Although I have been quoted extensively in many major publications about various aspects of the ongoing Twitter v. Musk litigation pending in the Delaware Court of Chancery regarding Twitter’s efforts to force Musk to consummate the offer by Musk to buy Twitter, I have not written much about the multitude of pre-trial rulings regarding the expedited trial scheduled, for now, to take place next month–because almost every publication imaginable seems to be providing breathless coverage of the daily developments, and this blog tends to focus more on the court decisions and corporate law developments of greater usefulness for practitioners–that are less likely to be covered elsewhere.

But worth noting for those who toil in the vineyards of corporate and commercial litigation in Delaware is the recent ruling on a motion to quash a subpoena issued to a non-party in the case. In Twitter, Inc. v. Elon R. Musk, et al., C.A. No. 2022-0613-KSJM (Del. Ch., Sept. 2, 2022), the Court reviewed the applicable rules of civil procedure, which in Delaware are modeled after the Federal rules:

Rule 45 requires a subpoenaing party to “take reasonable steps to avoid  imposing undue burden or expense on a person subject to that subpoena.” The court protects nonparties “from significant expense resulting from the inspection and copying commanded.” The court will “quash or modify the subpoena” in a number of circumstance[s], including if the subpoena “[f]ails to allow reasonable time for compliance” or “[s]ubjects a person to undue burden.” Rule 26 empowers the court to deny or limit discovery that is “unreasonably cumulative or duplicative” or “obtainable from some other source that is more convenient, less burdensome, or less expensive.” The movants bear the burden of establishing that the Delaware subpoenas exceed Rules 45 or 26.

Slip op. at 4 (footnotes omitted).

Notably, on a procedural level, the motion to quash was filed on Aug. 25, with an opposition and a reply filed before the court’s written Sept. 2 ruling linked above. That’s a fast disposition by any measure. (By the way, the same jurist issued several other substantial written opinions in this case–and in other unrelated cases–during the same short period of time.)

The motion to quash was based in large part on the subpoena in Delaware being duplicative of a similar subpoena filed in California. This letter ruling is a gift for the reader to the extent that it is only 5-pages long, so I encourage anyone interested in the topic to read the whole thing.

But the core reasoning for the Court’s denial of the motion to quash, which includes a description of behavior that may serve as an example of the type of reaction to a subpoena that would not help one to prevail in a motion to quash a subpoena, follows:

In other circumstances, I might view entirely duplicative subpoenas served for such tactical purposes as problematic. Where, as here, the subpoena recipient Tweets the subpoenaing attorneys the middle finger and a video of someone urinating on subpoenas, I am less bothered by it.

Slip op. at 5.

109 Elon Musk Twitter Photos - Free & Royalty-Free Stock ...

The Delaware General Corporation Law was recently updated to afford corporate officers the opportunity to enjoy the benefits of exculpation from some forms of liability that corporate directors have enjoyed protection from for many years.

Much has already been written about this topic, but a recent post on the Harvard Law School Corporate Governance Blog  provides helpful details, and encouragement for companies to amend their corporate charters to implement this important new statutory protection.

Vice Chancellor J. Travis Laster of the Delaware Court of Chancery gave a lecture at the University of Iowa College of Law on “Big Law Ethics”, or lack thereof, based on findings that His Honor described in the “A” trilogy of cases in which he scored the ethical lapses of several senior partners in a few of the largest and most prestigious law firms in the country.

The presentation, at the below link, should be watched by anyone interested in the role lawyers play in society.

Guest Lecture: Hon. J. Travis Laster, Vice Chancellor of the Court of Chancery State of Delaware – YouTube 

[For those who might want to skip the introductions and preliminary comments, the core of the presentation begins at about 13:00 of the video at the above link.]

