The plaintiff in Xiaoming Hu, a stockholder of Kandi Technologies (Kandi), brought claims against Kandi’s directors for breach of fiduciary duty and unjust enrichment, alleging the board approved inaccurate financials and related-party transactions over a period of multiple years in bad faith, and employee directors were unjustly enriched through incentive compensation driven by inaccurately reported results. The plaintiff’s claims were brought on a “derivative” (as opposed to a “direct”) basis because the harm was suffered directly by the corporation (and the plaintiff was only indirectly harmed by virtue of his ownership interest in Kandi).
Although Delaware law gives significant deference and latitude to the corporate officials responsible for managing the business and affairs of Delaware corporations, Delaware law permits stockholders to pursue derivative claims on behalf of (and for the benefit of) the corporation because any recovery on behalf of the corporation will indirectly benefit the stockholder-plaintiff. In order to pursue and maintain a derivative claim, the stockholder-plaintiff must establish that any “demand” for the corporation’s officials to pursue the claims on behalf of the corporation would be futile. This is called “demand futility.”
In Xiaoming Hu, the stockholder-plaintiff’s complaint alleged a seven-year history of ineffective internal control for financial reporting and related-party transactions, much of which the company had publicly acknowledged, and an Audit Committee lacking required knowledge that generally met only once a year—for less than an hour—and deferred to management despite having reason to doubt their representations. The stockholder-plaintiff sued after first obtaining books and records under 8 Del. C. § 220. In response to the books-and-records demand, the corporation produced certain documents and represented there were no other non-privileged materials responsive to the books-and-records inspection demand.