The Actual Litigation

Exam 2

Shareholder Derivative Suit

• If a corporation is harmed by a third party, the directors can bring a “derivative lawsuit” on behalf of the corporation. If the directors fail to bring suit, the shareholders can “derivatively” ask to bring a suit against the third party. Here, shareholders are representing the corporation, not themselves. Before shareholders can bring suit, they must make a written demand to the directors to bring a suit (and the directors can deny the shareholders).

  • Any harm which shareholders suffer collectively—as a group of shareholders—must be brought as a derivative suit

  • A shareholder derivative suit is commonly used to sue the directors

  • A court will usually dismiss a derivative suit if a committee of independent directors determines in good faith, and without conflicts of interest that the lawsuit is not in the best interest of the corporation (BJR)

  • Damages are awarded to the corporation, not Shareholders

• A shareholder can directly sue their corporation when they allege a harm unique to them, distinct from other shareholders.

McCann v. McCann - Facts and Issue

• Facts:

  • William McCann gave each of his two sons, Bill and Ron, 1/3 interest (each) in their corporation, McCann Ranch and Livestock Company. The corporation’s remaining 1/3 shares went into a trust to support their mother, Gertrude. The elder McCann eventually passed away, leaving Bill Jr. as the corp’s CEO and President. Bill Jr. subsequently paid nearly 75% of the corporation’s profits out to his mother, Gertrude.

  • Ron directly sued in a direct suit against the corporation, alleging a breach of the directors’ fiduciary duties. Ron claimed that the directors refused to give him a corporate job or board membership, failed to pay him dividends, and deprived him of income through a series of business dealings between Bill and Gertrude.

• Rule: “A director has a fiduciary responsibility to both the corporation and shareholders.”

• Issue 1: derivative suit: Did Ron have to bring the suit derivatively?

• Issue 2: Did the directors breach their fiduciary duties?

McCann v. McCann - Court and Holding

• Court: “An exception to the rule that a s/h must bring a derivative action for claims alleging injury to the corp is that in a close corporation a minority s/h may bring a direct action, rather than a derivative action, if the s/h alleges harm to himself distinct from that suffered by other shareholders of the corporation.”

  • Dividend Payments?

    • Court: By themselves any payment from the corporation do not harm Ron any more than they harm the other shareholders. It was thus improper for Ron to sue directly for dividend payments. It’s also not his right to dividends.

  • Lack of a corporate job and employment?

    • Many of the actions undertaken by the corporation are legitimate uses of corporate power and discretion. Regardless of his ownership interest, Ron is not entitled to a seat on the board, Nor is he entitled to corporate employment. Nor is there evidence that he is entitled to dividends.

  • “squeeze out?” (payments to Bill’s mother)

    • Since the corp did not use a less harmful means to provide for Gertrude, it may be argued that the transaction was not made in good faith.”

    • It was also an appropriate direct lawsuit since he was the only S/H harmed in the deal

• Holding: potential breach of the duty of loyalty: The corporation could have issued dividends to all shareholders. The direct lawsuit was proper.

In re Oracle - Facts and Issue

• Facts: Oracle’s directors were alleged to have engaged in insider trading based on confidential info about Oracle. The info asserted that Oracle was doing poorly, so the directors sold their stock based on it—this would violate the duty of loyalty. Shareholders demanded that the corporation sue the directors; a special litigation committee of directors denied the request. The shareholders pushed forward, alleging that their derivative lawsuit was improperly dismissed

• Issue: was the special committee independent enough to receive deference under the BJR?

In re Oracle - Key Facts

• Were the directors conflicted or independent?

  • Rule/analysis: The question of independence “turns on whether a director is, for any substantial reason, incapable of making a decision with only the best interests of the corporation in mind.” That is, the independence test ultimately “focus[es] on impartiality and objectivity.”

  • Key Facts:

    • two SLC members-both of whom are professors at Stanford University-are being asked to investigate fellow Oracle directors who have important ties to Stanford such as

      • a Stanford alumnus who has directed millions of dollars of contributions to Stanford during recent years

      • Oracle's CEO, who has made millions of dollars in donations to Stanford through a personal foundation and large donations indirectly through Oracle, and who was considering making donations of his $100 million house and $170 million for a scholarship program

      • A Stanford professor

In re Oracle - Ruling and Holding

• Ruling:

  • “Delaware law should not be based on a reductionist view of human nature that simplifies human motivations on the lines of the least sophisticated notions of the law and economics movement. Homo sapiens is not merely homo economicus. We may be thankful that an array of other motivations exist that influence human behavior; not all are any better than greed or avarice, think of envy, to name just one. But also think of motives like love, friendship, and collegiality, think of those among us who direct their behavior as best they can on a guiding creed or set of moral values. Nor should our law ignore the social nature of humans. To be direct, corporate directors are generally the sort of people deeply enmeshed in social institutions. Such institutions have norms, expectations that, explicitly and implicitly, influence and channel the behavior of those who participate in their operation. 48 Some things are “just not done,” or only at a cost, which might not be so severe as a loss of position, but may involve a loss of standing in the institution. In being appropriately sensitive to this factor, our law also cannot assume-absent some proof of the point-that corporate directors are, as a general matter, persons of unusual social bravery, who operate heedless to the inhibitions that social norms generate for ordinary folk”

  • The director’s decision to dismiss the derivative was likely influenced by their social standing, not just THE INTEREST OF THE CORPORATION.

