The #MeToo Movement and the Shareholder Derivative Action

Over the last couple of years, several shareholder derivative actions have been filed as allegations of inappropriate sexual conduct or gender discrimination at public companies surfaced. For example, in January 2019, the board of directors of Google’s parent company, Alphabet Inc., was sued in a shareholder derivative action for allegedly covering up a pattern of gender discrimination and sexual harassment perpetrated by Google executives. The shareholder plaintiff alleges that the board’s conduct had an adverse impact on company profits and ability to hire and retain top talent and exposed it to lawsuits and regulatory action. Similar derivative lawsuits have been filed on behalf of a wide range of notable public companies, including Twenty-First Century Fox, Nike, CBS Corporation, Wynn Resorts, Liberty Tax, Lululemon Athletica, and National Beverage Corp., among others.

These lawsuits generally allege that the director defendants had knowledge or were willfully blind to the alleged sexual misconduct occurring at the company. Because the misconduct often involves high-level executives, shareholder plaintiffs allege that directors minimize or conceal the misconduct to protect influential executives. Under the right set of facts, the shareholder derivative lawsuit can result in a multimillion-dollar recovery on behalf of the company. In the Twenty-First Century Fox shareholder derivative suit, for instance, the defendants agreed to settle the case in exchange for a $90 million monetary payment and corporate governance reforms.

Although the settlement that resulted from the Twenty-First Century Fox lawsuit is encouraging for potential shareholder plaintiffs, these shareholder derivative lawsuits face their own set of early pleading hurdles that are not easy to overcome. In addition to complications surrounding the need to either serve a demand or establish that demand on the board would be futile, shareholder derivative lawsuits are subject to many defenses, including the business judgment rule, which set a high bar for plaintiffs to overcome. In fact, similar lawsuits preceding the #MeToo movement found limited success. In 1998, a shareholder of ICN Pharmaceuticals Inc. sued the board, alleging that the company’s chief executive officer “repeatedly propositioned or groped and rewarded or punished female employees based on whether they complied or complained.” White v. Panic, 793 A.2d 356 (Del. Ch. 2000), affirmed 783 A.2d 543 (Del. 2001). The company helped facilitate payments totaling $3.5 million to settle the harassment suits. The lawsuit was dismissed because the shareholder plaintiff could not overcome the legal presumption that the directors’ decisions were a good-faith exercise of their business judgment. The Board’s decision to facilitate the settlements was deemed a business decision within the discretion of the Board’s business judgment. More recently, in 2012, the Delaware Chancery Court dismissed a similar shareholder derivative action brought on behalf the Hewlett-Packard Company based on the business judgment rule. Zucker v. Andreessen, No. 6014-VCP, 2012 WL 2366448 (Del. Ch. 2012).

• With the new landscape of the #MeToo movement, however, the reasonableness of the board’s conduct under the business judgment rules is bound to receive renewed scrutiny by courts. It is therefore imperative for boards to also take a fresh look at their companies’ policies and practices to ensure they fall under the protection of the business judgment rule. In doing so, boards should pay close attention to the following:
• Whether the strength of the company’s procedures are sufficient to identify, investigate, and address allegations of sexual misconduct and harassment, including whether the company has formed a personnel committee that can focus on the company’s human resource practices;
• Whether the company thoroughly investigates allegations of sexual misconduct, using unbiased counsel, which often requires using independent outside investigators;
• Whether the company is accurately making statements regarding the company’s compliance with applicable law and internal ethics standards, particularly those associated with personnel matters;
• Under what conditions a company makes severance payments to an alleged harasser following departure of that executive, and whether there is a connection with the severance payments and a settlement with the alleged victim; and
• Whether and to what extent allegations of sexual misconduct or the findings of an internal investigation related to a key executive should be disclosed.

Scott Carlton is an attorney with Paul Hastings in Los Angeles.

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