For nearly 30 years, Delaware courts applied two different demand futility tests, depending on the relationship between the current board (i.e., the directors to which a pre-suit demand would be directed) and the alleged misconduct. Where a complaint challenged a decision made by the same directors that would consider a litigation demand, the test articulated by the Delaware Supreme Court in Aronson v. Lewis, 473 A.2d 805 (Del. 1984), applied. Under the Aronson test, demand was excused as futile if the shareholder alleged with particularity facts that raise a reasonable doubt that “(1) the directors are disinterested and independent” or “(2) the challenged transaction was otherwise the product of a valid business judgment.” Id. at 814. In all other circumstances—that is, where the complaint did not challenge a specific board decision (e.g., claims based on the lack of oversight) or when the current directors did not participate in the challenged decision—the so-called “Rales test” applied. Under Rales, demand was excused if the shareholder alleged with particularity facts that create a reasonable doubt that the board “could have properly exercised its independent and disinterested business judgment in responding to a demand.” Rales v. Blasband, 634 A.2d 927, 934 (Del. 1993).
The Aronson and Rales tests both focused on the same fundamental question: whether directors can exercise business judgment impartially when considering a pre-suit demand. See, e.g., In re China Agritech, Inc. S’holder Deriv. Litig., 2013 WL 2181514, at *16 (Del. Ch. May 21, 2013) (“The Aronson and Rales [tests] have been described as complementary versions of the same inquiry.”) (citing cases). But because the two cases distinguished between challenges to decisions made by the demand board (Aronson) and challenges to decisions made by prior directors or other misconduct (Rales), derivative litigants have traditionally had to grapple with the threshold question of which test to apply.
Section 102(b)(7) and Exculpated Care Claims
In 1995, after Aronson and Rales were decided, the Delaware General Assembly enacted General Corporation Law section 102(b)(7), which enables corporations to adopt charter provisions immunizing directors from personal liability for breaches of their duty of care. See 8 Del. Code § 102(b)(7). Section 102(b)(7) was intended to address the concern that the risk of personal liability would dissuade directors from making decisions for the benefit of shareholders, and it enabled corporations to allow their directors to “take business risks without worrying about negligence lawsuits.” In re Cornerstone Therapeutics Inc, Stockholder Litig., 115 A.3d 1173, 1185 (Del. 2015) (quoting Malpiede v. Townson, 780 A.2d 1075, 1095 (Del. 2001)).
On its face, section 102(b)(7) had nothing to do with demand futility. But if directors are exculpated from duty of care claims (many corporations have adopted section 102(b)(7) charter provisions), are they ever really incapable of being impartial evaluators of a demand whether to advance such claims? In the years following the enactment of section 102(b)(7), Delaware courts began to explore this inherent tension between section 102(b)(7) and derivative litigation involving claims for which directors no longer faced personal liability. See, e.g., Malpiede, 780 A.2d at 1094 (holding that where a complaint advances only exculpated claims, “then Section 102(b)(7) would bar the claim[s]”); Cornerstone, 115 A.3d at 1186–87 (“[A] plaintiff must plead non-exculpated claims against a director who is protected by an exculpatory charter provision [under section 102(b)(7)] to survive a motion to dismiss, regardless of the underlying standard of review for the board’s conduct.”); Lenois v. Lawal, 2017 WL 5289611, at *14 (Del. Ch. Nov. 7, 2017) (“[W]here an exculpatory charter provision exists, demand is excused as futile under the second prong of Aronson with a showing that a majority of the board faces a substantial likelihood of liability for non-exculpated claims.”) (emphasis added).
The Zuckerberg Decision
Zuckerberg involved a decision by Facebook’s board of directors to create a new class of non-voting shares of Facebook stock. This had the practical effect of enabling Facebook’s founder, Mark Zuckerberg, to donate some of his Facebook stock to charity without diluting his voting control of the company. Facebook shareholders filed a class action challenging the board’s decision, arguing Facebook’s directors had violated their fiduciary duties to the company by preferring Zuckerberg’s personal interests over those of the company. Facebook’s board ultimately abandoned the challenged transaction, which mooted the class action, and then reached an agreement with class counsel on the amount of a fee award.