His Honor’s presentation lasted about an hour, and it’s worth watching in its entirety, but for those who may want the highlights, a few golden nuggets can be found in the following bullet points:

  • Our system depends on the integrity of lawyers.
  • There is a Latin maxim that translates as: Fraud destroys everything.
  • Most aspects of litigation occur outside the view of the court, so the court cannot police most of what happens in litigation, such as during the discovery process
  • Ethical lapses by senior partners at the largest and most prestigious law firms in the country, as described in the three Chancery decisions known as the “A” Trilogy: Akorn; AB Stable; and Anthem (one of which was 246-pages long; another over 300 pages), suggest that the problem of ethical lapses at law firms who occupy the loftiest levels of the legal profession is not an isolated occurrence, but might portend a more widespread problem.
  • Litigation will not function properly if lawyers are not honest and American society in general is based on voluntary compliance with legal obligations.
  • Even otherwise good people can experience moments of weakness

Three Reasons Why Good People May Do Bad Things

  1. Situational Dynamics: Clients can go elsewhere and most law firm partners are expected to originate business and bring in, or keep, clients. The job of a lawyer is to advance the goals of the client (though the lawyer must rise above the sometimes base or non-existent “morals of the marketplace”.)
  2. Cultural Norms: Lawyers are expected to be zealous advocates (though that word is not part of the ethical rules, as compared to being referenced in the comments). This can lead to “altruistic extremism” and bad behavior that they would not likely engage in if not arguing on behalf of a client. Lawyers make arguments for a living and some of the best advocates are in Big Law (among other places.)
  3. Slippery Slope or Ethical Fading: Minor ethical lapses, if not checked or corrected or discouraged, can lead to larger violations. The slippery slope can be flattened if minor violations are “nipped in the bud” and corrected.

Possible Solutions Suggested by V.C. Laster

  • Mentorship programs to help establish positive norms and check errant behavior, along with self-policing.
  • Be ready to fire a client who insists on improper actions.
  • Find supportive colleagues (e.g., American Inns of Court).
  • Be attentive and “look for” ethical issues, which are not always easy to recognize.
  • Use cautionary tales as lessons of behavior to avoid.
  • Remember that the coverup is often worse than the behavior attempted to be hidden.

Final Words of Wisdom:

  • A lawyer’s top priority should be justice. The duty to the court is higher than the duty to the client.
  • In the words of Justice Brandeis: sunlight is the best disinfectant

Any lawyer involved in litigation about issues surrounding an LLC member’s withdrawal from an LLC should become familiar with the recent decision in 5high LLC v. Feiler, C.A. No. 2022-0108-LWW (Del.Ch. Aug. 5, 2022).

Issue Addressed

Whether one of the original 50/50 members of an LLC resigned despite no written LLC agreement and no written resignation.

Essential Background Facts

Two members formed an LLC without a written LLC agreement but agreed orally that each would have a 50% ownership interest, each would co-manage the LLC, and each contributed an equal amount of capital. Shortly after the formation, one of the 50/50 members orally resigned and took several public actions to notify vendors, customers, employees, and others that he was resigning. The other 50% member orally accepted the resignation and the parties began exchanging draft formal documents–but they never signed a formal, written agreement to memorialize the resignation.

Important Legal Principles From Court’s Opinion

  • The Delaware Declaratory Judgment Act was an appropriate vehicle to present the issue for the Court to decide if one of the original 50/50 members remained as the sole member. Slip op. at 15-16 and n. 84.
  • The LLC Act allows an LLC agreement to be written, oral or implied. Slip op. at 18. See Section 18-101(9) of LLC Act.
  • The court defines an implied agreement and explains how one can be formed by conduct of the parties. Slip op. at 18-19.
  • Subjective intent is not relevant to determining if an implied contract was formed, and silence or failure to object can be treated as acceptance. Id.
  • Based on the circumstances of this case, it was not necessary to invoke the magic word “resign”, and there was ample evidence presented at trial on a paper record, to permit an objective observer to conclude that the departing member’s behavior demonstrated his intent to sever all ties with the LLC–and the remaining member accepted that offer to sever ties.
  • The LLC Act provides default provisions, but the parties’ implied contract modified those default provisions. Slip op. at 20-21.
  • The LLC Act’s default provisions would otherwise have prevented the resigning member from withdrawing prior to dissolution or winding up of the LLC. Id. and n. 104. See Section 18-603 of LLC Act.
  • The implied agreement was not conditioned on a formal, written agreement being signed, and efforts to memorialize the implied agreement did not alter the implied agreement. Slip op. at 21.
  • The court’s statement of the law and its reasoning highlighted above might possibly be applied to other situations where, for example, parties may agree–in an implied contract–to settlement terms in other contexts without signing a formal, written agreement.

