Delaware’s Director-by-Director Demand Futility Standard in Shareholder Derivative Suits: Ezell v. Dinges

Introduction

Ezell v. Dinges, 24-20050 (5th Cir. May 13, 2025), arises from a derivative action brought by Jody Ezell and fellow shareholders on behalf of Cabot Oil & Gas Corporation against its board members. Plaintiffs alleged that the directors breached their fiduciary duties by (1) failing to oversee and remediate environmental violations connected to the Marcellus Shale fracking operations in Dimock Township, PA; (2) issuing materially misleading disclosures in Cabot’s 2019 Form 10-Q filings; and (3) engaging in insider trading. The District Court dismissed all claims under Federal Rule 23.1 for failure to plead demand futility, and the Fifth Circuit affirmed.

Summary of the Judgment

The Fifth Circuit held that:

Shareholders failed to plead demand futility under Delaware law and thus must make a pre-suit demand on the board before suing derivatively.
The Court applies de novo review to a dismissal for failure to plead demand futility, aligning with multiple circuits’ authority (e.g., In re Cognizant, Rosenbloom).
Under Delaware’s newly articulated three-part, director-by-director test (United Food & Commercial Workers Union v. Zuckerberg), plaintiffs must show for at least half of the board that a director (i) received a personal benefit, or (ii) faces substantial likelihood of liability, or (iii) lacks independence from another conflicted director.
Plaintiffs did not plead particularized facts showing:
- a “conscious disregard” for oversight duties (the Caremark claim);
- knowing misrepresentations or omissions in the 2019 10-Qs (the disclosure claim); or
- insider trading that would entitle them to excuse demand as to half the board (the Brophy claim).
Accordingly, all derivative claims were properly dismissed with prejudice.

Analysis

1. Standard of Review & Governing Law

Federal Rule 23.1(b)(3) requires a verified derivative complaint to state with particularity the effort to obtain board action or reasons why such a demand would be futile. The Fifth Circuit joined the First, Second, Third, Sixth, Seventh, Eighth, Tenth, and other circuits in applying de novo review to Rule 23.1 dismissals. Under Delaware law (Cabot’s state of incorporation), demand is excused only if shareholders show the board could not dispassionately consider litigation:

Kamen v. Kemper: Federal rule does not define demand’s substantive contours—state law does.
Burks v. Lasker: Board’s power to initiate or refuse litigation rests on state corporation law.
Zuckerberg (Del. 2021): Adopts a unified director-by-director test for demand futility.

2. Delaware’s Director-by-Director Demand Futility Test

Under Zuckerberg, a derivative plaintiff must plead particularized facts showing that for at least half of the directors at the time of filing, one of three factors is met:

Material personal benefit from the alleged misconduct;
Substantial likelihood of liability for one of the claims asserted;
Lack of independence from a director who meets (i) or (ii).

3. Oversight Liability (Caremark Claims)

In re Caremark Int’l claims arise when directors either (a) fail to implement any reporting or information system, or (b) consciously fail to monitor an existing system and thus allow corporate violations to go unaddressed. Such claims require particularized pleading of bad faith—i.e., directors knew of “red flags” and deliberately ignored them.

In Ezell, the board’s Environmental, Health & Safety Committee received regular, detailed updates—minutes, test results, enforcement actions, lawsuits, consent orders—from 2011 through 2019. Although Cabot’s remediation efforts experienced setbacks, the board both (i) implemented and (ii) actively monitored compliance systems. Plaintiffs could not infer that directors acted in conscious disregard or knew they were violating the law. The Fifth Circuit therefore agreed no Caremark demand-futility exception existed.

4. Disclosure Liability

Delaware law imposes on directors a duty of honesty when they communicate with shareholders, including securities filings. Partial disclosures “that leave investors with a distorted impression” can breach the duty of loyalty if made knowingly or in bad faith. To establish demand futility in a disclosure-based derivative suit, plaintiffs must plead particularized facts showing that the directors “knowingly disseminated” false or misleading information.

The challenged statements in Cabot’s July and October 2019 Form 10-Qs described ongoing remediation efforts and potential penalties. Board minutes confirm that Cabot had indeed performed “appropriate remediation efforts” at the Howell wells and was actively investigating and sampling the Jeffers Farms wells under PaDEP consent orders. Reasonable investors would not interpret the disclosure as promising completed remediation, and no board member knew the statements to be false. Plaintiffs failed to plead scienter or bad faith by any director, so no majority of the board lacked independence from personal liability.

5. Insider Trading (Brophy) Claim

A derivative insider-trading claim under Brophy v. Cities Service requires that a director received a material personal benefit in trading on undisclosed corporate information. Plaintiffs asserted Dinges traded on inside knowledge, but presented no particularized facts showing a personal benefit or that the board’s other members were conflicted for half the board. The claim thus fails both on the merits and for demand futility.

Precedents Cited

Federal review standards: In re Cognizant Tech. Sols. (3d Cir. 2024); Rosenbloom (9th Cir.); Whitten (11th Cir.).
Rule 23.1 and demand: Kamen v. Kemper Fin. Servs. (1991); Burks v. Lasker (1979).
Director oversight (Caremark): In re Caremark (1996); Stone v. Ritter (Del. 2006); In re Massey Energy (Del. Ch. 2011).
Bad-faith oversight: City of Birmingham Ret. & Relief Sys. v. Good (Del. 2017).
Demand futility test: Zuckerberg (Del. 2021); United Food & Commercial Workers Union v. Zuckerberg (Del. Ch. 2020).
Disclosure duties: Malone v. Brincat (Del. 1998); Appel v. Berkman (Del. 2018).
Insider trading: Brophy v. Cities Service (Del. Ch. 1949).

Complex Concepts Simplified

Shareholder derivative suit: A lawsuit by shareholders on the corporation’s behalf to enforce rights the company itself has failed to enforce.
Demand requirement: Shareholders must ask the board to sue before filing derivatively, unless making demand would be “futile.”
Demand futility: Under Delaware law, plaintiffs must show the board lacked disinterested independence or faced potential liability such that it could not impartially decide a demand.
Caremark duty: Directors must implement and oversee compliance systems; bad-faith failures to monitor can expose them to liability.
Scienter/bad faith: Conscious knowledge of wrongdoing or deliberate indifference to red flags.
Brophy trading claim: A derivative claim that a director traded on undisclosed material corporate information.

Impact and Conclusion

Ezell v. Dinges solidifies that:

The Fifth Circuit reviews Rule 23.1 dismissals de novo.
Delaware’s director-by-director demand-futility test requires strong particularized allegations tying each director to personal conflict or liability.
Caremark oversight claims demand evidence of conscious disregard or bad faith.
Disclosure claims require particularized facts showing knowing falsity or omissions.
Insider-trading claims under Brophy must show a material personal benefit and contaminate half the board for demand futility.

By affirming dismissal, the Court reinforces a high pleading threshold in derivative litigation and underscores Delaware’s meticulous approach to corporate governance. Future plaintiffs will confront these exacting standards when seeking to excuse pre-suit demand and hold directors accountable.