaint asserted a single count alleging that Zuckerberg, Andreessen,
Thiel, Hastings, Bowles, and Desmond-Hellmann (collectively, the “Director Defendants”)
breached their fiduciary duties of care and loyalty by improperly negotiating and approving
the Reclassification.89 When Tri-State filed its complaint, Facebook’s board was composed
of nine directors: Zuckerberg, Andreessen, Bowles, Desmond-Hellman, Hastings, Thiel,
Sandberg, Chenault, and Zients (collectively, the “Demand Board”).90
The complaint alleged that demand was excused as futile under Court of Chancery
Rule 23.1 because “the Reclassification was not the product of a valid exercise of business
judgment” and because “a majority of the Board face[d] a substantial likelihood of liability[]
and/or lack[ed] independence.”91 Facebook and the Director Defendants moved to dismiss
the complaint under Court of Chancery Rule 23.1 for failing to comply with the demand
requirement.92
On October 26, 2020, the Court of Chancery issued a memorandum opinion
dismissing the complaint for failing to comply with Rule 23.1. The court held that demand
was required because the complaint did not contain particularized allegations raising a
88
Op. at 875.
89
Id.90
A46.
91
Id.92
Op. at 869.
17
reasonable doubt that a majority of the Demand Board received a material personal benefit
from the Reclassification, faced a substantial likelihood of liability for approving the
Reclassification, or lacked independence from another interested party.93
Tri-State appeals the Court of Chancery’s judgment dismissing the derivative
complaint under Rule 23.1 for failing to make a demand on the board or plead with
particularity facts establishing that demand would be futile.
II. STANDARD OF REVIEW
“[O]ur review of decisions of the Court of Chancery applying Rule 23.1 is de novo
and plenary.”94
III. ANALYSIS
“A cardinal precept” of Delaware law is “that directors, rather than shareholders,
manage the business and affairs of the corporation.”95 This precept is reflected in
Section 141(a) of the Delaware General Corporation Law (“DGCL”), which provides that
“[t]he business and affairs of every corporation organized under this chapter shall be
managed by or under the direction of a board of directors except as may be otherwise
provided in this chapter or in [a corporation’s] certificate of incorporation.”96 The board’s
authority to govern corporate affairs extends to decisions about what remedial actions a
93
Id. at 890-900.
94
Brehm v. Eisner, 746 A.2d 244, 253 (Del. 2000).
95
Aronson v. Lewis, 473 A.2d 805, 811 (Del. 1984), overruled on other grounds 746 A.2d 244(Del. 2000).
96
8 Del C. § 141(a) (emphasis added).
18
corporation should take after being harmed, including whether the corporation should file a
lawsuit against its directors, its officers, its controller, or an outsider.97
“In a derivative suit, a stockholder seeks to displace the board’s [decision-making]
authority over a litigation asset and assert the corporation’s claim.”98 Thus, “[b]y its very
nature[,] the derivative action” encroaches “on the managerial freedom of directors” by
seeking to deprive the board of control over a corporation’s litigation asset.99 “In order for
a stockholder to divest the directors of their authority to control the litigation asset and bring
a derivative action on behalf of the corporation, the stockholder must” (1) make a demand
on the company’s board of directors or (2) show that demand would be futile.100 The demand
requirement is a substantive requirement that “‘[e]nsure[s] that a stockholder exhausts his
intracorporate remedies,’ ‘provide[s] a safeguard against strike suits,’ and ‘assure[s] that the
stockholder affords the corporation the opportunity to address an alleged wrong without
litigation and to control any litigation which does occur.’”101
97
See, e.g., Lenois v. Lawal, 2017 WL 5289611, at *9 (Del. Ch. Nov. 7, 2017) (The board’s
“managerial decision making power . . . encompasses decisions whether to initiate, or refrain from
entering, litigation.” (quoting Zapata Corp. v. Maldonado, 430 A.2d 779, 782 (Del. 1981)) (citing
Levine v. Smith, 591 A.2d 194, 200 (Del. 1991); Spiegel v. Buntrock, 571 A.2d 767, 772-73
(Del. 1990); Aronson, 473 A.2d at 811)).
98
Op. at 16.
99
Aronson, 473 A.2d at 811.
100
Lenois, 2017 WL 5289611 at *9.
101
Id. (alterations in original) (first quoting Aronson, 473 A.2d at 811-12; and then quoting Kaplan
v. Peat, Marwick, Mitchell & Co., 540 A.2d 726, 730 (Del. 1988)).
19
Court of Chancery Rule 23.1 implements the substantive demand requirement at the
pleading stage by mandating that derivative complaints “allege with particularity the efforts,
if any, made by the plaintiff to obtain the action the plaintiff desires from the directors or
comparable authority and the reasons for the plaintiff’s failure to obtain the action or for not
making the effort.” To comply with Rule 23.1, the plaintiff must meet “stringent
requirements of factual particularity that differ substantially from . . . permissive notice
pleadings.”102 When considering a motion to dismiss a complaint for failing to comply with
Rule 23.1, the Court does not weigh the evidence, must accept as true all of the complaint’s
particularized and well-pleaded allegations, and must draw all reasonable inferences in the
plaintiff’s favor.103
The plaintiff in this action did not make a pre-suit demand. Thus, the question before
the Court is whether demand is excused as futile. This Court has articulated two tests to
determine whether the demand requirement should be excused as futile: the Aronson test
and the Rales test.104 The Aronson test applies where the complaint challenges a decision
made by the same board that would consider a litigation demand.105 Under Aronson,
demand is excused as futile if the complaint alleges particularized facts that raise a reasonable
doubt that “(1) the directors are disinterested and independent[,] [or] (2) the challenged
102
Brehm, 746 A.2d at 254.
103
See, e.g., White v. Panic, 783 A.2d 543, 549 (Del. 2001).
104
Aronson, 473 A.2d at 805; Rales, 634 A.2d at 927.
105
See, e.g., Rales, 634 A.2d at 933.
20
transaction was otherwise the product of a valid business judgment.”106 This reflects the
“rule . . . that where officers and directors are under an influence which sterilizes their
discretion, they cannot be considered proper persons to conduct litigation on behalf of the
corporation. Thus, demand would be futile.”107
The Rales test applies in all other circumstances. Under Rales, demand is excused as
futile if the complaint alleges particularized facts creating a “reasonable doubt that, as of the
time the complaint is filed,” a majority of the demand board “could have properly exercised
its independent and disinterested business judgment in responding to a demand.”108
“Fundamentally, Aronson and Rales both ‘address the same question of whether the board
can exercise its business judgment on the corporat[ion]’s behalf’ in considering demand.”109
For this reason, the Court of Chancery has recognized that the broader reasoning of Rales
encompasses Aronson, and therefore the Aronson test is best understood as a special
application of the Rales test.110
While Delaware law recognizes that there are circumstances where making a demand
would be futile because a majority of the directors “are under an influence which sterilizes
their discretion” and “cannot be considered proper persons to conduct litigation on behalf of
106
Aronson, 473 A.2d at 814.
