In Schoenmann v. Irvin, C.A. No. 2021-0326-SG (Del. Ch. June 2, 2022), the Delaware Court of Chancery denied defendants’ attempt to dismiss certain derivative claims on the basis of demand futility. In light of the requirement that the court draw all reasonable inferences in favor of plaintiff at this stage of the proceedings, the court found that demand would have been futile, even though plaintiff alleged facts concerning individuals who were not members of the board of directors as of the commencement of the case. Principles of equity permitted the court to disregard the subsequent change in the board’s composition and, based on the allegations of the complaint, conclude that a majority of the board lacked independence, thereby rendering the demand requirement futile.
Schoenmann involved direct and derivative claims against Clear Align LLC and its founder, manager, and majority member, Angelique Irvin. The claims were brought by a former manager of the company, Stuart Schoenmann, following his removal from the board. Plaintiff’s investigation into the company spanned several years. Irvin, as the controller and holder of the majority membership interests had the contractual authority to add or remove managers, as well as to determine the number of managers, which the complaint alleged she wielded frequently in furtherance of her self-interest. The complaint included other allegations of impropriety concerning Irvin, including, but not limited to allegations of fraud and forgery. In 2019, plaintiff served a demand upon the company. Having failed to receive adequate information in response to his books and records claims, plaintiff filed suit in April 2021. Unbeknownst to plaintiff and other members of the company until June 2021, Irvin had replaced two members of the board in January 2021.
Defendants challenged the derivative claims in the complaint based on plaintiff’s failure to make a demand upon the company. However, plaintiff pled demand futility. Demand futility carries a stringent pleading requirement, in which plaintiff must show that a majority of the board of directors could not exercise independent and disinterested judgment in relation to the demand. The court assesses demand futility on a director-by-director basis based on the factors set forth in Zuckerberg: (1) whether the director received a material benefit from the alleged misconduct; (2) whether the director would face a substantial likelihood of liability related to the alleged misconduct; and (3) whether the director lacks independence from someone who received a material personal benefit from the alleged misconduct or who faced a substantial likelihood of liability related to the alleged misconduct. Plaintiff focused on the third prong, in which it pled facts concerning the other directors’ compensation, their direct reporting to Irvin, and their susceptibility to removal at Irvin’s will.
Delaware law requires the court to focus its analysis on the members of the board as of the filing of the complaint, which commands relevance in this case, because the composition of the board changed in the months preceding the commencement of the litigation. Defendants conceded the partiality of Irvin, but plaintiff was still required to show that at least one other member of the three-member board lacked independence. The court accepted plaintiff’s well-pled allegations to infer that at least one other member of the board was beholden to Irvin. Defendants argued that plaintiff’s allegations did not concern the other members of the board in existence as of the filing of the complaint, in which Irvin purportedly replaced the other members of the board three months prior to the commencement of the litigation. The court made the inference that Irvin changed the board’s composition and backdated the consent notice in order to frustrate the lawsuit. Further, because the company did not provide timely notice of the change, the court excused plaintiff from having failed to make a demand upon a board of which he was unaware. The court concluded that the failure to provide notice was quintessential gamesmanship, in which the company was aware of plaintiff’s claims against the company and that his claims were derivative in part, for months prior to the filing of the lawsuit.
Schoenmann highlights the role that equity may play in a demand futility analysis. The pleading outlined a history of bad acts, which allowed for a reasonable inference that a demand upon those individuals comprising the board in existence prior to or as of the filing of the complaint was futile. Defendant’s actions “did not comport with equity,” thereby causing the court to disregard the January 2021 change in board membership and conclude that a demand upon the board was futile.
*Lauren Mauro, a summer associate at McCarter & English not yet admitted to the bar, contributed to this alert.