Delaware Court Dismisses Facebook Suit by Stockholders

In United Food and Commercial Workers Union and Participating Food Industry Employers Tri-State Pension Fund v. Zuckerberg, et al., CA No. 2018-0671 (Del. Ch. Oct. 26, 2020), the “Court”) dismissed a derivative action brought by the shareholders (the “Plaintiffs”) of Facebook, Inc. (“Facebook”) for failing to do so had to adequately assert the lack of debt in accordance with Court of Chancery Rule 23.1. The derivatives lawsuit accused members of Facebook’s board of directors (the “Board of Directors”) and Facebook CEO Mark Zuckerberg of violating their fiduciary duty of care and loyalty by pursuing and approving a stock reclassification proposal that would have enabled Zuckerberg to To retain voting rights. from Facebook while donating a significant portion of its common stock to charity. The court discussed the two main tests for determining the futility of inquiry in derivative actions – Aronson and Rales – and found that the futility of inquiry depends on whether a majority of a board of directors is disinterested, independent and capable of impartial judgment at the time the claim is brought a legal requirement to bring legal action on behalf of a company.

In December 2010, Zuckerberg accepted the Giving Pledge, calling on wealthy business people to donate a large portion of their wealth to philanthropy or charity. In March 2015, Zuckerberg developed a plan to fulfill the Giving Pledge by donating $ 2-3 billion worth of Facebook shares annually. It was clear to him that by making donations of this magnitude, he would quickly lose control of Facebook. To avoid this result, Zuckerberg proposed a reclassification of Facebook shares into a three-tier structure in which two new Class C shares are distributed once to each outstanding Class A and B share (the “Reclassification”). The Class C Shares would be publicly tradable but do not confer voting rights. The reclassification would triple Facebook’s outstanding shares and allow Zuckerberg to liquidate shares without giving up his voting rights.

In August 2015, the Board of Directors appointed a special committee (the “Committee”) to evaluate and negotiate the reclassification. However, according to the lawsuit, the committee approved the reclassification plan (i) without ever seriously negotiating with Zuckerberg and (ii) with a member of the committee who communicated regularly with Zuckerberg about the committee’s activities and how to overcome specific concerns expressed by other committee members . After the committee recommended the reclassification plan, it was approved by the board and shareholders, including Zuckerberg’s 4.7 billion votes. Without Zuckerberg’s voting rights, about 75% of Facebook shareholders voted against the reclassification. Following approval by the board and shareholders, certain Facebook shareholders filed lawsuits that directly challenged the reclassification (the “Reclassification Action”). On the eve of the reclassification lawsuit trial, the Board agreed to withdraw the reclassification proposal at Zuckerberg’s request.

In this derivative lawsuit, plaintiffs alleged that the board of directors violated its fiduciary duties in approving the reclassification, failed to get back the money used to defend the reclassification, and took action that damaged Facebook’s reputation. Plaintiffs alleged that reclassification prosecution and defense cost Facebook over $ 90 million and other damages, including significant reputational damage.

Under Delaware law, a shareholder may not bring a derivative action on behalf of a company unless: (i) they have requested that the company’s directors pursue the company’s claim and the directors wrongly refused to do so; or (ii) the claim is excused because the Directors are unable to make an impartial decision regarding the dispute, Ainscow v. Sanitary Co. of Am., 180 A. 614, 615 (Del. Ch. 1935). These “denial to claim” and “to apologize” doctrines are codified in Rule 23.1 of the Court of Chancery, which imposes an obligation to plead on any plaintiff attempting an inferred claim. Rule 23.1 states that when a shareholder attempts to pursue a derivative claim, the complaint “specifically has made the efforts of the plaintiff that the plaintiff requests the directors or equivalent authority, if any, and the reasons for failing to to receive the lawsuit or not to seek. ”ct. CH. E. 23.1 (a). In this case, plaintiffs chose not to make a pre-trial claim, and therefore the question before the court was whether such a claim was excused because the directors were unable to make an impartial decision on the litigation.

Before analyzing whether the plaintiffs’ claim was unsuccessful, the court explained the shortcomings of the landmark Aronson v. Lewis, 473 A.2d 805, 811 (Del. 1984) (“Aronson”). The court even questioned whether Aronson’s inquiry-futility test was still useful. The test formulated in Aronson only applies if the directors who committed the alleged wrong are the same directors who would consider a plaintiff’s claim. According to Aronson, a plaintiff must relate to facts that cast reasonable doubt that the directors are disinterested and independent and that the board’s act was a valid exercise of business judgment. The court stated that Aronson had proven narrow and inflexible in application and that evolving case law of Delaware “dismantled Aronson’s logic”. Alternatively, the wider frame that is used in Rales v. Blasband, 634 A.2d 927, 932 (Del. 1993) (“Rales”) has been shown to be broad and flexible, both for Aronson and for situations that Aronson did not address, such as when a board of directors does not act or the membership of a board of directors has changed. Rales is demanding that a plaintiff allege that a majority of the directors “either interested in the alleged wrongdoing or not independent of who it is”.

In applying Rales to determining whether the plaintiffs’ claim was excused, the court examined, for each director, whether that director received (i) a “material personal benefit from the alleged wrongdoing”, (ii) a “significant Likelihood of liability for “any of the claims” and (iii) lack of “independence from someone who has derived material personal benefit from the alleged misconduct” or “who has a significant likelihood of liability for any of the claims”. Based on the allegations in the lawsuit, the court made “pro-plaintiff assumptions” that three of the nine directors might not be disinterested and independent with respect to the plaintiffs’ claim. Zuckerberg would have received a material advantage in the reclassification and both Sheryl Sandberg and Marc Andreessen lacked the independence of Zuckerberg. Eventually, the court found that the majority of Facebook’s directors were independent and disinterested in considering a potential claim, and therefore the claim was not apologized and the lawsuit dismissed.