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Delaware Chancery Court Reaffirms High Standards for Pleading Demand Futility

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In an opinion released November 7, 2017, the Delaware Chancery Court reaffirmed the state’s high standards for pleading demand futility in shareholder derivative suits. The Court clarified that, where directors are protected by an exculpatory charter provision, a derivative plaintiff must plead particularized facts establishing non-exculpated claims against a majority of directors. This decision is significant because it establishes, in clear and unambiguous language, that non-exculpated claims against less than half of a company’s directors do not render demand futile.

In Lenois v. Lawal, 2017 WL 5289611 (Del. Ch. Nov. 7, 2017), a derivative plaintiff alleged breach of fiduciary duty claims emerging from a supposedly unfair transaction involving Erin Energy Corporation. Erin is a Delaware oil and gas exploration company whose controlling shareholder is Dr. Lawal. Erin purchased large offshore assets in Africa, as part of a three-party transaction. In the transaction, Public Investment Corporation Limited invested in Erin, which used the cash proceeds, stock, and debt to purchase oil mining rights from Allied Energy Plc, another entity controlled by Dr. Lawal.

In the negotiations, Dr. Lawal allegedly acted as the sole point of contact for Public Investment Corporation, as the controller of Allied, and as the controller of Erin, and negotiated with himself to shift around assets for his own benefit. He allegedly leveraged his position at Allied to pressure Erin’s other directors to accept the deal.

Erin’s directors, however, took steps to insulate the company from Dr. Lawal’s actions. They created a special committee of independent directors, which hired outside counsel and advisors, obtained better terms, and approved the transaction only after independent financial analysts determined that it was fair to Erin’s shareholders.

The derivative plaintiff alleged that Dr. Lawal abused his status as majority shareholder of both Allied and Erin to strong-arm Erin’s directors into accepting a deal that benefited Allied more than it did Erin and its shareholders. The derivative plaintiff argued that the potential claim against Dr. Lawal was by itself enough to excuse demand. The Delaware Chancery Court disagreed.

Under Delaware law, a company’s board of directors has the sole right to decide when to exercise the company’s right of litigation. Because the right to conduct litigation belongs to the board, a derivative plaintiff cannot sue on the company’s behalf unless he makes a demand on the board or alleges with particularity that demand would be futile because the directors could not consider it impartially.

Delaware’s demand futility tests present high burdens for derivative plaintiffs. In Lenois, the derivative plaintiff had to allege particularized facts sufficient to raise a reasonable doubt that the challenged transaction was the product of a valid exercise of business judgment. This is a “high burden,” requiring a derivative plaintiff to show that “the board’s decision was so egregious or irrational that it could not have been based on a valid assessment of the corporation’s best interest.” Lenois, 2017 WL 5289611, at *10 (quotations omitted).

The parties disagreed on what a derivative plaintiff must plead to prove demand futility in the face of a charter provision that exculpates directors from breaches of the duty of care. The defendants contended that the existence of an exculpatory charter provision requires a derivative plaintiff to plead particularized facts raising a reasonable doubt that a majority of the board acted honestly and in good faith. The derivative plaintiff countered that demand is also futile where the complaint pleads facts raising a reasonable doubt as to the good faith and honesty of any individual director.

Crystalizing years of Delaware case law, the Court agreed with the defendants and dismissed the derivative plaintiff’s case. Because the right to control a company’s litigation asset rests in the company’s board of directors—and not in any single director—the ability for a derivative plaintiff to wrest that choice away from the board necessitates a showing that non-exculpated claims exist against a majority of directors. “[W]here an exculpatory charter provision exists, demand is excused as futile . . . 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.” Id. at *14 (emphasis added).

This holding reaffirms Delaware’s high standards for pleading demand futility. It is significant because it unambiguously establishes that non-exculpated claims against a minority of directors is not enough to excuse demand for derivative plaintiffs. It clarifies that the allegedly bad acts of a single director, without more, do not wrench litigation rights away from an entire board.


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