A while back, Usha Rodrigues suggested that case book authors (pointing directly at Klein, Ramseyer & yours truly) include Del. County Emples. Ret. Fund v. Sanchez in the section on derivative litigation:
So it's nice to see Chief Justice Strine doing what he does best--writing a clear, accessible opinion acknowledging that independence is complicated and contextual. ... True, Chief Justice Strine acknowledges ... the economic dependence that the director in question also allegedly had to the defendant. But it is his eloquent defense of friendship that resonates for me. Just last week I paraphrased the Beam court as holding that "friendship alone is not enough." But I asked students if they would feel unbiased if they were a director and the defendant and fellow boardmember was their college roommate. Their answer was an emphatic no. I hazard that Chief Justice Strine might agree.
I ran Sanchez up the flag pole, but our little triumvirate rejected it for reasons I explained in an earlier post:
First, it is almost devoid of facts--especially interesting ones. ...
Which leads me to a question that really does puzzle me: How the [expletive deleted] are trial courts supposed to distinguish between mere social friendships and enduring close relationships? Especially because the issue will often be decided on the pleadings before discovery.
In the case at bar, the issue was easy because there was both an enduring friendship and close economic ties (at least according to Strine's version of the facts as opposed to that of the Chancery Court). But what if all you have are ties of friendship?
To which Usha has now responded:
But, although Steve is a very, very smart guy that knows him some Delaware law, I disagree with the plaint at his post's end: "How the [expletive deleted] are trial courts supposed to distinguish between mere social friendships and enduring close relationships? Especially because the issue will often be decided on the pleadings before discovery."
Aronson's first prong and Zapata both, in different contexts, try to get at this question: should we trust the board that recommends dismissing a derivative suit? or are the directors too biased? Answering that question gives us a chance to play that perennial law school game, "Rules or Standards?"
Rules approach: Has the director been paid by the defendant in question? Are they related? If yes, they are biased. If not, they're fine. This beauty of this definitional approach, as with all rules, is that it's simply, blessedly clear. But it also may be over- and under-inclusive.
Standards approach: Let's look at the situation. What is the director's tie to the defendant? Does the director depend on the defendant financially? Are they related? How closely? Are they friends? Are they in the same social circle? How close? The beauty of this situational approach is that it's granular. The cost is that it is a whole lot harder to apply, and harder to plan around.
I favor standards over rules for this particular question. The derivative suit is at core a sorting mechanism, and it would be too easy to game a rule and stack the board with manager-friendly-but-not-financially-dependent directors, rendering the whole derivative suit mechanism a farce.
Bringing us back to the classroom, I also like that Delaware has opted for standards here because I can use it to make the weird animal that is the derivative suit come alive for the students. Most of our students came straight through from undergrad. When I ask them: "Would you be unbiased in deciding whether the board should sue the defendant, if the defendant was your college roommate?", I get a visceral reaction, one that gets them to engage with the complexities of the derivative suit.
I agree with all of that (especially the first part!), but the problem is that Usha doesn't deal with the procedural posture. As the Delaware Supreme Court explained in Grimes v. Donald (1996):
A stockholder filing a derivative suit must allege either that the board rejected his pre-suit demand that the board assert the corporation's claim or allege with particularity why the stockholder was justified in not having made the effort to obtain board action.
The shareholder must include such allegations in the complaint when filed, without the benefit of having had any discovery:
If the stockholder cannot plead such assertions consistent with Chancery Rule 11, after using the “tools at hand” to obtain the necessary information before filing a derivative action, then the stockholder must make a pre-suit demand on the board.
In a footnote, the Court quotes its earlier decision in Rales to explain:
Although derivative plaintiffs may believe it is difficult to meet the particularization requirement of Aronson because they are not entitled to discovery to assist their compliance with Rule 23.1, ... they have many avenues available to obtain information bearing on the subject of their claims. For example, there is a variety of public sources from which the details of a corporate act may be discovered, including the media and governmental agencies such as the Securities and Exchange Commission. In addition, a stockholder who has met the procedural requirements and has shown a specific proper purpose may use the summary procedure embodied in 8 Del.C. § 220 to investigate the possibility of corporate wrongdoing. ... Surprisingly, little use has been made of section 220 as an information-gathering tool in the derivative context. Perhaps the problem arises in some cases out of an unseemly race to the court house, chiefly generated by the “first to file” custom seemingly permitting the winner of the race to be named lead counsel. The result has been a plethora of superficial complaints that could not be sustained. Nothing requires the Court of Chancery, or any other court having appropriate jurisdiction, to countenance this process by penalizing diligent counsel who has employed these methods, including section 220, in a deliberate and thorough manner in preparing a complaint that meets the demand excused test of Aronson.
My claim is that it will be much more difficult for plaintiffs use the "tools at hand" to develop sufficiently particularized facts relating to the nature of a friendship than an economic relationship. How often will a Section 220 books and records inspection produce evidence that the CEO and a director are life-long pals, for example. Or reading SEC filings, for that matter? Maybe plaintiffs will be able to find stories in the media about their lifelong friendship. A Google search turned up stories about Bill Gates being close friends at some point of his life with Paul Allen (still?), Water Buffett, Michael Larson, and Steve Ballmer (still?).
But what about less high profile CEOs with less high profile friends?
I await Usha's response eagerly.
Update: Of course, independence is an issue in many settings other than just demand excused cases. In many (most?) of those other situations, independence issues will be resolved at the summary judgment stage or even trial. Accordingly, in those cases, my objection is partially vitiated. Where to draw the line-something we must do even in a standards-based approach-remains a difficult question (IMHO).