107
Id. (citations omitted).
108
Rales, 634 A.2d at 934.
109
Lenois, 2017 WL 5289611, at *9 (quoting Kaplan, 540 A.2d at 730).
110
See, e.g., Hughes v. Hu, 2020 WL 1987029, at *12 (Del. Ch. Apr. 27, 2020); In re Wal-Mart
Stores, Inc. Del. Deriv. Litig., 2016 WL 2908344, at *11 (Del. Ch. May 13, 2016); David B. Shaev
Profit Sharing Account v. Armstrong, 2006 WL 391931, at *4 (Del. Ch. Feb. 13, 2006).
21
the corporation,”111 the demand requirement is not excused lightly because derivative
litigation upsets the balance of power that the DGCL establishes between a corporation’s
directors and its stockholders. Thus, the demand-futility analysis provides an important
doctrinal check that ensures the board is not improperly deprived of its decision-making
authority, while at the same time leaving a path for stockholders to file a derivative action
where there is reason to doubt that the board could bring its impartial business judgment to
bear on a litigation demand.
In this case, Tri-State alleged that demand was excused as futile for several reasons,
including that the board’s negotiation and approval of the Reclassification would not be
“protected by the business judgment rule” because “[t]heir approval was not fully informed”
or “duly considered,”112 and that a majority of the directors on the Demand Board lacked
independence from Zuckerberg.113 The Court of Chancery held that Tri-State failed to plead
with particularity facts establishing that demand was futile and dismissed the complaint
because it did not comply with Court of Chancery Rule 23.1.114
111
Aronson, 473 A.2d at 814.
112
A47. The complaint also contains conclusory allegations that the Director Defendants acted in
bad faith. Id. (The Director Defendants’ “approval was not fully informed, not duly considered, and
was not made in good faith for the best interests of Facebook.”). On appeal, Tri-State concedes that
the complaint did not plead with particularity that a majority of the Demand Board was subject to
liability for acting in bad faith. Compare Op. at 895-900 (holding that the complaint did not allege
with particularity bad faith claims against Hastings, Thiel, or Bowles) with Opening Br. (not
contesting this holding). Accordingly, the Court does not address whether demand is excused as
futile under the second prong of the Aronson test because a majority of the Demand Board
committed non-exculpated breaches of their fiduciary duties.
113
See A45-63.
114
Op. at 900-01.
22
On appeal, Tri-State raises two issues with the Court of Chancery’s demand-futility
analysis. First, Tri-State argues that the Court of Chancery erred by holding that exculpated
care violations do not satisfy the second prong of the Aronson test.115 Second, Tri-State
argues that its complaint contained particularized allegations establishing that a majority of
the directors on the Demand Board were beholden to Zuckerberg.116
For the reasons provided below, this Court affirms the Court of Chancery’s judgment.
A. Exculpated Care Violations Do Not Satisfy Aronson’s Second Prong
The directors and officers of a Delaware corporation owe two overarching fiduciary
duties—the duty of care and the duty of loyalty.117 “[P]redicated upon concepts of gross
negligence,” the duty of care requires that fiduciaries inform themselves of material
information before making a business decision and act prudently in carrying out their
duties.118 The duty of loyalty “‘requires an undivided and unselfish loyalty to the
corporation’ and ‘demands that there shall be no conflict between duty and self-interest.’”119
Tri-State alleges that the Director Defendants breached their duty of care in
negotiating and approving the Reclassification. Section 102(b)(7) of the DGCL authorizes
115
Opening Br. 23-36.
116
Id. at 37-47.
117
See, e.g., Dohmen v. Goodman, 234 A.3d 1161 (Del. 2020) (“Directors of Delaware corporations
owe duties of care and loyalty to the corporation and its stockholders.” (citing Stone ex
rel. AmSouth Bancorporation v. Ritter, 911 A.2d 362, 370 (Del. 2006))); Gantler v. Stephens, 965
A.2d 695, 708-709 (Del. 2009) (holding “that corporate officers owe fiduciary duties that are
identical to those owed by corporate directors”).
118
See, e.g., Aronson, 473 A.2d at 812.
119
City of Fort Myers Gen. Emps.’ Pension Fund v. Haley, 235 A.3d 702, 721 (Del. 2020) (citations
omitted) (quoting Guth v. Loft, 5 A.2d 503, 510 (Del. 1939)).
23
corporations to adopt a charter provision insulating directors from liability for breaching their
duty of care:
“[T]he certificate of incorporation may . . . contain any or all of
the following matters:
(7) A provision eliminating or limiting the personal
liability of a director to the corporation or its stockholders for
monetary damages for breach of fiduciary duty as a director,
provided that such provision shall not eliminate or limit the
liability of a director: (i) For any breach of the director’s duty of
loyalty to the corporation or its stockholders; (ii) for acts or
omissions not in good faith or which involve intentional
misconduct or a knowing violation of law; . . . or (iv) for any
transaction from which the director derived an improper
personal benefit.
Facebook’s charter contains a Section 102(b)(7) clause;120 as such, the Director
Defendants face no risk of personal liability from the allegations asserted in this action. Thus,
Tri-State’s demand-futility allegations raise the question whether a derivative plaintiff can
rely on exculpated care violations to establish that demand is futile under the second prong
of the Aronson test. The Court of Chancery held that exculpated care claims do not excuse
demand because the second prong of the Aronson test focuses on whether a director faces a
substantial likelihood of liability.121 Tri-State argues that this analysis was wrong because
120
App. to Answering Br. 77 (“Limitation of Liability. To the fullest extent permitted by law, no
director of the corporation shall be personally liable to the corporation or its stockholders for
monetary damages for breach of fiduciary duty as a director. Without limiting the effect of the
preceding sentence, if the General Corporation Law is hereafter amended to authorize the further
elimination or limitation of the liability of a director, then the liability of a director of the corporation
shall be eliminated or limited to the fullest extent permitted by the General Corporation Law, as so
amended.” (emphasis removed)).
121
Op. at 878-86.
24
Aronson’s second prong focuses on whether the challenged transaction “satisfies the
applicable standard of review,” not on whether directors face a substantial likelihood of
liability.122
The following discussion is divided into three parts. The first part affirms the Court
of Chancery’s holding that, in light of subsequent developments, exculpated care claims do
not excuse demand under Aronson’s second prong. The second part explains why Tri-State’s
counterarguments do not change our analysis. The third part adopts the Court of Chancery’s
three-part test as the universal test for demand futility.
1. The second prong of Aronson focuses on whether the directors face
a substantial likelihood of liability
The main question on appeal is whether allegations of exculpated care violations can
establish that demand is excused under Aronson’s second prong. According to Tri-State, the
second prong excuses demand whenever the complaint raises a reasonable doubt that the
challenged transaction was a valid exercise of business judgment, regardless of whether the
directors face a substantial likelihood of liability for approving the challenged transaction.
