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.
The Delaware Chancery Court has dismissed GrafTech International, Ltd. investors’ suit over their directors’ alleged overpayment for the repurchase of a controlling shareholder’s stock in a ruling citing two recent state high court decisions that make it tougher for shareholders to challenge stock deals without proof of bad faith, in Simons v. GrafTech International Ltd., et al., No. 2020-0841-KSJM opinion issued (Del. Ch. Jan. 21, 2022).
Chancellor Kathaleen McCormick’s Jan. 21 opinion dismissed all breach-of-duty charges against the GrafTech directors and controlling shareholder Brookfield Asset Management, Inc. over a $250 million stock repurchase, applying standards from one state Supreme Court decision that narrowed the types of stock suits that qualify as direct rather than derivative — and another that requires plaintiffs to show bad faith or disloyalty to avoid dismissal of those derivative claims.
In the first case relied on, the Delaware Supreme Court ruled in Brookfield Asset Management, Inc. v. Rosson, 261 A.3d 1251 (Del. 2021), that the type of claim made against the GrafTech board’s alleged power to expand its number of directors at will was derivative, not direct — which meant the plaintiff could not survive a motion to dismiss without showing that the directors were too conflicted to objectively review the charges.
In the second, the high court affirmed Vice Chancellor Travis Laster’s milestone ruling in United Food & Com. Workers Union v. Zuckerberg, 250 A.3d 862, 889 (Del. Ch. 2020), finding that many Delaware-chartered companies had opted into the state’s exculpatory clause exempting their directors from money damages for ordinary negligence, and as a result, did not face liability that would present a conflict of interest in reviewing those charges. Therefore, only well-supported bad faith and disloyalty claims would overcome an exculpatory clause and pass the derivative pre-suit demand test, the Delaware’s Supreme Court ruling agreed.
Under the new three-part Supreme Court test in the Zuckerberg case, as applied by the Court of Chancery chief judge in her Jan. 21 ruling, on a motion to dismiss, Delaware courts must now count heads and ask whether each director;
(i) Received a material personal benefit from the alleged misconduct that is the subject of the litigation demand;
(ii) Faces a substantial likelihood of liability on any of the claims that would be the subject of the litigation demand; and
(iii) 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 demand.
Only if the answer to any of those three questions is “yes” can the plaintiff survive a motion to dismiss for failure to first ask the directors to bring charges of investor share dilution or overpayment in a stock transaction such as this one, the Chancellor said.
According to shareholder plaintiff Steve Simons’ complaint, in 2015, Brookfield acquired a controlling stock interest in GrafTech, a publicly traded Delaware corporation that manufactures graphite electrode products essential to the production of electric arc furnace steel and other metals. But by 2020, asset manager Brookfield wanted to unload a large block of stock, after acquiring inside information that dark fiscal clouds were on GrafTech’s horizon, and the GrafTech directors approved a buyback at an unfairly high price, the complaint said. In addition, Simons charged that the board allegedly misused a bylaw that lets them expand the number of directors from seven to as many as eleven.
He claimed that by raising the number of directors from eight up to nine, seven months after approving the allegedly over-generous repurchase, the board tried to make itself litigation-proof. Since the additional independent director came after the repurchase, she was able to tip the new nine-member board balance in favor of five directors who took no part in the repurchase.
Simons claimed the directors breached their duty by timing the new appointment to thwart what would have otherwise been a charge that could have withstood a motion to dismiss.
Adding a director is okay
The Chancellor found that GrafTech’s charter permitted the board to name additional directors without limitation up to eleven and did not bar the board from choosing an independent director. In addition, GrafTech’s exculpatory clause means that the plaintiff would have to show that the board’s appointment was a breach of the directors’ duty of loyalty, the Chancellor ruled.
The Court found that none of the five outside directors had business relationships long enough to compromise their independence or disinterest, so all of them were capable of objectively reviewing a pre-suit demand and the motion to dismiss should be granted.