This post was prepared by Frank Reynolds, who has been following Delaware corporate law, and writing about it for various legal publications, for over 30 years.
A shareholder who made a veiled threat to take action against a biopharmaceutical company over its directors’ allegedly excessive compensation effectively made a pre-suit demand and cannot later sue and claim that a demand would have been futile, the Delaware Chancery Court has ruled in Solak v. Welch, et al., No. 2018-0810 KSJM, memorandum opinion (Del. Ch. Oct. 30, 2019).
Vice Chancellor Kathaleen St. Jude McCormick’s October 30 opinion dismissed John Solak’s derivative suit against Ultragenyx Pharmaceutical Inc.’s directors, finding that his pre-suit letter requesting them to address non-employee board member compensation was not a harmless investor request. Rather, it was a “proverbial wolf in sheep’s clothing” demand “with far more legal bite” that required the plaintiff to either prove the directors wrongfully refused to take action or suffer the court’s dismissal of his breach of duty and waste of assets charges, the vice chancellor said.
Only two choices
She said the Delaware Supreme Court’s Spiegel v. Buntrock decision gives investors seeking to sue in the name of the company two choices: either first demand that the directors, as managers of the company, take action to right a wrong or skip the demand and show that it would have been futile because the directors are too conflicted to give the charges a fair review. Spiegel v. Buntrock 571 A.2d 767, 772-73 (Del 1990).
The vice chancellor’s opinion says Spiegel does not allow a shareholder to demand an action under the guise of seeking better corporate governance practices and then use the second Buntrock option and argue that his letter was not a pre-suit demand but rather “an informal, good faith attempt to educate the board and encourage it to make changes.”
According to Vice Chancellor McCormick’s opinion, Solak’s counsel sent a June 2018 letter to the Novato, Calif. company’s directors suggesting that they correct the excessive $400,000 a year average compensation the independent directors have been receiving since 2014.
The letter claimed that pay plan lacks meaningful limitations and renders the company “more susceptible than ever to shareholder challenges and that Solak would consider “all available shareholder remedies” unless Ultragenyx responded in thirty days.
When the board rejected the request the following October after an internal investigation of compensation policies, Solak sued in Chancery Court one month later and the directors moved to dismiss it in December for failure to show that plaintiff’s pre-suit demand was improperly refused.
The ‘steeper’ route
After hearing oral argument on the motion in August, the vice chancellor said the pivotal issue was whether Solak’s letter constituted a pre-suit demand. That’s because of the two Spiegel options for a derivative plaintiff, successfully pleading that pre-suit demand would have been futile because of director conflict was a “steep” route, he said; but proving that his demand was wrongly refused was “steeper yet.”
In light of the Spiegel court’s holding that a plaintiff who makes a pre-suit demand “tacitly concedes” that the board is qualified to consider that demand under the protective business judgment rule, Solak argued that the letter was not a pre-suit demand.
The judge said under Delaware caselaw, a pre-suit letter is a demand if it provides, “(1) the identity of the alleged wrongdoing, (2) the wrongdoing allegedly perpetrated and the resultant injury to the corporation and (3) the legal action the shareholder wants the board to take.”
She said the disclaimer in Solak’s letter that it could not be construed as a pre-suit demand does not shield it from the Delaware law prohibition against both making a pre-suit demand and pleading demand futility “to cover all the bases.”
The vice chancellor also rejected Solak’s argument that his letter was not a demand because it did not expressly demand that the directors commence litigation. She said previous Chancery Court decisions have found that clearly demanding corporate action is sufficient.
Moreover, Solak’s letter “reads like a complaint” and is “nearly a carbon copy” of his later-filed lawsuit in drawing comparisons with compensation levels at other companies and in the remedial measures it requests, the opinion says.
In addressing Solak’s argument that shareholders will be deterred from even ambiguous communications that might be considered a demand, making a subsequent derivative suit procedurally more difficult, the vice chancellor said normally, the investor’s ambiguity would get the benefit of the doubt.
Similar suit, same result
However, she noted a 2018 New York state court decision dismissing a suit by Solak after he made what constituted a pre-suit demand for action by another corporation’s board to correct alleged excessive director compensation. Solak v. Fundaro, Index No. 655205/2017, slip opinion (N.Y. Sup. Ct. Mar. 19, 2018).
She said in that New York case, Solak unsuccessfully attempted to “dress down” the pre-suit communication. “The product of this tactical wordsmithing is not the sort of “ambiguity” warranting a plaintiff-friendly presumption.”
Applying the business judgment rule, the vice chancellor found no reason to doubt the good faith of the directors’ decision to refuse the pre-suit demand and dismissed Solak’s suit.