Thus, exculpated care violations can establish that demand is futile.123
Tri-State’s argument hinges on the plain language of Aronson’s second prong, which
focuses on whether “the challenged transaction was . . . the product of a valid business
judgment”:
122
Opening Br. 26.
123
See id. at 23-36.
25
[I]n determining demand futility, the Court of Chancery
. . . must decide whether, under the particularized facts alleged,
a reasonable doubt is created that: (1) the directors are
disinterested and independent and (2) the challenged
transaction was otherwise the product of a valid business
judgment. Hence, the Court of Chancery must make two
inquiries, one into the independence and disinterestedness of the
directors and the other into the substantive nature of the
challenged transaction and the board’s approval thereof.124
Later opinions issued by this Court contain similar language that can be read to
suggest that Aronson’s second prong focuses on the propriety of the challenged
transaction.125 These passages do not address, however, why Aronson used the standard of
review as a proxy for whether the board could impartially consider a litigation demand. The
likely answer is that, before the General Assembly adopted Section 102(b)(7) in 1995,126
rebutting the business judgment rule through allegations of care violations exposed directors
to a substantial likelihood of liability. Thus, even if the demand board was independent and
124
Aronson, 473 A.2d at 814 (emphasis added).
125
See, e.g., Levine v. Smith, 591 A.2d 194, 205-06 (Del. 1991) (“Assuming a plaintiff cannot prove
that directors are interested or otherwise not capable of exercising independent business judgment, a
plaintiff in a demand futility case must plead particularized facts creating a reasonable doubt as to
the ‘soundness’ of the challenged transaction sufficient to rebut the presumption that the business
judgment rule attaches to the transaction.”), overruled on other grounds by Brehm v. Eisner,
746 A.2d 244 (Del. 2000); C.L. Grimes v. Donald, 673 A.2d 1207, 1216 (Del. 1996) (One ground
for alleging with particularity that demand would be futile is that a ‘reasonable doubt’ exists that the
board is capable of making an independent decision to assert the claim if demand were made. The
basis for claiming demand excusal would normally be that . . . the underlying transaction is not the
product of a valid exercise of business judgment.” (citations omitted)), overruled on other grounds
by Brehm, 746 A.2d at 244. But see Kaplan, 540 A.2d at 732 (“The demand futility test established
in Aronson provides a standard for determining whether the directors who approved the challenged
transaction are under an influence which precludes them from being ‘considered the proper persons
to conduct the litigation on behalf of the corporation.” (quoting Aronson, 473 A.2d at 814)).
126
1995 Delaware Laws Ch. 79 (S.B. 175).
26
disinterested with respect to the challenged transaction, the litigation presented a threat that
would “sterilize [the board’s] discretion” with respect to a demand.127
Aronson supports this conclusion. For example, in Aronson the Court noted that,
although naming directors as defendants is not enough to establish that demand would be
futile, “in rare cases a transaction may be so egregious on its face that board approval cannot
meet the test of business judgment, and a substantial likelihood of liability therefore
exists. . . . [I]n that context demand is excused.”128 This passage helps to illuminate the
connection that the Court drew between rebutting the business judgment rule and the board’s
ability to consider a litigation demand. At that time, if the business judgment rule did not
apply, allowing the derivative litigation to go forward would expose the directors to a
substantial likelihood of liability for breach-of-care claims supported by well-pleaded factual
allegations. It is reasonable to doubt that a director would be willing to take that personal
risk. Thus, demand is excused.
On the other hand, if the business judgment rule would apply, allowing the derivative
litigation to go forward would expose the directors to a minimal threat of liability. A remote
threat of liability is not a good enough reason to deprive the board of control over the
corporation’s litigation assets. Thus, demand is required.
127
Aronson, 473 A.2d at 814.
128
Id. at 815 (emphasis added) (citing Gimbel v. Signal Cos., Inc., 316 A.2d 599 (Del. Ch. 1974),
aff’d 316 A.2d 619; Cottrell v. Pawcatuck, Co., 128 A.2d 225 (Del. 1956)).
27
Although not unanimous,129 the weight of Delaware authority since the enactment of
Section 102(b)(7) supports holding that exculpated care violations do not excuse demand
under Aronson’s second prong.130 For example, in Lenois, the Court of Chancery held that
the second prong focuses on whether director-defendants face a substantial likelihood of
liability:
[W]here an exculpatory charter provision exists, demand is
excused as futile under the second prong of Aronson with a
showing that a majority of the board faces a substantial
likelihood of liability for non-exculpated claims. That a non-
exculpated claim may be brought against less than a majority of
the board or some other individual at the company, or that the
board committed exculpated duty of care violations alone, will
not affect the board’s right to control a company’s litigation.131
In reaching that conclusion, Lenois examined several other Court of Chancery
decisions holding that Section 102(b)(7) provisions are relevant when assessing whether
demand should be excused under Aronson’s second prong:
• In Higher Education Management Group, Inc v. Matthews, the Court of
Chancery noted that because the corporation’s charter contained a
Section 102(b)(7) provision, and the complaint did “not support an inference of
bad faith conduct by a majority of the Director Defendants,” demand was required
because “there would be no recourse for Plaintiffs and no substantial likelihood of
liability if the Director Defendants’ only failing was that they had not become fully
informed.”132
129
See McPadden v. Sidhu, 964 A.2d 1262, 1271-73 (Del. Ch. 2008) (holding that exculpated
breach-of-care claims can excuse demand under the second prong of the Aronson test).
130
See, e.g., Lenois, 2017 WL 5289611, at *12-14 (collecting cases).
131
Id. at *14.
132
2014 WL 5573325, at *11, *11 n.63 (Del. Ch. Nov. 3, 2014).
28
• In Pfeiffer v. Leedle, the Court of Chancery held that demand was “excused under
the second prong of Aronson” because the board committed “breaches of the duty
of loyalty” that “cannot be exculpated” under the charter.133
• In In re Goldman Sachs, the Court of Chancery noted that where a corporation’s
charter contains a Section 102(b)(7) provision, the second prong of Aronson
requires that the plaintiff “plead particularized facts that demonstrate that the
directors acted with scienter; i.e., there was an ‘intentional dereliction of duty’ or
a ‘conscious disregard’ for their responsibilities, amount to bad faith.”134 In other
words, to establish that making a demand would be futile under the second prong
of Aronson a derivative complaint would have to raise a reasonable doubt that the
directors faced a substantial likelihood of liability for committing non-exculpated
breaches of their fiduciary duties.135
• In In re Lear, the Court of Chancery reached the same conclusion that where a
corporation’s charter has a Section 102(b)(7) provision, “the plaintiffs [must]
plead particularized facts supporting an inference that the directors committed a
breach of their fiduciary duty of loyalty” by “act[ing] in bad faith.”136
• In Disney I, the Court of Chancery held that making a demand would be futile
because the complaint raised a reasonable “doubt whether the board’s actions
were taken honestly and in good faith,” exposing the directors to liability for non-
exculpated breaches of their fiduciary duties.137
Several opinions issued after Lenois support the same analysis:138
• In Ellis v. Gonzalez, the Court of Chancery held that because the corporation’s
charter contained a Section 102(b)(7) provision, “under either Aronson or Rales,
the question . . . is the same: Does the Complaint adequately allege that a majority
of . . . [the] board faces a substantial likelihood of liability for breaching the duty
