Reed Smith Client Alerts

The Delaware Court of Chancery’s recent decision in The Raj and Sonal Abhyanker Family Trust v. Blake, C.A. No. 2020-0521-KSJM (Del. Ch. June 17, 2021) highlights how a stockholder of a Delaware corporation can materially prejudice their derivative claims against the corporation’s board of directors if the stockholder “demands” the board (or certain board members) take remedial actions in connection with the stockholder’s claims. The stockholder in Blake made a demand on the corporation’s board that resulted in the application of the director-friendly business judgment rule and dismissal of the stockholder’s claims. The court’s decision underscores the importance of engaging legal counsel with subject-matter expertise before taking steps to pursue, or even investigate, claims against directors and/or officers of Delaware corporations.

Case background

A stockholder-plaintiff filed a lawsuit in the Delaware Court of Chancery asserting derivative claims against directors and officers of UpCounsel, Inc. (the Company), a Delaware corporation. Specifically, the stockholder-plaintiff alleged three of the Company’s fiduciaries, Messrs. Faustman, Blake, and Rudin, breached their fiduciary duties and were unjustly enriched through an agreement to license UpCounsel’s intellectual property to a third party and then dissolve the Company.

In September 2019, following a sale process, the Company’s board of directors proposed a transaction in which the Company would license its intellectual property to a non-party and redirect traffic from its website to the non-party’s website. In connection with the proposed transaction, the Company would wind down its business within 120 days and dissolve “as promptly as practicable.” The Company also agreed to use commercially reasonable efforts to ensure that employees, including Messrs. Faustman and Blake, accept employment with the non-party licensee. The transaction was approved by holders of 85 percent of the Company’s stock. Thereafter, the Company notified its stockholders, including the plaintiff, that the Company’s assets would be insufficient to satisfy the preferred stockholders’ liquidation preference and that common stockholders, like the plaintiff, would receive nothing in connection with the dissolution.

On January 25, 2020, the stockholder-plaintiff sent the Company an email titled “URGENT NOTICE - Minority Shareholder NOTICE to UpCOUNSEL board ->>>> Notice of Objection to Prospective Action by UpCounsel, Inc. & [non-party licensee].” The stockholder-plaintiff’s January 25 email asserted that redirecting traffic to the non-party licensee would cause irreparable harm. The stockholder-plaintiff wrote in his email that redirecting the website traffic would constitute “a gross breach of [the board’s] fiduciary duties” and would “give rise to . . . a shareholder derivivitive [sic] lawsuit.” The stockholder-plaintiff demanded in the January 25 email that Messrs. Faustman and Blake recuse themselves from any board decision regarding redirection and that Blake be removed as CEO.

Two days later, on January 27, 2020, the stockholder-plaintiff sent a second email to the Company titled “Immediate Demand to Act, UpCounsel, Inc. Board.” The January 27 email demanded the board terminate Messrs. Faustman and Blake from their directorships and file an action against them for “breaching their fiduciary duties, and unjust enrichment and self-dealing.” The stockholder-plaintiff wrote that the January 27 email was intended to serve as an Official Notice to the Board, per [Steven M. Rales, et al. v. Alfred Blasband, No. 210, 1993, opinion (Del. Dec. 22, 1993; rev. Dec. 23, 1993)].” The stockholder-plaintiff characterized the January 27 email as “a former [sic] demand” to terminate Messrs. Faustman and Blake and sue them for breach of fiduciary duty. The defendants took none of the actions the stockholder-plaintiff demanded and the stockholder-plaintiff filed suit in the Delaware Court of Chancery in June 2020.

The defendants moved to dismiss the derivative claims under Court of Chancery Rule 23.1 on the ground that the stockholder-plaintiff’s January 25 and January 27 emails constituted a litigation demand and, thus, the stockholder-plaintiff conceded the board’s disinterest and independence for the purposes of deciding whether to pursue litigation on the Company’s behalf. The stockholder-plaintiff argued that the January 25 and January 27 emails were not referenced in the complaint and, therefore, may not be considered on a motion to dismiss. The stockholder-plaintiff further argued that even if they could be considered, the emails did not constitute a litigation demand.