Rich ex rel. Fuqi International, Inc. v. Yu Kwai Chong
2013 Del. Ch. LEXIS 106, 66 A.3d 963 (2013)
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Rule of Law:
A shareholder who has made a litigation demand on a board may proceed with a derivative suit, even without a formal rejection of the demand, by pleading particularized facts that create a reasonable doubt that the board's failure to respond is consistent with its fiduciary duties of good faith and due care.
Facts:
- Fuqi International, Inc. ('Fuqi'), a Delaware corporation operating as a Chinese jewelry company, completed a public offering in the U.S. in 2009, raising approximately $120 million.
- In March 2010, Fuqi announced it had discovered significant accounting errors related to inventory and cost of sales, which would require a restatement of its 2009 financial statements and constituted a 'material weakness' in its internal controls.
- On July 19, 2010, George Rich, Jr., a Fuqi stockholder, sent a formal demand letter to Fuqi's board of directors, asking it to take action to remedy breaches of fiduciary duty and correct the company's deficient internal controls.
- Between September 2009 and November 2010, Fuqi's Chairman, Yu Kwai Chong, authorized transfers of over $130 million in corporate cash to various unverified third-party entities in China.
- The board formed a Special Committee to investigate the demand, but it became defunct after its members resigned or were reassigned.
- The board's separate Audit Committee commenced an investigation but was forced to suspend its work after Fuqi management failed to pay the fees of its outside legal counsel and forensic specialists.
- In January 2012, two independent directors on the Audit Committee, Eileen Brody and Victor Hollander, resigned in protest, stating that their efforts to serve shareholders had been 'completely frustrated by Management'.
- Over two years after Rich made his demand, the board had not formally responded, and its investigative efforts had been abandoned.
Procedural Posture:
- Plaintiff George Rich, Jr., a stockholder, made a pre-suit litigation demand to the board of Defendant Fuqi International, Inc. on July 19, 2010.
- After two years passed without a formal response from the board, Rich filed a shareholder derivative complaint in the Delaware Court of Chancery on June 13, 2012.
- The Defendants (Fuqi and its directors) filed a motion to dismiss the complaint pursuant to Court of Chancery Rules 23.1 (for failure to satisfy the demand requirement) and 12(b)(6) (for failure to state a claim upon which relief can be granted).
- Defendants also moved to dismiss or stay the case in favor of prior-filed federal actions in New York.
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Issue:
Does a board's failure to formally respond to a shareholder's litigation demand for over two years, combined with actions that effectively abandon and obstruct any investigation into the demand, constitute a wrongful refusal that permits the shareholder to proceed with a derivative lawsuit under Court of Chancery Rule 23.1?
Opinions:
Majority - Glasscock, Vice Chancellor
Yes, the board's prolonged inaction and obstruction constitute a wrongful refusal, allowing the shareholder's derivative suit to proceed. While a board is entitled to the presumption of the business judgment rule in how it responds to a shareholder demand, a plaintiff can overcome this by pleading particularized facts that raise a reasonable doubt about the board's good faith. Here, the passage of over two years without a response, the dissolution of the Special Committee, the deliberate de-funding of the Audit Committee's investigation, and the resignation of independent directors in protest collectively demonstrate an abdication of the board's duty. Such actions are not protected by the business judgment rule, as the rule has no role where directors have abdicated their functions or failed to act in the face of a known duty. Therefore, the board's failure to act is deemed a wrongful refusal, satisfying the requirements of Rule 23.1 and allowing the plaintiff to pursue the derivative action.
Analysis:
This decision clarifies the 'wrongful refusal' standard in a 'demand-made' derivative action where a board fails to formally act, rather than explicitly rejecting the demand. It establishes that prolonged, bad-faith inaction combined with obstruction can be treated as a constructive refusal, preventing a board from indefinitely stonewalling a derivative suit by claiming an investigation is 'ongoing'. This precedent empowers shareholders to proceed when a board abdicates its duty to investigate, ensuring that the demand requirement does not become a tool for boards to bury meritorious claims through delay and impedance. The ruling also serves as a strong warning to directors that their handling of a demand is itself a fiduciary act subject to judicial review for good faith.
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