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    March 04, 2022 Articles

    Delaware Supreme Court Adopts New Three-Part “Universal Test” for Demand Futility

    The new test replaces the long-standing Aronson and Rales tests for determining when making a demand on a board of directors of a Delaware company is futile.

    By Erik Luedeke, Danielle Myers, and Erika Oliver

    On September 23, 2021, the Delaware Supreme Court adopted a new “universal test” for assessing whether making a demand on the board of directors of a Delaware corporation to pursue litigation should be excused as futile. See United Food & Commercial Workers Union v. Zuckerberg, No. 404, 2020, slip op. at 38–39 (Del. Sept. 23, 2021). The test requires courts to evaluate the following in relation to each of the individual directors when assessing allegations of demand futility:

    (i)         whether the director received a material personal benefit from the alleged misconduct that is the subject of the litigation demand;
    (ii)        whether the director faces a substantial likelihood of liability on any of the claims that would be the subject of the litigation demand; and
    (iii)       whether the director lacks independence from someone who received a material personal benefit from the alleged misconduct that would be the subject of the litigation demand or who would face a substantial likelihood of liability on any of the claims that are the subject of the litigation demand.

    Id.

    “If the answer to any of the questions is ‘yes’ for at least half of the members of the demand board, then demand is excused as futile” and the shareholder plaintiff may proceed with the derivative claims. Id. at 41.

    The new three-part “universal” test replaces Delaware’s long-standing Aronson and Rales tests and eliminates the choice between them. 473 A.2d 805 (Del. 1984); Rales v. Blasband, 634 A.2d 927 (Del. 1993). These traditional tests both focused on the disinterest and independence of the board, leading courts to acknowledge that the “Rales test, in reality, folds the two-pronged Aronson test into one broader examination.” David B. Shaev Profit Sharing Account v. Armstrong, 2006 WL 391931, at *4 (Del. Ch. Feb. 13, 2006), aff’d, 911 A.2d 802 (Del. 2006). Subtle nuances between them remained, however, including the fact that the Aronson test was to be applied to allegations of demand futility based on board action, whereas the Rales test applied where there was no business decision by the board. As a result, developments in the law since their adoption led to inconsistencies in their application.

    While the Delaware Supreme Court specified that the new demand futility test is consistent with Aronson and Rales and their progeny, and thus cases applying those tests remain “good law,” how the test is interpreted and applied by the courts will ultimately reveal its impact on a shareholder’s ability to proceed derivatively without first making a demand on the board of a Delaware corporation.

    Erik Luedeke and Danielle Meyers are partners and Erika Oliver is an associate at Robbins Geller Rudman & Dowd in San Diego, California.

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