The independence of a member of the board of directors of a company has always been an important issue under Delaware law, but the issue has gained increasing national importance based on the recent requirements for the New York Stock Exchange and Nasdaq-listed companies, as well as the recent Sarbanes-Oxley Act. In addition to the fact that most NYSE companies are incorporated in Delaware, the issue is critical for purposes of filing a derivative action against a corporation because as a practical matter, if a majority of the board is deemed independent, and presuit demand is required, claims against a corporation may never go to trial.
In Beam v. Stewart, the Delaware Supreme Court on March 31, 2004 analyzed whether presuit demand needed to have been made on the board of directors of Martha Stewart Living Omnimedia, Inc., or whether a majority of the members of that board were independent, and therefore, requiring a presuit demand prior to filing a derivative action against the company.

The sole issue on appeal before the Supreme Court was the Chancery Court’s decision to dismiss the plaintiff’s derivative claim under CHANCERY COURT RULE 23.1.¹ That Rule requires, among other things, that a plaintiff asserting a derivative complaint make a presuit demand upon the corporation. This demand requirement, however, is excused if the plaintiff properly alleges that such demand would be futile. Futility occurs when a director is unable to act objectively relative to a presuit demand because the director is not independent. To show a lack of independence, the complaint must allege facts that create a reasonable doubt that a director is so beholden to an interested director that the director’s discretion would be sterilized.² In affirming the Chancery Court, the Supreme Court, upon de novo review, addressed the issue of the “quantum of doubt about a director’s independence that is “reasonable” in order to excuse a presuit demand.” To complete this analysis the Supreme Court reviewed the plaintiff’s demand allegations relative to each MSO director.
The case stemmed from Martha Stewart’s much publicized trouble with ImClone. Martha Stewart, at all relevant times, was MSO’s chairman and CEO. Stewart effectively controlled 94% of the shareholder votes. In her complaint, the plaintiff alleged, among other things, that Martha Stewart breached her fiduciary duties of loyalty and due care to MSO by illegally selling ImClone stock and that she further aggravated that problem by mishandling the ensuing media attention that followed. All of this, according to Beam, jeopardized MSO’s financial future. The plaintiff named all six MSO directors, including Stewart, as co-defendants. The plaintiff alleged, as to those directors, that each lacked independence from Stewart such that they were incapable of making an objective business decision regarding a corporate claim against Stewart for breach of her fiduciary duties arising out of the ImClone debacle. To this end, the plaintiff asserted that presuit demand was, therefore, futile.
To prevail, the plaintiff was obligated to plead facts sufficient to give rise to a reasonable doubt that at least one-half of the MSO board lacked independence from Stewart.³ Because two directors, including Stewart herself, were admittedly not independent for presuit demand purposes, all the plaintiff need to do to carry their burden was to establish that one other director was likewise disabled. To that end, the plaintiff alleged that each of the other directors had a longstanding personal and/or business relationship with Stewart. The plaintiff asserted that these relationships gave rise to a reasonable doubt as to their independence from Stewart. The plaintiff supported the allegations with a detailed background report on each director’s longstanding, personal relationship with Stewart including attending social events and weddings as well as business dealings.
The Supreme Court acknowledged that in some cases a personal or business relationship between directors might adequately support a reasonable doubt analysis sufficient to excuse pre-suit demand. The Court noted, however, that “to render [a director] unable to consider [a presuit] demand, a relationship [between the directors] must be of a bias producing nature. Allegations of mere personal friendship or a mere outside business relationship, standing alone, are insufficient to raise a reasonable doubt about a director’s independence.” Despite the fact that Stewart controlled 94% of the voting, and presumably controlled who served on the board as a consequence, and despite the longstanding personal relationships with Stewart, the Supreme Court concluded that the plaintiff nonetheless failed to overcome the presumption supporting the directors’ judgment. (See generally, exemptions from recent stock exchange rules requiring independent boards if more than 50% of shares are controlled by one person.)
The Beam opinion makes clear that to excuse demand the plaintiff faces several significant hurdles. First, the case law presumes that the directors were “faithful to their fiduciary duties” to the corporation.⁴ Second, the plaintiff bears the burden to overcome that presumption.⁵ Third, in most derivative actions the plaintiff is not entitled to discovery to support their derivative claim.⁶ In dicta, the Supreme Court went on to note that the plaintiff made their task more difficult, and presumably less likely to succeed, because “tools at hand” were not used to obtain more details prior to filing suit. The Court pointed out that, had the plaintiff first instituted an action under 8 Del. C. Section 220 to seek review of the corporate books and records, the plaintiff might have uncovered useful information to support their derivative claim.
In the last part of the decision the court addressed the recent Delaware Court of Chancery opinion of In Re: Oracle Corp. Derivative Litigation, 824 A.2d 917 (Del. Ch. 2003). In Oracle, an exhaustive analysis concluded that certain directors were not independent. See also, F.G.X. Pileggi, “Recent Delaware Decisions Clarify Definition of ‘Independent Director,'” Delaware Corporate Litigation Reporter (August 4, 2003) (discussing details of the Oracle decision).
A cursory reading of the Oracle decision, which included an exhaustive analysis of the factors involving the independence of a director, and the more recent Beam decision by the Delaware Supreme Court, could leave one with a question about how to reconcile the conclusions of the two decisions on the issue of independence. The Delaware Supreme Court addresses that issue by clearly stating at page 23 that: “We need not decide whether the substantive standard of independence in an SLC (Special Litigation Committee) case (such as Oracle), differs from that in a presuit demand case.” Nonetheless, the Delaware Supreme Court went on to add that unlike the demand-excusal context (in a derivative case involving Rule 23.1), where the board is presumed to be independent, the SLC “has the burden of establishing its own independence by a yardstick that must be ‘like Caesar’s wife-above reproach.’ Moreover, unlike the presuit demand context, the SLC analysis contemplates not only a shift in the burden of persuasion, but also the availability of discovery into various issues, including independence.” Id. The court noted that this procedural distinction relating to the completely different burdens of proof and the availability of discovery may be outcome determinative. The court also distinguished the Oracle decision and the case before it, based on the specific facts of the Oracle case.
The importance of the Oracle and the Beam decisions, each of which includes thorough analysis and great detail, does not lend itself to a glib summary or comparison. For purposes of the limited space available here, suffice it to say that the specific factual analysis that applies to an inquiry into the independence of a board member, and the procedural posture of such an analysis, will often be the prevailing considerations regarding the ability to present substantive derivative claims for judicial review.
¹The Chancery Court decision dismissed several other of the plaintiff’s claims. The only issue upon which the plaintiff’s appealed, however, was the Chancery Court’s decision to dismiss the derivative claim.
²Grimes v. Donald, 673 A.2d 1207, 1217 (Del.1996).
³Beneville v. York, 769 A.2d 80, 85 86 (Del.Ch.2000).
⁴Aronson v. Lewis, 473 A.2d 805, 814 (Del.1984).
⁵Levine v. Smith, 591 A.2d 199, 205 06 (Del.1991); Grobow v. Perot, 539 A.2d 180, 187 89 (Del.1988). To excuse presuit demand in this case, the plaintiff had the burden to plead particularized facts that create a reasonable doubt sufficient to rebut the presumption that the directors were independent of the defendant Martha Stewart.
⁶Rales v. Blasband, 634 A.2d 927, 934 n.10 (Del.1993).