of loyalty?”139
133
2013 WL 5988416, at *9 (Del. Ch. Nov. 8, 2013).
134
2011 WL 4826104, at *12 (Del. Ch. Oct. 12, 2011).
135
See id.136
967 A.2d 640, 657 (Del. Ch. 2008).
137
825 A.2d 275, 286 (Del. Ch. 2003).
138
The Court acknowledges that some of the opinions applied the Rales test for demand futility.
139
2018 WL 3360816, at *6 (Del. Ch. July 10, 2018) (citations omitted).
29
• In Steinberg v. Bearden, the Court of Chancery’s demand-futility analysis focused
on whether “a majority of the Board face[d] a substantial threat of personal
liability . . . such that the Board could not consider a demand impartially.”140
This Court’s opinion in In re Cornerstone Therapeutics, Inc. Stockholder Litigation,
changed the landscape even more.141 Before Cornerstone, there was some uncertainty about
how to apply a Section 102(b)(7) provision when deciding a motion to dismiss under Court
of Chancery Rule 12(b)(6). Some courts held that an exculpation clause could warrant
dismissing a complaint alleging care claims.142 Others, particularly where the entire fairness
standard of review might apply, ruled that more factual development was needed to
determine whether the director’s breach would be exculpated.143 Thus, a complaint alleging
exculpated care violations might compromise a director’s ability to impartially consider a
litigation demand by exposing them to the distraction of protracted litigation, public scrutiny,
and potential reputational harm, even if the risk was low that the director would be found
liable for breaching their fiduciary duties.
140
2018 WL 2434558, at *8-9 (Del. Ch. May 30, 2018).
141
115 A.3d 1173, 1186-87 (Del. 2015) (“[W]hen the plaintiffs have pled no facts to support an
inference that any of the independent directors breached their duty of loyalty, fidelity to the purpose
of Section 102(b)(7) requires dismissal of the complaint against those directors.”).
142
See, e.g., Pfeiffer, 2013 WL 5988416, at *9 (considering a 102(b)(7) provision when deciding to
dismiss a complaint for failing to comply with Rule 23.1); Malpiede v. Townson, 780 A.2d 1075,
1094-96 (holding that the Court could apply a 102(b)(7) provision clause when considering a motion
to dismiss a suit challenging an arm’s length merger approved by disinterested stockholders).
143
See, e.g., Emerald P’rs v. Berlin, 726 A.2d 1215, 1223 (Del. 1999) (holding that a
Section 102(b)(7) provision did not justify granting summary judgment because there were disputed
facts about whether the directors committed non-exculpated breaches of their fiduciary duties).
30
Cornerstone eliminated any uncertainty and held that where a corporation’s charter
contains a Section 102(b)(7) provision, “[a] plaintiff seeking only monetary damages must
plead non-exculpated claims against a director who is protected by an exculpatory charter
provision to survive a motion to dismiss, regardless of the underlying standard of review for
the board’s conduct.”144 Thus, under current law a Section 102(b)(7) provision removes the
threat of liability and protracted litigation for breach of care claims. As such, Cornerstone
eliminated “any continuing vitality from Aronson’s use of the standard of review for the
challenged transaction as a proxy for whether directors face a substantial likelihood of
liability sufficient to render demand futile.”145
Accordingly, this Court affirms the Court of Chancery’s holding that exculpated care
claims do not satisfy Aronson’s second prong. This Court’s decisions construing Aronson
have consistently focused on whether the demand board has a connection to the challenged
transaction that would render it incapable of impartially considering a litigation demand.146
144
See Cornerstone, 115 A.3d at 1186-87.
145
Op. at 885.
146
See, e.g., Levine, 591 A.2d at 205 (“The premise of a shareholder claim of futility of demand is
that a majority of the board of directors either has a financial interest in the challenged transaction or
lacks independence or otherwise failed to exercise due care. On either showing, it may be inferred
that the Board is incapable of exercising its power and authority to pursue the derivative claims
directly.”); C.L. Grimes, 673 A.2d at 1216 (“One ground for alleging with particularity that demand
would be futile is that a ‘reasonable doubt’ exists that the board is capable of making an independent
decision to assert the claim if demand were made.” (quoting Aronson, 473 A.2d at 814)); see also
Wood v. Baum, 953 A.2d 136, 140 (Del. 2008) (“A stockholder may not pursue a derivative suit to
assert a claim of the corporation unless the stockholder (a) [makes a demand] . . .; or (b) establishes
that pre-suit demand is excused because the directors are deemed incapable of making an impartial
decision regarding the pursuit of the litigation.” (citation omitted)).
31
When Aronson was decided, raising a reasonable doubt that directors breached their duty of
care exposed them to a substantial likelihood of liability and protracted litigation, raising
doubt as to their ability to impartially consider demand. The ground has since shifted, and
exculpated breach of care claims no longer pose a threat that neutralizes director discretion.
These developments must be factored into demand-futility analysis, and Tri-State has failed
to provide a reasoned explanation of why rebutting the business judgment rule should
automatically render directors incapable of impartially considering a litigation demand given
the current landscape. For these reasons, the Court of Chancery’s judgment is affirmed.
2. Tri-State’s other arguments do not change the analysis
Tri-State raises a few more counterarguments that do not change the Court’s analysis.
First, Tri-State argues that construing the second prong of Aronson to focus on
whether directors face a substantial likelihood of liability erases any distinction between the
two prongs of the Aronson test.147 The argument goes like this. If directors face a substantial
likelihood of liability for approving the challenged transaction, then they are interested with
respect to the challenged transaction. The first prong of Aronson already addresses whether
directors are interested in the challenged transaction. Thus, construing the second prong to
require a substantial risk of liability makes it redundant.148 This argument misconstrues
Aronson. The first prong of Aronson focuses on whether the directors had a personal interest
147
See Opening Br. 27-28.
148
See id.32
in the challenged transaction (i.e., a personal financial benefit from the challenged transaction
that is not equally shared by the stockholders).149 This is a different consideration than
whether the directors face a substantial likelihood of liability for approving the challenged
transaction, even if they received nothing personal from the challenged transaction. The
second prong excuses demand in that circumstance. Thus, the first and second prongs of
Aronson perform separate functions, even if those functions are complementary.
