Rule 23.1 of the Delaware Court of Chancery Rules requires a plaintiff asserting a shareholder derivative action to plead “with particularity the efforts, if any, made by the plaintiff to obtain the action the plaintiff desires from the directors or comparable authority and the reasons for the plaintiff’s failure to obtain the action or for not making the effort” (emphasis added). In Elburn v. Albanese, 2020 Del. Ch. LEXIS 156 (Del. Ch. Apr. 21, 2020), the Delaware Court of Chancery (Slights, V.C.), addressed the “fundamental,” but rarely asked, “question of what is required to plead a fact ‘with particularity’ under Rule 23.1.” In addressing this question, the Court applied authority interpreting the particularity requirement set forth in Rule 9(b) of the Court of Chancery Rules holding that the standard is met so long as the plaintiff pleads particularized facts sufficient to apprise the defendants of the basis for the claim. The Court declined to require the pleading of “so-called ‘newspaper facts’—who, what, when, where and how” —in all cases under Rule 23.1, holding that even under Rule 9(b) such details are not required in all cases. The Court’s analysis in Elburn recognizes that a shareholder plaintiff’s burden to plead specific facts varies depending on the plaintiff’s reasonable access to the facts underlying his or her theory of demand futility.
In Elburn, the shareholder plaintiff alleged that the board of directors of Investors Bancorp, Inc. breached its fiduciary duties by voting to approve an equity incentive plan in favor of Kevin Cummings and Domenick Cama—each, respectively, a member of the board and an officer of the company. In 2016, plaintiff had previously brought a derivative action against the board (including Cummings and Cama) in connection with a decision by the board granting themselves approximately $50 million in stock options and restricted stock units (“RSUs”). That action settled with Cummings and Cama agreeing to forfeit their entire award, but allowing the rest of the non-employee directors to retain a portion of the awards granted to them. After the parties settled the first action, the board granted Cummings and Cama a replacement award that gave them all of the cancelled RSUs and a large portion of the cancelled stock options. Plaintiff alleged that the replacement award constituted “excessive compensation” and was granted as a result of a quid pro quo arrangement between Cummings and Cama, on the one hand, and the nonemployee board members on the other. The theory, as pled in the Complaint, was that Cummings and Cama agreed to forfeit their share of the earlier awards so that the nonemployee directors could pocket more of their own awards, but only after the nonemployee directors secretly committed to issue the replacement awards.
Defendants filed a motion to dismiss plaintiff’s claims for breach of fiduciary duty and unjust enrichment arising from the board’s decision to grant the replacement awards to Cummings and Cama, arguing that plaintiff had failed to plead particularized facts sufficient to show that the board was incapable of exercising its independent business judgment. Defendants challenged the adequacy of plaintiffs’ factual allegations of the supposed quid pro quo arrangement between Cummings, Cama and the non-employee board members. Defendants argued that the plaintiff was required to plead so-called “newspaper facts” identifying the “who, what, when, where and how” of the circumstances justifying a finding of demand excusal—similar to what they argued is required to plead affirmative fraud with particularity pursuant to Rule 9(b). The Court, however, did not agree that Rule 9(b) requires such details in every fraud case Rather, it agreed with plaintiff that the degree of particularity required is, instead, analogous to pleading fraudulent omission. Allegations of demand futility should be sufficient when:
[I]t informs “defendants of the precise transactions at issue, and the fraud alleged to have occurred in those transactions, so as to place defendants on notice of the precise misconduct with which they are charged.”
The Court explained that it employed the standard set forth above because a derivative plaintiff is hard-pressed to plead the “newspaper facts” concerning a breach of fiduciary duty “when they were not in the boardroom and, unlike fraud, were not the direct targets of the wrongful behavior.”
The Court held that demand futility was sufficiently pled because the complaint “plainly describes the specific misconduct in which each Defendant is alleged to have participated and the bases upon which Plaintiff alleges that an illicit quid pro quo arrangement led to the Replacement Awards.” The Court recognized that defendants strongly denied the quid pro quo arrangement, but believed that targeted discovery could quickly reveal if such arrangement existed and, if it did not, entitle defendants to summary judgment.
The Elburn court’s decision to apply a more lenient standard to the pleading of demand futility seems to run counter to the Delaware courts’ repeated admonishment to shareholder plaintiffs that they should avail themselves of the inspection rights available to shareholders under 8 Del. C. § 220 to obtain the detail necessary to plead demand futility before a complaint is filed. The Court also seemed to ignore an unsound aspect of plaintiff’s theory. Plaintiff alleged that Cummings and Cama agreed to settle the first derivative action and forfeit their initial incentive awards, while allowing the incentive awards to remain in place for the rest of the board, in exchange for agreeing to the replacement award after the settlement. It is unclear, however, how Cummings and Cama (as just two directors on an at least nine-member board) had the power to derail the settlement in the prior derivative action.