This post was prepared by Frank Reynolds, who has been following Delaware law and writing about it in various publications for over 30 years.

Delaware’s Court of Chancery recently dismissed a shareholder challenge to The Trade Desk Inc. (TTD) charter amendment that extended the advertising software company’s dual stock class structure and its CEO’s control, finding TTD met all six qualifications of the Delaware high court’s seminal MFW ruling, entitling it to deferential business judgment review in City Fund for Firefighters and Police Officers in the City of Miami v. The Trade Desk Inc.,et al. opinion issued, (Del. Ch. July 29, 2022).

In his July 29 memorandum opinion, Vice Chancellor Paul Fioravanti threw out the breach of duty charges that the City Fund for Firefighters and Police Officers in the City of Miami had brought against TTD officers and directors for allegedly helping CEO and controlling shareholder Jeff Green trick common shareholders into approving Green’s self-interested stock scheme.  He said the plaintiffs failed to show that investors were duped into voting for an amendment to delay the end of a dual stock class or were uninformed about Green’s supposed hidden urgency to dispose of his many Class B shares that carried ten votes per share.

The ruling called on the Chancery Court to apply the Delaware Supreme Court’s milestone MFW opinion, which set out the six conditions that could exempt a controller’s transaction from the heightened scrutiny of review under the exacting entire fairness standard announced in Kahn v. M & F Worldwide Corp., 88 A.3d 635 (Del. 2014) (commonly referred to as MFW.)  Since the TTD amendment fit the MFW framework, it only faced examination under the more lenient business judgment rule, the vice chancellor said.

Background

According to the court record, Jeff Green co-founded TTD, a Ventura, California, technology company that markets “a software platform to provide data-driven digital advertising campaigns” and has served as its President, Chief Executive Officer, and as chairman of the Delaware-chartered company’s board of directors.  Green controlled a majority of TTD’s stock through his ownership of most of its Class B stock but that was due to change when the number of those non-public shares shrank.

After lengthy negotiations and the creation of a three-director special review committee, the TTD board company endorsed an extension of the projected sunset of the Class B shares and their conversion into the common Class A stock and that continued Green’s control at a crucial juncture.

After the pension fund filed its complaint, defendants moved to dismiss based on failure to plead a claim and the case focused on whether the disputed transaction fit the MFW framework by complying with six elements:

  • the controller conditions the procession of the transaction on the approval of both a Special Committee and a majority of the minority stockholders;
  • the Special Committee is independent;
  • the Special Committee is empowered to freely select its own advisors and to say no definitively;
  • the Special Committee meets its duty of care in negotiating a fair price;
  • the vote of the minority is informed; and
  • there is no coercion of the minority.

Plaintiffs focused on elements two and five, arguing that the independence of the special committee was tainted by director Lisa Buyer and the vote was uninformed because shareholders were kept in the dark about the scheduled end of the Class B stock and Green’s need to unload his shares.

The Special Committee’s independence

Plaintiff charged that the Chair of the committee, Buyer, had been a consultant for  Green during TTD’s initial public offering and received a large compensation for her services that compromised her neutrality.

But the vice chancellor noted that the MFW opinion requires an inquiry before such a determination. “This court is hesitant to infer materiality of compensation absent well-pleaded facts. The determination of whether a director’s compensation from the Company is sufficient to raise a reason to doubt her independence is a fact intensive inquiry. See In re MFW S’holders Litig., 67 A.3d at 510–13.

Plaintiff contended that Buyer caused the other two independent directors to function under a “control mindset” that skewed the committee’s decisions.

The decision

The court determined that, “Even assuming that Buyer’s TTD compensation creates a reasonable inference that her director compensation was material to her and that she was, therefore, not independent, the Plaintiff has not alleged facts that create a reason to doubt that a majority of the committee lacked independence or that Buyer so dominated the committee process that it undermined its integrity as a whole.”

“Plaintiff has not pleaded sufficient facts alleging that Buyer’s conduct dominated or subverted the Special Committee process so as render the entire committee defective, even if she was determined to be lacking in independence,” Vice Chancellor Fioravanti added, noting that the controlled mindset theory is not part of the MFW analysis.

Was the vote uninformed?