Second, Tri-State argues that this holding places an unfair burden on plaintiffs and
will fail to deter controllers from pressuring boards to approve unfair transactions.150
Although not entirely clear, Tri-State appears to argue that because the entire fairness
standard of review applies ab initio to a conflicted-controller transaction,151 demand is
automatically excused under Aronson’s second prong. As the Court of Chancery noted
below, some cases have suggested that demand is automatically excused under Aronson’s
second prong if the complaint raises a reasonable doubt that the business judgment standard
of review will apply, even if the business judgment rule is rebutted for a reason unrelated to
the conduct or interests of a majority of the directors on the demand board.152 The Court of
Chancery’s case law developed in a different direction, however, concluding that demand is
not futile under the second prong of Aronson simply because entire fairness applies ab initio
149
473 A.2d at 814.
150
See Opening Br. 35-36.
151
See, e.g., Kahn v. Tremont Corp., 694 A.2d 422, 428-29 (Del. 1997).
152
Op. 880-882.
33
to a controlling stockholder transaction. As the Court of Chancery has explained, the theory
that demand should be excused simply because an alleged controlling stockholder stood on
both sides of the transaction is “inconsistent with Delaware Supreme Court authority that
focuses the test for demand futility exclusively on the ability of a corporation’s board of
directors to impartially consider a demand to institute litigation on behalf of the
corporation—including litigation implicating the interests of a controlling stockholder.”153
Further, Tri-State’s argument presumes that a stockholder has a general right to
control corporate claims. Not so. The directors are tasked with managing the affairs of the
corporation, including whether to file action on behalf of the corporation. A stockholder can
only displace the directors if the stockholder alleges with particularity that “the directors are
under an influence which sterilizes their discretion” such that “they cannot be considered
proper persons to conduct litigation on behalf of the corporation.”154 As such, enforcing the
demand requirement where a stockholder has only alleged exculpated conduct does not
“undermine shareholder rights;” instead, it recognizes the delegation of powers outlined in
the DGCL.
Finally, Tri-State’s argument collapses the distinction between the board’s capacity to
consider a litigation demand and the propriety of the challenged transaction. It is entirely
153
Teamsters Union 25 Health Servs. & Ins. Plan v. Baiera, 2015 WL 4192107, at *1 (Del.
Ch. July 13, 2015); see, e.g., In re BGC P’rs, Inc., 2019 WL 4745121, at *7-9 (Del. Ch. Sept. 30,
2019) (rejecting the plaintiff’s argument that demand was automatically excused under Aronson’s
second prong because the derivative complaint challenged a conflicted-controller transaction).
154
Aronson, 473 A.2d at 814.
34
possible that an independent and disinterested board, exercising its impartial business
judgment, could decide that it is not in the corporation’s best interest to spend the time and
money to pursue a claim that is likely to succeed. Yet, Tri-State asks the Court to deprive
directors and officers of the power to make such a decision, at least where the derivative
action would challenge a conflicted-controller transaction. This rule may have its benefits,
but it runs counter to the “cardinal precept” of Delaware law that independent and
disinterested directors are generally in the best position to manage a corporation’s affairs,
including whether the corporation should exercise its legal rights.155
For these reasons, Tri-State cannot satisfy the demand requirement by pleading—for
reasons unrelated to the conduct or interests of a majority of the directors on the demand
board—that the entire fairness standard of review would apply to the Reclassification.
Rather, to satisfy Rule 23.1, Tri-State must plead with particularity facts establishing that a
majority of the directors on the demand board are subject to an influence that would sterilize
their discretion with respect to the litigation demand.
Third, Tri-State argues that this holding is contrary to Brehm v. Eisner,156 H&N
Management Group v. Couch,157 and McPadden.158 This Court’s opinion in Brehm contains
language that can be read to suggest that the second prong of the Aronson test focuses on the
155
See Aronson, 473 A.2d at 811.
156
746 A.2d 244 (Del. 2000).
157
2017 WL 3500245 (Del. Ch. Aug. 1, 2017).
158
964 A.2d at 1262.
35
propriety of the challenged transaction rather than on whether the directors face a substantial
likelihood of liability for approving the transaction. For example, the Court’s demand-futility
analysis focused on duty of care violations even though the opinion was issued after the
legislature adopted Section 102(b)(7) and it appears that Disney’s corporate charter had an
exculpation clause.159 Nonetheless, the Court did not hold that exculpated claims can
establish demand futility,160 and on remand the plaintiff relied on non-exculpated claims to
establish that demand was futile.161 Thus, Brehm did not hold that exculpated care violations
can excuse demand under Aronson’s second prong.
H&N Management is inapposite because the corporation’s charter did not exculpate
directors for breaches of the duty of care.162 Thus, the Court of Chancery did not address
whether exculpated claims could excuse demand under the second prong of the Aronson test.
This leaves McPadden, which appears to be the only Delaware decision squarely
holding that exculpated care violations can excuse demand under the second prong of
Aronson.163 It is understandable that the Court of Chancery reached this holding given the
159
See Brehm, 746 A.2d at 259 (“Pre-suit demand will be excused in a derivative suit only if the
Court of Chancery in the first instance, and this Court in its de novo review, conclude that the
particularized facts in the complaint create a reasonable doubt that the informational component of
the directors’ decision[-]making process, measured by concepts of gross negligence, included
consideration of all material information reasonably available.”); In re Walt Disney Co. Derivative
Litig., 825 A.2d 275, 290 (Del. Ch. 2003) (stating that Disney had an exculpation clause).
160
Brehm, 746 A.2d at 262-63.
161
In re Walt Disney, 825 A.2d at 289-90.
162
2017 WL 3500245, at *7 (“Defendants do not benefit from a provision that exculpates them for
grossly negligent conduct . . . .”).
163
964 A.2d at 1270-75 (holding that demand was excused under the second prong of Aronson
“because plaintiff has pleaded a duty of care violation with particularity sufficient to create a
36
plain language of Aronson. Nonetheless, given the subsequent developments in Delaware
law, it is our view that exculpated care violations no longer pose a sufficient threat to excuse
demand under the second prong of the Aronson test. Rather, the second prong requires
particularized allegations raising a reasonable doubt that a majority of the demand board is
subject to a sterilizing influence because directors face a substantial likelihood of liability for
engaging in the conduct that the derivative claim challenges.
3. This Court adopts the Court of Chancery’s three-part test for
demand futility
This issue raises one more question—whether the three-part test for demand futility
the Court of Chancery applied below is consistent with Aronson, Rales, and their progeny.