After the class action settled, another Facebook shareholder brought a subsequent derivative complaint, based on similar allegations but seeking to recoup the money Facebook spent defending against the class action. The plaintiff did not make a pre-suit demand on Facebook’s board, alleging instead that demand was futile under Aronson because a majority of Facebook’s board lacked independence from Zuckerberg and because the board’s underlying decision was not a valid exercise of business judgment. The Court of Chancery dismissed the complaint under Rule 23.1, and the Delaware Supreme Court affirmed.
Zuckerberg announced two key doctrinal developments. The one that has captured most of the headlines, given the long tenure of Aronson and Rales as the two-headed governor of demand futility law, is the new, universally applicable test to evaluate whether demand should be excused as futile. Going forward, in all cases, courts are to apply the following tripartite test, on a director-by-director basis, when assessing the futility of a litigation demand:
(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.
Zuckerberg, 262 A.3d at 1059.
If the answer to any of those three questions is “yes” for at least half of the current board (i.e., the board that would consider a litigation demand), then demand is excused as futile. See id.
By combining Aronson and Rales to form a uniform demand futility test, the Zuckerberg court “refocuse[d] the inquiry on the decision regarding the litigation demand, rather than the decision being challenged,” which is consistent with the fundamental question: “whether the directors on the demand board cannot be considered proper persons to conduct litigation on behalf of the corporation because they are under an influence which sterilizes their discretion.” Id. at 1058–59 (citing Aronson, 473 A.2d at 814) (internal quotation marks omitted). The court was therefore clear that, because the new test “is consistent with and enhances Aronson, Rales, and their progeny,” Zuckerberg should not be interpreted to overrule those cases, which remain good law. Id. at 1059.
Zuckerberg’s second development in the demand futility doctrine involves how to analyze demand futility in connection with claims that are exculpated pursuant to a section 102(b)(7) charter provision. Facebook’s charter contains such a provision, immunizing its directors from any risk of personal liability for duty of care claims. Focusing on the second prong of the Aronson test—which asks whether the challenged transaction was “the product of a valid business judgment,” Aronson, 473 A.2d at 814—the Zuckerberg plaintiff argued that its duty of care claims could establish demand futility notwithstanding the existence of Facebook’s 102(b)(7) provision, because the business judgment rule would not protect the challenged decision to allow Zuckerberg to donate his stock. Thus, the plaintiff argued, Aronson’s second prong could apply even where the directors faced no likelihood of liability for approving the challenged transaction. See Zuckerberg, 262 A.3d at 1050–51.
The Delaware Supreme Court disagreed. It reasoned that, at the time Aronson was decided, section 102(b)(7) did not exist. Therefore, “rebutting the business judgment rule through allegations of care violations exposed directors to a substantial likelihood of liability,” rendering demand futile. Id. at 1051. That is why, the court explained, the Aronson court focused on a plaintiff’s ability to rebut the business judgment rule—because doing so would expose directors to a substantial likelihood of liability, which, in turn, would affect their ability to impartially consider a demand. After the advent of section 102(b)(7) provisions, which “remove[d] the threat of liability and protracted litigation for breach of care claims,” such claims no longer jeopardize a director’s ability to be impartial. Id. at 1054. Because directors face no likelihood of liability for exculpated claims, such claims can never, in and of themselves, establish demand futility.
Conclusion
Zuckerberg announced two doctrinal shifts, both of which promise to have significant effect on derivative litigants going forward. First, it adopted a new, uniform, three-part test for evaluating demand futility, which, at minimum, simplifies the doctrine and eliminates the need to litigate which test to apply. The new test similarly refocuses the inquiry on the key question underlying Rule 23.1: whether directors are capable of impartially assessing a litigation demand. Second, Zuckerberg clarified that exculpated duty of care claims—for which directors cannot face personal liability—are incapable of establishing demand futility on their own. This presents an additional hurdle for shareholders seeking to sue corporations with section 102(b)(7) charter provisions.
