Wood v. Baum

Supreme Court of Delaware · Corporations

CorporationsDerivative suitsDemand futilityDirector oversightRule 23.1demand futilityAronsonRales

Facts

MME was a Delaware LLC with a ten-member board, and its operating agreement eliminated director liability except for fraudulent or illegal conduct. The complaint alleged that directors caused improper asset valuations, improper charitable contributions, related-party transactions, and failures of accounting and reporting controls that led to restatements and an SEC investigation. Five defendants served on the audit committee, and the plaintiff argued demand was excused because the directors faced a substantial risk of personal liability. The plaintiff relied on the directors' signing of public filings, approval of transactions, audit committee membership, and alleged red flags to show knowing misconduct.

Issue

Whether the plaintiff's derivative complaint alleged particularized facts sufficient to excuse pre-suit demand on MME's board. More specifically, whether the complaint created a reasonable doubt that a majority of the directors could properly exercise independent and disinterested business judgment because they faced a substantial likelihood of liability for non-exculpated misconduct.

Rule

A plaintiff who does not make a pre-suit demand must plead demand futility with particularized facts under Rule 23.1. When directors are exculpated from liability except for fraudulent, illegal, or bad-faith conduct, a substantial threat of liability exists only if the complaint pleads a non-exculpated claim supported by particularized facts showing scienter, meaning actual or constructive knowledge that the conduct was legally improper. Signing financial reports, approving transactions, audit committee membership, or generalized red flags, without more, do not reasonably support an inference of knowing illegality or bad faith.

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One of 10 multiple-choice questions for this case. Pick an answer to see why.

Lakefront Housing Finance, LLC, a Delaware LLC based in Cleveland, has a board of nine managers. Its operating agreement eliminates manager liability except for fraudulent or illegal conduct. Nina Patel files a derivative suit without making demand, alleging the managers face personal liability because the company later restated earnings after asset values were overstated.

Which additional allegation would most likely be necessary for Nina to excuse demand based on a substantial likelihood of personal liability?

Explanation. When directors or managers are exculpated except for fraudulent, illegal, or bad-faith conduct, demand futility based on personal liability requires a non-exculpated claim pled with particularized facts. The key is scienter: actual or constructive knowledge that the conduct was legally improper. A large restatement, general sophistication, or routine board meetings do not by themselves support that inference. (Derived from Wood v. Baum (n.d.).)