The Court of Chancery noted that turnover on Facebook’s board, along with a director’s
decision to abstain from voting on the Reclassification, made it difficult to apply the Aronson
test to the facts of this case:
The composition of the Board in this case exemplifies the
difficulties that the Aronson test struggles to overcome. The
Board has nine members, six of whom served on the Board
when it approved the Reclassification. Under a strict reading of
Rales, because the Board does not have a new majority of
directors, Aronson provides the governing test. But one of those
six directors abstained from the vote on the Reclassification,
meaning that the Aronson analysis only has traction for five of
the nine. Aronson does not provide guidance about what to do
with either the director who abstained or the two directors who
joined the Board later. The director who abstained from voting
on the Reclassification suffers from other conflicts that renders
reasonable doubt that the transaction at issue was the product of a valid exercise of business
judgment,” but dismissing the complaint as to certain directors due to a Section 102(b)(7) provision).
37
her incapable of considering a demand, yet a strict reading of
Aronson only focuses on the challenged decision and therefore
would not account for those conflicts. Similarly, the plaintiff
alleges that one of the directors who subsequently joined the
Board has conflicts that render him incapable of considering a
demand, but a strict reading of Aronson would not account for
that either. Precedent thus calls for applying Aronson, but its
analytical framework is not up to the task. The Rales test, by
contrast, can accommodate all of these considerations.164
The court also suggested that in light of the developments discussed above, “Aronson
is broken in its own right because subsequent jurisprudential developments have rendered
non-viable the core premise on which Aronson depends—the notion that an elevated
standard of review standing alone results in a substantial likelihood of liability sufficient to
excuse demand. Perhaps the time has come to move on from Aronson entirely.”165
To address these concerns, the Court of Chancery applied the following three-part test
on a director-by-director basis to determine whether demand should be excused as futile:
(i) whether the director received a material personal
benefit from the alleged misconduct that is the subject of the
litigation demand;
(ii) whether the director would face a substantial
likelihood of liability on any of the claims that are the subject of
the litigation demand; and
(iii) whether the director lacks independence from
someone who received a material personal benefit from the
alleged misconduct that is the subject of the litigation demand
164
Op. at 890.
165
Id. at 889-90.
38
or who would face a substantial likelihood of liability on any of
the claims that are the subject of the litigation demand.166
This approach treated “Rales as the general demand futility test,” while “draw[ing] upon
Aronson-like principles when evaluating whether particular directors face a substantial
likelihood of liability as a result of having participated in the decision to approve the
Reclassification.”167
This Court adopts the Court of Chancery’s three-part test as the universal test for
assessing whether demand should be excused as futile. When the Court decided Aronson, it
made sense to use the standard of review to assess whether directors were subject to an
influence that would sterilize their discretion with respect to a litigation demand. Subsequent
changes in the law have eroded the ground upon which that framework rested. Those
changes cannot be ignored, and it is both appropriate and necessary that the common law
evolve in an orderly fashion to incorporate those developments. The Court of Chancery’s
three-part test achieves that important goal. Blending the Aronson test with the Rales test is
appropriate because “both ‘address the same question of whether the board can exercise its
business judgment on the corporat[ion]’s behalf’ in considering demand”; 168 and the refined
test does not change the result of demand-futility analysis.169
166
Id. at 890.
167
Id.
168
Lenois, 2017 WL 5289611, at *9 (quoting Kaplan, 540 A.2d at 730).
169
If a director is interested in the challenged transaction—or lacks independence from someone
else who is interested in the transaction—then the first prong of Aronson excuses demand with
respect to that director. Aronson, 473 A.2d at 814. The first and third prongs of the refined three-
39
Further, the refined test “refocuses the inquiry on the decision regarding the litigation
demand, rather than the decision being challenged.”170 Notwithstanding text focusing on the
propriety of the challenged transaction, this approach is consistent with the overarching
concern that Aronson identified: whether the directors on the demand board “cannot be
considered proper persons to conduct litigation on behalf of the corporation” because they
“are under an influence which sterilizes their discretion.”171 The purpose of the demand-
futility analysis is to assess whether the board should be deprived of its decision-making
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. That is a different consideration
than whether the derivative claim is strong or weak because the challenged transaction is
likely to pass or fail the applicable standard of review. It is helpful to keep those inquiries
separate. And the Court of Chancery’s three-part test is particularly helpful where, like here,
board turnover and director abstention make it difficult to apply the Aronson test as written.
Finally, because the three-part test is consistent with and enhances Aronson, Rales,
and their progeny, the Court need not overrule Aronson to adopt this refined test, and cases
properly construing Aronson, Rales, and their progeny remain good law.
part test yield the same result. Op. at 890. Similarly, if the derivative litigation would expose a
director to a substantial likelihood of liability, then the demand requirement is excused as futile with
respect to that director under the second prong of the Aronson test and the second prong of the refined
test. See Aronson, 473 A.2d at 814; Op. at 890. Thus, the refined three-part test excuses demand
whenever the Aronson test would excuse demand.
170
Op. at 887.
171
Aronson, 473 A.2d at 814.
40
Accordingly, from this point forward, courts should ask the following three questions
on a director-by-director basis when evaluating allegations of demand futility:
(i) whether the director received a material personal
benefit from the alleged misconduct that is the subject of the
litigation demand;
(ii) whether the director faces a substantial likelihood of
liability on any of the claims that would be the subject of the
litigation demand; and
(iii) 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.
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. It is no longer necessary to determine whether the
Aronson test or the Rales test governs a complaint’s demand-futility allegations.
B. The Complaint Does Not Plead with Particularity Facts Establishing that
Demand Would Be Futile
The second issue on appeal is whether Tri-State’s complaint pleaded with
particularity facts establishing that a litigation demand on Facebook’s board would be futile.
The Court resolves this issue by applying the three-part test adopted above on a director-by-
director basis.
The Demand Board was composed of nine directors. Tri-State concedes on appeal
that two of those directors, Chenault and Zients, could have impartially considered a
41
litigation demand.172 And Facebook does not argue on appeal that Zuckerberg, Sandberg,
or Andreessen could have impartially considered a litigation demand.173 Thus, in order to
show that demand is futile, Tri-State must sufficiently allege that two of the following
directors could not impartially consider demand: Thiel, Hastings, Bowles, and Desmond-
Hellmann.
Tri-State concedes on appeal that neither Thiel, Hastings, Bowles, nor Desmond-
Hellmann had a personal interest in the Reclassification.174 This eliminates the possibility
that demand could be excused under the first prong of the demand-futility test, as none of the
remaining four directors obtained a material personal benefit from the alleged misconduct
that is the subject of the litigation demand.
Similarly, there is no dispute that Facebook has a broad Section 102(b)(7)
provision;175 and Tri-State concedes on appeal that the complaint does not plead with
particularity that Thiel, Hastings, Bowles, or Desmond-Hellmann committed a non-
exculpated breach of their fiduciary duties with respect to the Reclassification.176 This
172
Compare Op. at 895-900 (holding that the complaint did not establish that Chenault or Zients
lacked independence) with Opening Br. (not challenging that holding).
173
Compare Op. at 893 (assuming that Zuckerberg, Sandberg, and Andreessen were incapable of
impartially considering a litigation demand) with Answering Br. (neither conceding nor challenging
that assumption for the purpose of considering the motion to dismiss).
