“Delaware’s common law of corporations makes it clear that when a stockholder makes a demand upon the company board to take legal action, she is conceding that the directors are able to bring their business judgment to bear to consider that demand.” In Mancine Dahle, et al. v. John C. Pope, et al., the Court of Chancery upheld this Delaware corporate principle when dismissing a complaint brought derivatively on behalf of R.R. Donnelley & Sons Company (the company).
Prior to the filing of the complaint, in October 2018, counsel for the plaintiffs sent a letter (the demand letter) to the company’s board of directors “to suggest” corrective action to address alleged excessive director compensation as well as compensation practices and policies. The demand letter made the strong overture of potential litigation by referencing “all available shareholder remedies” absent “immediate remedial measures” by the board. In response to the letter, the board retained outside counsel, initiated an investigation, and, treating the letter as a litigation demand, declined to commence a civil action as being in the best interests of the company.
In February 2019, the plaintiffs filed a three-count derivative complaint alleging demand futility without referencing the demand letter or the board’s response. The Court dismissed the complaint pursuant to Rule 23.1 on the grounds that the demand letter constituted a legal pre-suit demand, and the plaintiffs could not (and did not attempt to) satisfy the higher pleading burden for a refused demand.
In determining that the demand letter constituted a pre-suit demand as a matter of law, the Court relied extensively on Vice Chancellor McCormick’s analysis in Solak ex rel Ultragenyx Pharm. Inc. v. Welch, decided in October 2019 under “virtually identical” factual circumstances. Specifically, the Court found that the demand letter’s strong overtures of litigation coupled with the presentment of the company’s susceptibility to shareholder challenges and the legal basis for such challenges satisfied the governing Yaw test. The Court also noted the fact that the complaint was nearly a “carbon copy” of the demand letter and that the remedial measures sought through the demand letter were consistent with benefits achieved through derivative lawsuits. Finally, the Court did not favor any perceived ambiguity in the demand letter as “tactical wordsmithing” designed to exploit a plaintiff-friendly presumption.
The Dahle and Ultragenyx decisions are a warning to plaintiffs-side counsel that pre-suit demands made on a board of directors have consequences that often preclude the subsequent initiation of litigation. The Court of Chancery will not give in to the tactical wordsmithing or “clever draftsmanship” of pre-litigation “letters” designed to have a board take legal action in response to an explicit demand yet at the same time attempt to avoid the tacit concession that the directors are independent and able to bring their business judgement to consider the demand. Those on the company and board side charged with responding to pre-suit demand letters should take comfort in knowing that the Court of Chancery will review the substance of a pre-suit demand over its form to determine compliance with Rule 23. Before responding, the substance of a pre-suit demand should be thoroughly reviewed to determine whether the stockholders’ requested remedial measures are sufficiently similar to what can be obtained through derivative litigation. If so, any response should make explicit that it is treating the pre-suit communication as a formal demand.