Delaware Pre-suit Demand Refusal & Bad Faith Standards

Spoiler alert:  wrongful refusal of demand and bad faith standards are the same in recent Delaware Court of Chancery case: Andersen v. Mattel, Inc., C.A. No. 11816-VCMR (Del. Ch. Jan. 19, 2017, Op by VC Montgomery-Reeves).  

But sometimes a reminder that the law is the same and can be clearly stated is worth a blog post in its own right.  Professors can use this as a hypo or case note and those in the trenches can update case citations to a 2017 (and 2016) case.

In Andersen v. Mattel, Inc., VC Montgomery-Reeves dismissed a derivative suit, holding that plaintiff did not prove wrongful refusal of pre-suit demand.  The derivative action claimed that the Mattel board of directors refused to bring suit to recover up to $11.5 million paid in severance/consulting fees to the former chairman and chief executive officer who left in the wake of a falling stock price. Plaintiff challenged disclosure discrepancies over whether Stockton resigned or was terminated and the resulting entitlement to severance payments.  Mattel's board of directors unanimously rejected the demand after consultation with outside counsel, 24 witness interviews and a review of approximately 12,400 documents.

The relied upon case law is unchanged, but the clear recitation of the law is worth noting:

Where, as here, a plaintiff makes demand on the board of directors, the plaintiff concedes that the board is disinterested and independent for purposes of responding to the demand. The effect of such concession is that the decision to refuse demand is treated as any other disinterested and independent decision of the board—it is subject to the business judgment rule. Accordingly, the only issues the Court must examine in analyzing whether the board’s demand refusal was proper are “the good faith and reasonableness of its investigation. (internal citations omitted)

To successfully challenge the good faith and reasonableness of the board's investigation, Plaintiff's complaint was required to state particularized facts raising a reasonable doubt that: 

(1) the board’s decision to deny the demand was consistent with its duty of care to act on an informed basis, that is, was not grossly negligent; or (2) the board acted in good faith, consistent with its duty of loyalty. Otherwise, the decision of the board is entitled to deference as a valid exercise of its business judgment.

First, Plaintiff challenged the board's demand refusal on the grounds that they did not disclose the investigation report or the supporting documents in conjunction with the demand refusal.  The Court was unpersuaded given that Plaintiff had the right to seek the report and records through a Section 220 demand, but chose not to do so.

Second, Plaintiff challenged the board's demand refusal on the grounds that it failed to form a special committee. Absent any facts that the Mattel board considering the demand was not independent, there was no requirement for the board to form a special committee.

Third, and final, Plaintiff challenged the board's good faith in rejecting the demand on the grounds that Stockton's employment was not voluntarily terminated. The court cautioned that:

[T]he question is not whether the [b]oard’s conclusion was wrong; the question is whether the [b]oard intentionally acted in disregard of [Mattel’s] best interests in deciding not to pursue the litigation the Plaintiff demanded. [T]he fact that the [b]oard’s justifications for  refusing [the] demand fall within ‘the bounds of reasonable judgment’ is fatal to [the] claim that the refusal was made in bad faith. (citing to Friedman v. Maffei, (Del. Ch. Apr. 13, 2016))

Francis Pileggi at the excellent Delaware Corporate and Commercial Litigation Blog first brought this case to my attention.  Practitioners and Professors alike should be certain to include his blog on your weekly round up.  He is a sure source of concise and insightful summaries of the latest Delaware court developments.  

-Anne Tucker