Sandys v. Pincus: Delaware Supreme Court Reverses the Court of Chancery’s Dismissal for Failure to Plead Demand Excusal
January 12, 2017
In Sandys v. Pincus, — A.3d —-, 2016 WL 7094027 (Del. Dec. 5, 2016), the Delaware Supreme Court reversed the Court of Chancery’s dismissal of a derivative suit for failure to plead demand excusal, holding that plaintiff had pled facts, including co-ownership of an airplane and interlocking business relationships, that created a pleading-stage reasonable doubt as to the ability of a majority of the board to adequately consider a demand.
In the derivative action below, stockholder plaintiff alleged that members of the board of directors of Zynga Inc. (“Zynga”) breached their fiduciary duties by approving exceptions to lock-up agreements and other trading restrictions that allowed certain officers and directors, including its controlling stockholder, to sell their shares in a secondary offering before Zynga announced earnings for the first quarter of 2012 (which earnings announcement reflected a decline in certain of Zynga’s operating metrics). Analyzing the board’s actions under the Rales test, the Court of Chancery found that plaintiff failed to plead sufficient particularized facts showing that a majority of the Zynga board lacked independence and that a demand on the board would have been futile, and granted the defendants’ motion to dismiss.
Writing for the majority, Chief Justice Strine disagreed with the Court of Chancery’s findings with respect to the independence of three Zynga directors. Although the Court noted that the case “again highlight[ed] the wisdom of the representative plaintiff bar heeding the repeated admonitions of [the Delaware Supreme Court] to make a pre-suit investigation into the board’s independence,” it found that plaintiff pled enough particularized facts at the pleading stage to create a reasonable doubt that a majority of the directors could impartially consider a demand.
In particular, the Court disagreed with the Court of Chancery’s determination as to the independence of a director who, together with her spouse, co-owned a plane with Mark Pincus, Zynga’s controlling stockholder and former chief executive officer. The Court characterized such co-ownership as a “powerful and unusual fact” that was indicative of a very close personal relationship that would heavily influence such director’s ability to impartially consider a demand.
The Court further disagreed that two other directors, who were partners at a venture capital firm that controlled more than 9% of Zynga’s equity, were able to impartially consider a demand. The venture capital firm affiliated with those directors invested in other companies that had ties to Mr. Pincus and to another director who was given an exemption to sell in the secondary offering. The Court noted that these “interlocking relationships” could “give rise to human motivations that would materially affect the parties’ ability to impartially consider a demand adverse to each other.”
In addition, in considering the independence of these two directors, the Court referenced Zynga’s filings with the Securities and Exchange Commission showing that the board had determined that those directors did not qualify as independent under the NASDAQ rules. In considering this factor at the trial court level, the Court of Chancery found that plaintiff failed to allege why the directors lacked independence under the NASDAQ rules in support of his demand excusal claim and that without this additional information, the directors’ lack of independence under the NASDAQ rules and the other facts pled by plaintiff were insufficient to question the directors’ independence. The Delaware Supreme Court disagreed, stating that “to have a derivative suit dismissed on demand excusal grounds because of the presumptive independence of directors whose own colleagues will not accord them the appellation of independence creates cognitive dissonance that our jurisprudence should not ignore.” Although the Court did agree with the Court of Chancery that the Delaware independence standard is context-specific and does not perfectly marry with the standards of the stock exchange, the Court noted that the criteria NASDAQ has articulated as bearing on independence are relevant under Delaware law and likely influenced by Delaware law. As such, the Court held that, where plaintiff pled facts suggesting that directors have a mutually beneficial ongoing business relationships with a company’s controller and “the company’s own board has determined that the directors . . . cannot be considered independent, a reasonable doubt exists under Rales.”
Justice Valihura dissented, stating that she would have affirmed the Court of Chancery decision. With respect to the directors affiliated with the venture capital firm, Justice Valihura noted that in the absence of further facts, such as facts relating to the size, profits or materiality of the investments and interests that plaintiff had pled in support of his demand futility claim, the investments and interests (as pled) were insufficient to raise a reasonable doubt as to the directors’ independence. Justice Valihura further noted that the fact that such directors were designated as not independent under the NASDAQ rules was relevant, but not dispositive, to the independence analysis and that, in the absence of pleadings as to why such directors were determined not to be independent, it was not difficult to conceive a situation in which a director might not be independent under stock exchange rules but yet be independent for demand futility purposes. Justice Valihura also noted, with respect to the close personal relationship that the majority opinion inferred from co-ownership of a plane, that plaintiff had only pled that the co-ownership of the plane constituted an existing business relationship between the director and Mr. Pincus. Accordingly, because plaintiff had not pled specific factual allegations in support of a disabling personal relationship between the director and Mr. Pincus, the dissent stressed that the Court could not and should not consider facts outside the complaint in its analysis of whether a particular relationship is of a “bias-producing nature.”