The court concluded that none of six alleged material non-disclosures altered the “total mix of information” available to the investors who needed to consider whether to vote for the extension amendment.

  • Green’s desire to sell Class B stock;
  • the Company’s expectations as to when the Dilution Trigger would likely be tripped;
  • advice that Centerview provided to the Special Committee;
  • Green’s counsel’s acknowledgement that a business rationale would be needed to justify any amendment to the Dilution Trigger;
  • the Special Committee’s efforts to obtain stockholder support for the Dilution Trigger Amendment; and
  • the Compensation Committee’s consideration of an equity grant to Green in December 2020

The court concluded that as Defendants aptly put it, “anyone reading the Proxy would understand both that Green desired to retain control through the Trigger Amendment and that the amendment would enable him to continue his (disclosed) historical practice of selling shares without losing that control.”

The Delaware Court of Chancery recently published a post-trial decision involving the officer of a company who breached his fiduciary duties by, among other things, competing against the company for which he served as president. Metro Stores International LLC v. Harron, C.A. No. 2018-0937-JTL (Del. Ch. May 4, 2022), is a 128-page opinion that warrants a plenary review, but for purposes of this short blog post I am only highlighting a few gems of Delaware corporate and commercial law that every Delaware litigator should know.

Brief Overview

The first 34 pages or so of the opinion describe in extensive detail the factual background. A basic outline of the facts includes an existing U.S. company that was a large player in the self-storage facility business.  They brought on a person who was assigned the job of growing the business in Brazil.  The court’s decision goes into great detail about how this person, in his capacity as president of the LLC that was responsible for the business in Brazil, in violation of his contractual and fiduciary duties, competed against the company and took confidential information from the company when he left.

Selected Key Principles of Delaware Law

  • The Court reviewed the elements that must be established in order to successfully pursue a breach of fiduciary duty claim, with a special emphasis on such a claim against the officer of a company, as compared to a director. Slip op. at 36-39.
  • The opinion describes the three potential levels of review that the court uses to determine if a fiduciary duty was breached. In this case, the court determined that the “entire fairness standard” applied.
  • The court explained that the state of the law in Delaware regarding the analysis of the duty of care of an officer applies the “Director Model”. Slip   at 40–47.
  • The court highlighted the important difference between the provisions in an LLC Agreement that:

(i)  waive or limit the scope of fiduciary duties – – as compared with;

(ii)  an exculpation cause which merely limits liability for certain actions.  Slip op. at 47–48.

  • Notably, a clause limiting liability for certain actions does not limit fiduciary duties–and would merely bar money damages but not other potential remedies.
  • In an extensive footnote, the court explains that an officer is an agent of the company, and like all agents is a fiduciary–but not all fiduciaries are agents. See footnote 18.
  • The court expounded on the duty of loyalty and its various nuances. Slip op. at 40.
  • The court also described in great detail the duty of disclosure that an agent has. Slip op. at 55–57.
  • The court explained the very useful distinction between behavior that could be either a breach of contract and/or a breach of fiduciary duty – – and when both claims may proceed in the same case to the extent that they are not overlapping.
  • The court found that the unauthorized access to the former employer’s computer system, without authority, was not only a breach of confidentiality obligations but also a breach of a federal statute called the Stored Communications Act.  Slip op. at 120–122.
  • In particular, the court found that the federal statute involved, the Stored Communications Act, was violated because the former officer accessed an electronic communication while it was being stored, by either intentionally accessing the computer system without authorization or exceeding his authorization.  See 18 U. S. C. §2701.

The Delaware Supreme Court recently provided guidance to corporate litigators regarding the nuances of DGCL Section 220, which most readers recognize as the statute the allows stockholders to demand certain corporate records if the prerequisites in the statute–and those imposed by countless court decisions–have been satisfied. In NVIDIA Corp. v. City of Westmoreland Policy and Fire Retirement System, Del. Supr., No. 259, 2021 (July 19, 2022), a divided en banc bench of Delaware’s High Court explained in a 54-page decision why the “credible basis” requirement may be satisfied in some circumstances by “reliable hearsay”.