174
Compare Op. 892-901 (holding that the complaint did not allege that these directors had a
personal interest); with Opening Br. (not contesting that holding).
175
See, e.g., App. to Answering Br. 77.
176
Compare Op. 892-901(holding that the complaint did not allege with particularity that these
directors committed non-exculpated breaches of their fiduciary duties); with Opening Br. (not
contesting that holding).
42
eliminates the possibility that demand could be excused under the second prong of the
demand-futility test, as none of the remaining four directors would face a substantial
likelihood of liability on any of the claims that would be the subject of the litigation demand.
This leaves one unanswered question: whether the complaint pleaded with
particularity facts establishing that two of the four remaining directors lacked independence
from Zuckerberg.
“The primary basis upon which a director’s independence must be measured is
whether the director’s decision is based on the corporate merits of the subject before the
board, rather than extraneous considerations or influences.”177 Whether a director is
independent “is a fact-specific determination” that depends upon “the context of a particular
case.”178 To show a lack of independence, a derivative complaint must plead with
particularity facts creating “a reasonable doubt that a director is . . . so ‘beholden’ to an
interested director . . . that his or her ‘discretion would be sterilized.’”179
177
Beam ex rel. Martha Stewart Living Omnimedia, Inc. v. Stewart, 845 A.2d 1040, 1049
(Del. 2004) (citing Rales, 634 A.2d at 936); see also Sandys v. Pincus, 152 A.3d 124, 128
(Del. 2016) (“At the pleading stage, a lack of independence turns on ‘whether the plaintiffs have pled
facts from which the director’s ability to act impartially on a matter important to the interested party
can be doubted because that director may feel either subject to the interested party’s dominion or
beholden to that interested party.’” (quoting Del. C’ty Empls. Ret. Fund v. Sanchez, 124 A.3d 1017,
1024 n.25 (Del. 2015))).
178
Beam, 845 A.2d at 1049.
179
Id. at 1050 (quoting Rales, 634 A.2d at 936).
43
“A plaintiff seeking to show that a director was not independent must satisfy a
materiality standard.” 180 The plaintiff must allege that “the director in question had ties to
the person whose proposal or actions he or she is evaluating that are sufficiently substantial
that he or she could not objectively discharge his or her fiduciary duties.”181 In other words,
the question is “whether, applying a subjective standard, those ties were material, in the sense
that the alleged ties could have affected the impartiality of the individual director.”182 “Our
law requires that all the pled facts regarding a director’s relationship to the interested party
be considered in full context in making the, admittedly imprecise, pleading stage
determination of independence.”183 And while “the plaintiff is bound to plead particularized
facts in . . . a derivative complaint, so too is the court bound to draw all inferences from those
particularized facts in favor of the plaintiff, not the defendant, when dismissal of a derivative
complaint is sought.”184
“A variety of motivations, including friendship, may influence the demand futility
inquiry. But, to render a director unable to consider demand, a relationship must be of a bias-
180
Kahn v. M&F Worldwide Corp., 88 A.3d 635, 649 (Del. 2014) (citing Cinerama, Inc. v.
Technicolor, Inc., 663 A.2d 1156, 1167 (Del. 1995)); Brehm, 746 A.2d at 259 n.49), overruled on
other grounds by Flood v. Synutra Int’l, Inc., 88 A.3d 635 (Del. 2018).
181
Id.182
Id. (citing Cinerama, Inc. v. Technicolor, Inc., 663 A.2d 1156 (Del.1995); Cede & Co. v.
Technicolor, Inc., 634 A.2d 345, 363 (Del.1993); Grimes v. Donald, 673 A.2d 1207, 1216
(Del. 1996)).
183
Sandys, 152 A.3d at 128 (quoting Sanchez, 124 A.3d at 1024 n.25).
184
Id.44
producing nature.”185 Alleging that a director had a “personal friendship” with someone else,
or that a director had an “outside business relationship,” are “insufficient to raise a reasonable
doubt” that the director lacked independence.186 “Consistent with [the] predicate materiality
requirement, the existence of some financial ties between the interested party and the
director, without more, is not disqualifying.”187
Like the Court of Chancery below, we hold that Tri-State failed to raise a reasonable
doubt that either Thiel, Hastings, or Bowles was beholden to Zuckerberg.188
1. Hastings
The complaint does not raise a reasonable doubt that Hastings lacked independence
from Zuckerberg. According to the complaint, Hastings was not independent because:
• “Netflix purchased advertisements from Facebook at relevant times,” and
maintains “ongoing and potential future business relationships with” Facebook.189
• According to an article published by The New York Times, Facebook gave to
Netflix and several other technology companies “more intrusive access to users’
personal data than it ha[d] disclosed, effectively exempting those partners from
privacy rules.”190
• “Hastings (as a Netflix founder) is biased in favor of founders maintaining control
of their companies.”191
185
Beam, 845 A.2d at 1050.
186
Id.187
M&F Worldwide, 88 A.3d at 649.
188
Because the complaint failed to raise a reasonable doubt that Hastings, Thiel, or Bowles were not
independent, this Opinion need not address whether Desmond-Hellmann was beholden to
Zuckerberg.
189
A60.
190
A61.
191
A60.
45
• “Hastings has . . . publicly supported large philanthropic donations by founders
during their lifetimes. Indeed, both Hastings and Zuckerberg have been
significant contributors . . . [to] a well-known foundation known for soliciting and
obtaining large contributions from company founders and which manages donor
funds for both Hastings . . . and Zuckerberg . . . .”192
These allegations do not raise a reasonable doubt that Hastings was beholden to
Zuckerberg. Even if Netflix purchased advertisements from Facebook, the complaint does
not allege that those purchases were material to Netflix or that Netflix received anything
other than arm’s length terms under those agreements. Similarly, the complaint does not
make any particularized allegations explaining how obtaining special access to Facebook
user data was material to Netflix’s business interests, or that Netflix used its special access to
user data to obtain any concrete benefits in its own business.
Further, having a bias in favor of founder-control does not mean that Hastings lacks
independence from Zuckerberg. Hastings might have a good-faith belief that founder
control maximizes a corporation’s value over the long-haul. If so, that good-faith belief
would play a valid role in Hasting’s exercise of his impartial business judgment.193
Finally, alleging that Hastings and Zuckerberg have a track record of donating to
similar causes falls short of showing that Hastings is beholden to Zuckerberg. As the Court
192
Id.193
See generally Frederick Hsu Living Tr. v. ODN Hldg. Corp., 2017 WL 1437308, at *18
(Del. Ch. Apr. 14, 2017) (“[T]he fiduciary relationship requires that the directors act prudently,
loyally, and in good faith to maximize the value of the corporation over the long-term for the benefit
of the providers of presumptively permanent equity capital, as warranted for an entity with a
presumptively perpetual life in which the residual claimants have locked in their investment.”
