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In a recent precedential decision, United Food and Commercial Workers Union v. Zuckerberg et al., the Delaware Supreme Court unanimously affirmed the Delaware Court of Chancery’s dismissal of a derivative suit brought by a Facebook stockholder against Facebook’s board of directors, because the stockholder failed to make a pre-suit demand on the board to bring an action on behalf of Facebook and the complaint failed to “plead with particularity” facts that would establish that such a demand would be futile. In reaching such a conclusion, the Supreme Court adopted a new more stringent three-part universal demand-futility test that combines the demand futility factors under the well-established Aronson and Rales tests.

Case background

The dispute in United Food and Commercial Workers Union v. Zuckerberg et al. involved a Facebook stockholder (the Stockholder) who filed a derivative complaint in the Delaware Court of Chancery alleging that the Facebook, Inc. (Facebook) board of directors (the Board) violated their fiduciary duties when the Board voted in favor of a stock reclassification (the Reclassification) in 2016. The Reclassification would have allowed Mark Zuckerberg ‒Facebook’s controller, chairman, and chief executive officer ‒ to sell most of his Facebook stock while maintaining voting control of the company. Zuckerberg proposed the Reclassification to allow him and his wife to fulfill a pledge to donate most of their wealth to philanthropic causes. With Zuckerberg casting the deciding vote, Facebook’s stockholders approved the Reclassification.

The Stockholder’s claims also stemmed from Facebook’s settlement of a previous derivative suit, which involved questions of whether Facebook could engage in the Reclassification. Facebook spent $21.8 million to defend the earlier suit, and paid another $68.7 million in the settlement, which resulted in Facebook’s abandonment of the Reclassification. In addition to the Stockholder’s allegations that the Facebook directors’ approval of the Reclassification breached their fiduciary duties, the Stockholder sought to recoup the sum that Facebook spent defending and settling that earlier lawsuit.

The Stockholder did not make a litigation demand on the Board in the case at hand. Instead, the Stockholder pleaded that demand was futile because (i) the Board’s negotiation and approval of the Reclassification was not a valid exercise of its business judgment since it was not “fully informed” or “duly considered,” and (ii) a majority of the directors lacked independence because they were beholden to Zuckerberg.

The Supreme Court’s decision

Facebook and the other defendants moved to dismiss the Stockholder’s complaint under Court of Chancery Rule 23.1, arguing that the Stockholder did not make demand or prove that demand was futile. In October 2020, the Court of Chancery dismissed the Stockholder’s complaint under Rule 23.1, finding that the Stockholder failed to justify its decision to sidestep the Board and sue Facebook directly. In reaching that conclusion, the Court of Chancery blended two demand-futility tests articulated in Delaware’s Aronson v. Lewis and Rales v. Blasband rulings, thus creating a new universal three-part test.

The Stockholder appealed the Court of Chancery’s judgment to the Delaware Supreme Court, which affirmed the Court of Chancery’s decision to dismiss the derivative action and agreed with the lower court’s finding that the Stockholder should have first taken its demand for action to the Board before filing a derivative action in the Court of Chancery.

The Supreme Court emphasized that the demand futility analysis provides an important “doctrinal check” that ensures the board of a Delaware company is not improperly deprived of its decision-making authority, but still leaves stockholders with a path to sue derivatively if the board lacks independence:

While Delaware law recognizes that there are circumstances where making a demand would be futile because a majority of the directors “are under an influence which sterilizes their discretion” and “cannot be considered proper persons to conduct litigation on behalf of the corporation,” the demand requirement is not excused lightly because derivative litigation upsets the balance of power that the DGCL establishes between a corporation’s directors and its stockholders. Thus, the demand-futility analysis provides an important doctrinal check that ensures the board is not improperly deprived of its decision-making authority, while at the same time leaving a path for stockholders to file a derivative action where there is reason to doubt that the board could bring its impartial business judgment to bear on a litigation demand.

The Supreme Court adopted the new three-part demand-futility test that combines tests outlined in its Aronson v. Lewis and Rales v. Blasband decisions. The test set forth in Aronson applied where the complaint challenged an affirmative decision made by the same board considering the demand. Under Aronson, demand was excused as futile if the complaint alleged particularized facts that raised a reasonable doubt that: (1) directors were disinterested and independent; and (2) the challenged transaction was otherwise the product of a valid business judgment. In all other situations, the test in Rales applied and asked whether the plaintiff alleged particularized facts creating a reasonable doubt that, as of the time the complaint was filed, a majority of the board could have properly exercised its independent and disinterested business judgment in responding to a demand. Both previously espoused tests essentially addressed the same question ‒ whether the board could exercise its business judgment on a corporation’s behalf in considering a litigation demand.