Reed Smith Client Alerts

Recently, in Shabbouei v. Potdevin, et al.,1 the Delaware Court of Chancery dismissed a derivative lawsuit brought by a stockholder (Plaintiff) on behalf of lululemon athletica inc. (lululemon), a Delaware corporation, against the lululemon board of directors (Board). The Court found the derivative complaint fell well short of pleading with particularity that the board members breached their fiduciary duty of loyalty by approving a severance package of $5 million for a CEO accused of “pervasive misconduct.”

Authors: Brian M. Rostocki Benjamin P. Chapple Alexandria P. Murphy

Background

In Shabbouei, the Board consulted extensively with outside counsel and met several times over the course of three months after reports were made that the former lululemon CEO Laurent Potdevin engaged in “pervasive misconduct.”2 After verifying the reports, the Board elected to pursue a negotiated separation of the CEO’s employment rather than a termination for cause.3 The negotiated separation agreement called for severance payments to the CEO totaling $5 million.4 Had the Board elected to terminate the CEO for cause, he would have received no severance payment.5

Plaintiff sued derivatively on behalf of lululemon, alleging the Board breached its fiduciary duties by acting too slowly in uncovering and responding to the CEO’s misdeeds, but then acting too quickly in deciding to negotiate a separation with the CEO rather than firing him outright.6 Plaintiff also claimed the separation agreement constituted corporate waste and the former CEO was unjustly enriched.7

Defendants moved to dismiss the derivative complaint under Court of Chancery Rule 23.1, arguing Plaintiff did not make a pre-suit demand on the Board and failed to plead demand futility with the particularity required by Delaware law.8 Plaintiff (unsuccessfully) attempted to place his claims within the “demand futility paradigm” by arguing the Board’s decision to enter into the separation agreement was (i) an interested transaction, (ii) not a product of valid business judgment, or (iii) waste.9

The Court of Chancery’s Decision

The Court followed a “deliberate path” in its analysis of the derivative complaint.10 First, the Court addressed the “unique” and “stringent” Rule 23.1 pleading standard, which requires a derivative plaintiff plead with “factual particularity” when, as in Shabbouei, the plaintiff does not make a pre-suit demand.11 Rule 23.1 acts as a “procedural imperative” to prevent shareholders from “imping[ing] on the managerial freedom of directors.”12 Indeed, Delaware courts have held “the demand requirement of Rule 23.1 exists at the threshold, first to insure that a stockholder exhausts his intra-corporate remedies, and then to provide a safeguard against strike suits.”13 Rule 23.1 is consistent with well-established Delaware law that the board of directors, not stockholders, manage the business and affairs of the corporation, including the business decision to cause the corporation to sue.14