An Exercise of Business Judgment: Chancery Court Dismisses Shareholder Derivative Demand-Refused Case

Gavel and Hundred-Dollar Bill

Last week, Vice Chancellor Glasscock released an important decision dismissing a case under Rule 23.1 that was brought by a DuPont shareholder who alleged that the board improperly refused a demand to sue DuPont’s officers and directors.  The suing shareholder alleged that the individual defendants caused DuPont to incur sanctions in, and eventually lose, a patent-infringement case brought by Monsanto concerning DuPont’s unauthorized use of Monsanto’s patents.

The Delaware court held that the plaintiff had not adequately alleged that DuPont’s board of directors had been unreasonable or acted in bad faith in rejecting a demand to sue the directors and officers who were purportedly responsible for DuPont’s liability in the Monsanto patent litigation.

In the Monsanto case, a Missouri federal court sanctioned DuPont for advancing an interpretation of a license agreement with Monsanto that documents obtained in discovery revealed DuPont knew was frivolous.  DuPont was also hit with a $1 billion jury verdict, though while appeal of that verdict was pending, that award was replaced by a $1.75 billion settlement and license agreement.

Prior to the Delaware action, the derivative shareholder plaintiff made a litigation demand on DuPont’s board, alleging that the directors’ and officers’ breaches of fiduciary duties resulted in the Monsanto outcome.  After conducting an investigation, a demand review committee recommended rejecting the demand, and the board agreed.  The ensuing lawsuit alleged various supposed inadequacies in the demand review committee’s investigation of the demand, including that DuPont’s current and former CEOs were not interviewed.  Plaintiff also suggested that a board cannot in good faith rely on a demand review committee report that is clearly at odds with the facts:  there was a sanctions order and jury infringement verdict against DuPont, but the demand committee found no actionable breach of duty.

In a detailed decision, Vice Chancellor Glasscock pointed out the principal difference between a demand refused and a demand futility case: in a demand refused case, the shareholder, by asking the corporation to act, concedes the independence of the board to consider the demand.  Consequently, “the decision to refuse a demand is treated as any other disinterested and independent decision of the board–it is subject to the business judgment rule.”  Thus, the court considers only the reasonableness and good faith of the rejection of the demand.

Analyzing the plaintiff’s demand under this demand refused standard, the court held that the board was adequately informed and acted in good faith in rejecting the demand.  The court rejected Plaintiff’s challenge concerning the demand review committee’s interview process, holding that Plaintiff failed to allege “how the information unique to these individuals can have changed the Board’s determination to refuse the demand, in light of the otherwise exhaustive investigation conducted by the Committee and transmitted to the Board.”  Moreover, the court held that a plaintiff cannot show that a rejection of a shareholder demand for breach of fiduciary duty was in bad faith simply because a prior court found a different kind of wrongdoing in a separate litigation.  Furthermore, the court pointed out that even if the demand review committee had found a potentially actionable fiduciary duty claim against the individual defendants, the company was not obligated, under the business judgment rule, to pursue it.

Demand refusal cases are relatively rare in Delaware, and this decision is notable for discussing the standard that courts should use to evaluate these unusual cases.  Furthermore, this decision ably illustrates the Delaware courts’ reluctance to second-guess the business judgment of corporate boards, even following a corporate calamity.