Regular readers of these pages will be forgiven if their reaction might be: what more can be said about the relatively simple right of stockholders to demand corporate records, in some circumstances, pursuant to DGCL Section 220–that hasn’t already been covered by the hundred or more Section 220 cases highlighted on these pages over the last 17 years, as well as the thousands of court decisions on the topic over the many decades preceding this publication? In short, when the Delaware Supreme Court speaks, those who labor in its vineyard need to listen. And one indication that this topic is not as simple as the statute might suggest, is that those with the final word on Delaware corporate law–the members of the Delaware Supreme Court–were not in complete unanimity in their decision in this case. A concurrence was not in 100% agreement with the majority opinion.

Key Takeaway

Prior to this decision, it was not well-settled whether a stockholder could satisfy the “proper purpose” requirement under DGCL Section 220 with hearsay–instead of live testimony, for example. The Delaware Supreme Court ruled that: “The Court of Chancery did not err in holding that sufficiently reliably hearsay may be used to show proper purpose in a Section 220 litigation, but did err in allowing the stockholders in this case to rely on hearsay evidence because the stockholders’ actions deprived NVIDIA of the opportunity to test the stockholders’ stated purpose.” Slip op. at 4. (emphasis added).

Overview of Background

After finding post-trial both a proper purpose and a credible basis for the requests, the trial court ordered the production of documents to investigate: possible wrongdoing and mismanagement; the ability of the board to consider a pre-suit demand; and to determine if the board members were fit to serve on the board. The trial court rejected the defenses that: the requests were overbroad and not tailored with rifled precision to what is necessary and essential for the stated purpose; no proper purpose was shown; no credible basis was demonstrated to infer wrongdoing; and the stockholder failed to follow the “form and manner” requirements–in part by changing the list of requested documents during the litigation.

Several stockholders consolidated their demands prior to suit, and 530,000 pages were produced prior to the litigation. Suit was filed in February 2020 based in part on public statements made during an earnings call. Prior to trial, the stockholders were less than forthcoming about whether they would call any witnesses, or which witnesses they would call at trial to establish their proper purpose. The Supreme Court held that the lack of pre-trial transparency by the stockholders deprived the company of the option to depose witnesses to explore the proper purpose issue prior to trial.

The Basics

Most readers are familiar with the basic Section 220 requirements, but the Court’s review provides a helpful reminder. Some of the prerequisites include:

  • Stockholders must demonstrate by a preponderance of the evidence a credible basis from which the court may “infer possible mismanagement that would warrant further investigation.” Slip op. at 18
  • The requested documents must be “essential to the accomplishment of the stockholder’s articulated purpose of inspection.” Id.

Key Highlights and Takeaways

  • The Court of Chancery has discretion to trim overly broad requests to craft a production order circumscribed with rifled precision.
  • Although a stockholder may not broaden the scope of their requests throughout the litigation, a Section 220 plaintiff may narrow their requests if they do so in good faith and such narrowing does not prejudice the company.
  • The Court observed that Section 220 cases are “summary proceedings” and such trials do not always include live testimony. Thus, the court reasoned that: “hearsay is admissible in a Section 220 proceeding when the hearsay is sufficiently reliable.” Slip op. at 38.
  • The Court cautioned that Section 220 plaintiffs should not abuse the hearsay exception, and “must be up front about their plans regarding witnesses” in the pre-trial phase of a case. Slip op. at 41. In this case the Court held that the company was deprived of the “ability to test the stockholders’ purpose”, such as through a deposition or otherwise, because the stockholders did not give the company sufficient notice about what they would rely on at trial to establish a proper purpose. Slip op. at 42-43.
  • In dicta, the Court upheld the trial court’s inference made by “connecting the dots” that the credible basis requirement was satisfied based on a combination of: insider stock sales, public statements that may have been false, and concurrent securities litigation supported by ample research. Slip op. at 45.
  • The Court restated the law that the “credible basis threshold may be satisfied by a credible showing, through documents, logic, testimony, or otherwise, that there are legitimate issues of wrongdoing.” Slip op. at 46.

The concurring opinion of one member of the High Court observed that Section 220 cases often involve the issue of whether the “stated purpose” is the “actual purpose”, which makes the truth of the stockholder’s statements on that point a key issue.  The concurrence also emphasized the importance of the distinction between a proper purpose and the threshold requirement of credible basis–and that a stockholder who is neither an employee nor an officer of a company will rarely have first-had knowledge of wrongdoing, but a typical stockholder “will always have knowledge of her purpose because it is, after all, her purpose.” Slip op. at 54. (emphasis in original).