(citation omitted)).
46
of Chancery noted below, “[t]here is no logical reason to think that a shared interest in
philanthropy would undercut Hastings’ independence. Nor is it apparent how donating to
the same charitable fund would result in Hastings feeling obligated to serve Zuckerberg’s
interests.”194 Accordingly, the Court affirms the Court of Chancery’s holding that the
complaint does not raise a reasonable doubt about Hastings’s independence.
2. Thiel
The complaint does not raise a reasonable doubt that Thiel lacked independence from
Zuckerberg. According to the complaint, Thiel was not independent because:
• “Thiel was one of the early investors in Facebook,” is “its longest-tenured board
member besides Zuckerberg,” and “has . . . been instrumental to Facebook’s
business strategy and direction over the years.”195
• “Thiel has a personal bias in favor of keeping founders in control of the companies
they created . . . .”196
• The venture capital firm at which Thiel is a partner, Founders Fund, “gets ‘good
deal flow’” from its “high-profile association with Facebook.”197
• “According to Facebook’s 2018 Proxy Statement, the Facebook shares owned by
the Founders Fund (i.e., by Thiel and Andreessen) will be released from escrow
in connection with” an acquisition.198
• “Thiel is Zuckerberg’s close friend and mentor.”199
• In October 2016, Thiel made a $1 million donation to an “organization that paid
[a substantial sum to] Cambridge Analytica” and “cofounded the Cambridge
194
Op. at 896.
195
A57-58.
196
A58.
197
Id.198
Id.199
A57.
47
Analytica-linked data firm Palantir.”200 Even though “[t]he Cambridge Analytica
scandal has exposed Facebook to regulatory investigations”201 and litigation,
Zuckerberg did not try to remove Thiel from the board.
• Similarly, Thiel’s “acknowledge[ment] that he secretly funded various lawsuits
aimed at bankrupting [the] news website Gawker Media” lead to “widespread
calls for Zuckerberg to remove Thiel from Facebook’s Board given Thiel’s
apparent antagonism toward a free press.”202 Zuckerberg ignored those calls and
did not seek to remove Thiel from Facebook’s board.
These allegations do not raise a reasonable doubt that Thiel is beholden to
Zuckerberg. The complaint does not explain why Thiel’s status as a long-serving board
member, early investor, or his contributions to Facebook’s business strategy make him
beholden to Zuckerberg. And for the same reasons provided above, a director’s good faith
belief that founder controller maximizes value does not raise a reasonable doubt that the
director lacks independence from a corporation’s founder.
While the complaint alleges that Founders Fund “gets ‘good deal flow’” from Thiel’s
“high-profile association with Facebook,”203 the complaint does not identify a single deal
that flowed to—or is expected to flow to—Founders Fund through this association, let alone
any deals that would be material to Thiel’s interests. The complaint also fails to draw any
connection between Thiel’s continued status as a director and the vesting of Facebook stock
200
A59.
201
Id.202
Id.203
A58.
48
related to the acquisition. And alleging that Thiel is a personal friend of Zuckerberg is
insufficient to establish a lack of independence.204
The final pair of allegations suggest that because “Zuckerberg stood by Thiel” in the
face of public scandals, “Thiel feels a sense of obligation to Zuckerberg.”205 These
allegations can only raise a reasonable doubt about Thiel’s independence if remaining a
Facebook director was financially or personally material to Thiel. As the Court of Chancery
noted below, given Thiel’s wealth and stature, “[t]he complaint does not support an inference
that Thiel’s service on the Board is financially material to him. Nor does the complaint
sufficiently allege that serving as a Facebook director confers such cachet that Thiel’s
independence is compromised.”206 Accordingly, this Court affirms the Court of Chancery’s
holding that the complaint does not raise a reasonable doubt about Thiel’s independence.
3. Bowles
The complaint does not raise a reasonable doubt that Bowles lacked independence
from Zuckerberg. According to the complaint, Thiel was not independent because:
• “Bowles is beholden to the entire board” because it granted “a waiver of the
mandatory retirement age for directors set forth in Facebook’s Corporate
Governance Guidelines,” allowing “Bowles to stand for reelection despite having
reached 70 years old before” the May 2018 annual meeting.207
204
See, e.g., Beam, 845 A.2d at 1050.
205
Op. at 898.
206
Id. at 898-99.
207
A56-57.
49
• “Morgan Stanley—a company for which [Bowles] . . . served as a longstanding
board member at the time (2005-2017)—directly benefited by receiving over
$2 million in fees for its work . . . in connection with the Reclassification . . . .”208
• Bowles “ensured that Evercore and his close friend Altman financially benefitted
from the Special Committee’s engagement” without properly vetting Evercore’s
competency or considering alternatives.209
These allegations do not raise a reasonable doubt that Bowles is beholden to
Zuckerberg or the other members of the Demand Board. The complaint does not make any
particularized allegation explaining why the board’s decision to grant Bowles a waiver from
the mandatory retirement age would compromise his ability to impartially consider a
litigation demand or engender a sense of debt to the other directors. For example, the
complaint does not allege that Bowles was expected to do anything in exchange for the
waiver, or that remaining a director was financially or personally material to Bowles.
The complaint’s allegations regarding Bowles’s links to financial advisors are
similarly ill-supported. None of these allegations suggest that Bowles received a personal
benefit from the Reclassification, or that Bowles’s ties to these advisors made him beholden
to Zuckerberg as a condition of sending business to Morgan Stanley, Evercore, or his “close
friend Altman.”210 Accordingly, this Court affirms the Court of Chancery’s holding that the
complaint does not raise a reasonable doubt about Bowles’s independence.211
208
A57.
209
Id.
210
Id.
211
The factual section of the complaint also alleges that “Bowles privately told Zuckerberg” that
Bowles was “proud to be a small part of [Zuckerberg’s] life” after learning about Zuckerberg’s plan
50
IV. CONCLUSION
For the reasons provided above, the Court of Chancery’s judgment is affirmed.
to make accelerated donations to fulfill his pledge. See A33. Tri-State did not repeat this allegation
in the portion of the complaint addressing demand futility. See A56-57. It is therefore unclear
whether the complaint relies on this assertion to establish that Bowles lacks independence.
Nonetheless, Tri-State has argued below and on appeal that Bowles’s expression of gratitude is
“hardly a sign of director independence” and is “a harbinger of [his] flawed tenure on the Special
Committee.” Opening Br. 43. To the extent Tri-State intended to rely on this allegation to help
establish that demand is futile, this Court agrees entirely with the Court of Chancery’s analysis.
“These allegations suggest that Zuckerberg and Bowles had a collegial relationship, which is not
sufficient to compromise Bowles’s independence.” 250 A.3d at 899; see also Beam,
845 A.2d at 1050 (noting that the existence of a “personal friendship” is insufficient to establish that
a director is not independent).
51