McElrath v. Kalanick
Unpublished (Jan. 13, 2020) (2020)
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Rule of Law:
In a derivative action, demand on the board is excused as futile only if a plaintiff can plead with particularity that a majority of the board, at the time the complaint was filed, was either interested in the challenged transaction or lacked independence from an interested director, particularly when an exculpatory charter provision shields directors from monetary liability for due care violations absent a showing of bad faith or intentional dereliction of duty.
Facts:
- In 2015, Travis Kalanick, Uber's founder, recruited Anthony Levandowski, then Google's autonomous vehicle engineering manager, to leave Google and join Uber, developing an 'extremely close' relationship.
- In January 2016, Levandowski founded Otto while still employed by Google, and after leaving Google, he hired over a dozen former Google employees for Otto.
- Weeks later, Uber agreed to acquire Otto, a company the plaintiff alleged had no real operations, with Kalanick stating the acquisition was primarily for hiring Levandowski and his team.
- Uber hired Stroz Friedberg, an investigative firm, to conduct due diligence on whether Otto employees had taken Google's proprietary information or might breach non-solicitation/non-compete obligations.
- Stroz's preliminary report in early April 2016 found Otto employees possessed substantial confidential Google files and tried to delete them; Uber's general counsel learned of this and expressed 'serious reservations' to Kalanick but did not inform the full board.
- On April 11, 2016, Uber's board, including Kalanick, approved the Otto acquisition without Kalanick presenting Stroz's preliminary findings, and other directors did not request the report, though diligence was generally discussed and represented as 'okay.'
- The board also discussed and approved unusual indemnification provisions in the merger agreement, which limited Uber's ability to seek indemnification from Otto or its employees for certain breaches or misconduct.
- After the transaction closed, Google sued Uber and Otto in February 2017 for misappropriation of proprietary information, leading Uber to settle by issuing $245 million in stock to Google and terminating Levandowski's employment.
Procedural Posture:
- Lenza H. McElrath, III, an Uber stockholder and former employee, filed a derivative suit in the Delaware Court of Chancery against the directors who approved and closed the Otto acquisition, and two Uber officers.
- The defendants moved to dismiss the complaint under Court of Chancery Rule 23.1 for failure to make a demand on the board.
- The Court of Chancery found that only Travis Kalanick was an interested director and that a majority of the board was independent from him at the time the complaint was filed.
- The Court of Chancery dismissed the complaint with prejudice because the plaintiff did not make a demand on the board as required by Rule 23.1.
- The plaintiff appealed the Court of Chancery's decision to the Supreme Court of the State of Delaware.
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Issue:
Does a derivative plaintiff's complaint plead with sufficient particularity to establish a reasonable doubt that a majority of Uber's board of directors, at the time the complaint was filed, could have exercised independent and disinterested business judgment in responding to a demand to pursue litigation, thereby excusing the demand requirement under Court of Chancery Rule 23.1?
Opinions:
Majority - Seitz, Chief Justice
No, a derivative plaintiff's complaint does not plead with sufficient particularity to establish a reasonable doubt that a majority of Uber's board of directors could have exercised independent and disinterested business judgment, and thus the demand requirement under Rule 23.1 is not excused. The Delaware Supreme Court affirmed the Court of Chancery's dismissal, finding that only Travis Kalanick was an interested director and that a majority of the remaining directors were independent of him. Applying the Rales v. Blasband test for demand futility, the Court noted that Uber’s exculpatory charter provision protected directors from monetary liability for fiduciary duty breaches unless they acted with 'scienter'—actual or constructive knowledge of legal impropriety—or engaged in 'intentional dereliction of duty, a conscious disregard for one’s responsibilities.' The plaintiff failed to plead that any directors, other than Kalanick, acted in bad faith when approving or closing the Otto acquisition. Despite allegations about Kalanick's past and unusual indemnification provisions, the complaint described a functioning board that heard presentations, discussed risks, and asked questions. While the board's effort might have been flawed, it did not rise to the level of intentional wrongdoing or conscious disregard of duties, which would be necessary to overcome the exculpatory provision. Such conduct, at most, amounted to a due care violation, which is exculpated. The Court also found that director John Thain was independent of Kalanick, despite being appointed during a power struggle. With Thain, a majority of the board (six out of eleven) was disinterested and independent, thereby requiring the plaintiff to make a demand on the board before filing suit, which he failed to do.
Analysis:
This case significantly reaffirms the high procedural bar for derivative plaintiffs in Delaware, particularly regarding demand futility. It clarifies that allegations of gross negligence or even a 'flawed effort' by directors are insufficient to establish bad faith when an exculpatory charter provision is in place, requiring a strong showing of 'scienter' or intentional dereliction of duty. The ruling underscores the deference afforded to corporate boards in determining whether to pursue litigation on the corporation's behalf, making it more challenging for shareholders to bypass the demand requirement. This decision will likely reduce the number of derivative suits brought against directors for decisions that, while perhaps poor business judgments, do not involve provable intentional misconduct or lack of independence by a majority of the board.