In Sum

Although this decision may make it easier in some ways for a stockholder to prove its case in a Section 220 lawsuit, companies still have several tools at their disposal to test the basis for a stockholder’s assertion of a proper purpose and other statutory and court-made prerequisites for a Section 220 demand.

A recent Court of Chancery decision provides a few basic but important statements of Delaware law that are useful for the toolbox of corporate and commercial litigators. In Klein v. ECG Topco Holding, LLC, C.A. No. 2021-0701-LWW (Del. Ch. July 8, 2022), the Court pithily decides issues that arose in the context of the disputed buyout of a member of an LLC. Specifically, the issues included (i) whether the lack of ripeness of the disputed payment for the member’s LLC interest deprived the court of subject matter jurisdiction; (ii) whether the failure to allege any harm from the application of the restrictive covenant warranted dismissal under Rule 12(b)(6); and (iii) if an alleged breach excused performance.

Essential Background Facts

For this very short blog post, the salient facts involve a member of an LLC whose divorce led to his ex-wife acquiring most of his interest in the LLC. That event triggered a buyback provision in the LLC agreement which described how the shares were to be bought back, and at what price and when payments were to be made. The event also triggered a restrictive covenant.

Key Takeaways

The complaint appeared to ask for a declaratory judgment regarding the exact price that was due for the purchase of the LLC interests. But the court read the LLC agreement as not requiring payments, at the earliest, for several more months–which rendered that issue not yet ripe for the court to decide it. Thus, under Rule 12 (b)(1), the court did not have subject matter jurisdiction to decide an issue that was not ripe.

The next two issues involved a restrictive covenant. The court reasoned that there were no allegations that the restrictive covenant was harming the plaintiff. To the contrary, the court took judicial notice of a press release indicating that the plaintiff was already gainfully employed. Moreover, there was an argument that the company did not comply with a notice provision. The court was not persuaded that the notice provision applied, but even it did apply, and if the notice were not sent, the court restated basic principles applicable to restrictive covenants: “Delaware courts excuse performance on non-compete obligations following a material breach” that “goes to the essence” of the agreement. Slip op. at 16 (citation omitted). Even if the notice provision at issue applied, the plaintiff did not allege harm from the lack of notice–or that the alleged breach was material.

The Delaware Court of Chancery recently denied a frivolous pro se motion to recuse, and the introduction to the reasons why the motion was denied might be used as an eloquent preface for a rebuttal to almost any frivolous accusation that a recipient may be reluctant to dignify with a response.

In Wollner v. PearPop Inc., C.A. No. 2021-0157-KSJM (Del. Ch. July 9, 2022), the Court began its analysis with the following “money quote”:

In a world of misinformation, disinformation, and mal-information, [the pro se movant]’s theory falls in one of the first two categories because it is based on totally false premises. At the risk of seeming to credit by response a theory too divorced from reality to warrant one, I can easily dispel it….”

Slip op. at 3.

This post was prepared by Frank Reynolds, who has been following Delaware law and writing about it in various publications for over 30 years.

The Chancery Court recently ruled Carvana Company’s controlling family must prove their  stock deal was entirely fair to the on-line used car dealer’s investors after finding the long, dependent business relationships two directors had with the CEO excused the plaintiffs’ pre-suit demand on the board in  In Re Carvana Co. Stockholders Litigation, C.A. No. 2020-0415-KSJM (Del. Ch. June 30, 2022).

In her June 30 opinion, Chancellor Kathaleen McCormick declined to dismiss breach of duty charges against Carvana CEO, President and Chairman of the Board Ernest Garcia III for allegedly profiting by orchestrating an allegedly unfairly-priced $600 million stock offering while Carvana’s share price was depressed by the pandemic.  She found that even under the new universal pre-suit demand standards affirmed by the Delaware Supreme Court in a failed challenge to Mark Zuckerberg’s Facebook stock dealings, the pension fund plaintiffs showed that two Carvana directors owed their careers, fortunes and livelihoods to Ernest Garcia III and his father, Ernest Garcia II.