  • Oracle had formed a committee burdened by conflicts of interests, instead of forming an independent committee

• Holding: The committee’s decision to dismiss the lawsuit was conflicted and thus, the shareholders may bring a derivative lawsuit against the directors who participated in the insider trading

In re Facebook 220 Litigation - Facts and Issue

• Facts:

  • Facebook failed to adequately protects its users’ data, which led the FTC and other governmental agencies to react. The transferability of data is part of the corp’s business model. One effect was a consent decree in which Facebook agreed to implement better protections of users’ data. It was alleged that Facebook did not, ultimately, comply. Then came the Cambridge Analytica Scandal in which poor protections enabled the Russian government to access data of millions of users to profile voters. Other lawsuits occurred too based on similar breaches.

  • Facebook has incurred fortunes of penalties and claims in lawsuits.

  • Shareholders of Facebook sued (what is the shareholders’ claim?

    • Caremark violation for failing to monitor the corp and comply with the law.

  • The directors refused to provide the S/Hs with info about the corp

• Issue?

  • Do the shareholders have a right to access the corp’s books and records under 220 to bring a lawsuit against the corp and its directors.

In re Facebook 220 Litigation - Court

• DGCL 220: “any stockholder… shall, upon written demand under oath, have the right…to inspect for any proper purpose, and to make copies and extracts from: a. The corporation’s stock ledger, a list of its stockholders, and its other books and records…”

• Facebook: the corp cannot be responsible for what outside third parties do and therefore, the shareholders lack a proper purpose.

• Rules: An intent to investigate mismanagement or wrongdoing is a proper purpose

• Court

  • “a credible basis from which the court can infer that mismanagement, waste or wrongdoing may have occurred.”

  • According to the Parliamentary Report, “[i]f [Facebook] had fully complied with the [Consent Decree], [the Cambridge Analatica scandal] ... would not have happened.” …

  • “Plaintiffs have presented a credible basis to infer that the Board acted with disobedience by allowing Facebook to violate the Consent Decree. They are entitled to inspect books and records to investigate that potential wrongdoing…”

• 220 compels Facebook’s directors to provide access to books and records.

In re Limited - Facts

• Facts: Mr. Wexner is the Limited’s founder and president. In 1999, the corporation bought $750 of Mr. Wexner’s stock at a $90 million premium (the self tender)--$55ish/share. At the same time, the corporation rescinded its prior “option” to buy Mr. Wexner’s stock at $18.75 share and $25/share. In other words, the corp could have bought his stock at $18.75 but, instead, gave him a $55/share.

• Shareholders: brought a derivative lawsuit, claiming waste and a breach of fiduciary duties

  • “Plaintiffs allege that the only reason for structuring the transactions in this manner was to enable Mr. Wexner to avoid the terms of the Redemption Agreement which, they assert, had become particularly unfavorable to him. Plaintiffs' argue that these transactions lacked any legitimate business purpose other than to benefit Mr. Wexner at the Company's expense and came without a corresponding benefit to the Company.”

• The directors rejected the shareholders’ derivative lawsuit.

• So what is the shareholder’s impediment?

In re Limited - Ruling

• Obstacle: The shareholders seem to have a strong case alleging waste and breach of fiduciary duties by the directors. But the directors are empowered to bring a lawsuit (or not) on behalf of the corporation. That is, the directors would typically enjoy the BJR, causing the suit’s dismissal. For the shareholders to proceed with their derivative suit, they must show that the board labored under a conflict of interest when rejecting the lawsuit. This would defeat the BJR.

• Ruling: “six of the twelve directors of The Limited are either interested (Mr. Wexner and Mrs. Wexner) in the challenged transactions or subject to a reasonable doubt about their independence (Gilman, Trust, Schlesinger and Gee) from Mr. Wexner's domination.”

  • 1. the derivative lawsuit may proceed over the directors’ objections.

  • 2. breach of loyalty: “I am satisfied that the Complaint states a claim for breach of the duty of loyalty. The challenged transactions were approved by a unanimous board of twelve; six of those directors were either interested or subject to disqualifying doubts about their independence. Thus, because the challenged transactions were not approved by a majority of independent and disinterested directors, the Complaint states a loyalty claim ”

  • 3. Doesn’t satisfy waste.

  • 4. “Plaintiffs, without much enthusiasm, also allege that the challenged transactions are the product of the directors' breach of their duty of care. The Complaint does not allege gross negligence or the insufficiency of the information upon which the Board based its decision.”