Her decision — that those two directors could not make an objective decision as to whether the company should press charges against the Garcias over the stock deal – meant that counting Garcia III, half of the six-member board was compromised; therefore, pre-suit demand was excused and the derivative suit could go forward.

The Chancellor’s June ruling sets out a clear though demanding heavily fact-supported standard to satisfy what has been dubbed the third of three prongs of the Zuckerberg opinion, which was initially penned by Vice Chancellor J. Travis Laster and endorsed by the Supreme Court.  United Food & Com. Workers Union & Participating Food Indus. Empls. Tri-State Pension Fund v. Zuckerberg, 250 A.3d 862, 876 (Del. Ch. 2020), aff’d, 262 A.3d 1034 (Del. 2021).

It sets out a new universal three-part, director-by-director test for a plaintiff bringing suit on behalf of all shareholders to avoid letting the board decide whether the company should take up the action:

  • whether the director received a material personal benefit from the alleged misconduct that is the subject of the litigation demand;
  • whether the director faces a substantial likelihood of liability on any of the claims that would be the subject of the litigation demand; and
  • 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.

Background

The Garcias founded several companies that bought and sold or rented cars, including Carvana in 2012.  Carvana had a unique dual class stock structure with a common stock carrying one vote per share and a Class B which had 10 votes per share—but only when owned by the Garcias, who controlled 88 million shares of the company.

Following the pandemic in 2020, the stock price dropped dramatically but as an e-commerce company it was uniquely situated to weather the economic storm.  Nevertheless, even though Carvana did not need the funds to operate, Garcia III orchestrated a $600 million stock sale while the stock price was depressed.  It was available only to hand-picked investors, the court said.

Three pension funds filed breach of duty allegations that were consolidated in January 2021.  Carvana and Garcia moved to dismiss for lack of pre-suit demand and failure to state a complaint.  Garcia Senior moved to dismiss for lack of personal jurisdiction, but the Court said it would rule on that later.

Garcia Junior’s motion to dismiss focused on whether two of the six Carvana directors — Gregory Sullivan and Ira Platt — both of whom allegedly had a long and tangled relationship with the Garcias — could render an objective opinion on the charges against the Garcias.

Sullivan — Thick-as-thieves?

Sullivan’s business relationship allegedly dates back to Garcia Senior’s founding of his used-car empire after pleading guilty in 1990, to a felony bank fraud related to Charles Keating’s Lincoln Savings & Loan scandal. In 1992, Senior consented to a censure and permanent bar from “membership or employment or association with any New York Stock Exchange member or member organization.”

Sullivan was censured by the government for his role in the Garcias’ companies in connection with the Garcias wrongdoing, but they provided him with positions that supplied him with a career, a livelihood and a fortune during that time, the Chancellor said.

“Put succinctly, it is reasonably conceivable that Sullivan might be incapable of impartially considering a demand to sue the man who allegedly saved his career, helped generate his personal wealth, and financially shores his current livelihood,” he said.

This closeness creates a reasonable doubt about Sullivan’s ability to objectively consider a demand to pursue litigation against Garcia Senior’s son, particularly litigation for the same wrongdoing alleged against Garcia Senior, the court said.

“Mere allegations of payment of director fees are insufficient to create a reasonable doubt as to the director’s independence,” the Chancellor said, but she added that, “Indeed, the fee allegations are eclipsed entirely by Plaintiffs’ unusual thick-as-thieves narrative concerning Sullivan and Garcia Senior.”

Platt — Reasonable doubt?

“Although the allegations regarding the large stock gift and exclusive investment opportunities shine brightest in Platt’s constellation of facts raising a reasonable doubt as to his independence from the Garcias, there are other stars as well,” the court said.   These include:

  • Platt securing a position for Garcia Junior and Garcia Junior securing a position for Platt’s son;
  • Platt’s appointment to the boards of numerous Garcia-controlled entities and accompanying director compensation; and
  • the historical relationship between Platt and Garcia Senior while Platt was DriveTime’s primary relationship banker at Greenwich Capital.

States a claim
The Chancellor also declined to dismiss for failure to state a claim because although Garcia Junior abstained from the vote on the stock deal, plaintiffs allege that Garcia Junior “shepherded the [Direct] Offering” from “conception to its execution over the course of a few hurried days.”