Strict Enforcement of Demand Requirement in Delaware Derivative Actions: McElrath v. Uber Technologies

Strict Enforcement of Demand Requirement in Delaware Derivative Actions: McElrath v. Uber Technologies

Introduction

McElrath v. Uber Technologies, Inc. (224 A.3d 982) is a pivotal case decided by the Supreme Court of the State of Delaware on January 13, 2020. The plaintiff, Lenza H. McElrath, III, a shareholder and former employee of Uber Technologies, Inc., filed a derivative lawsuit against several directors and officers, including CEO Travis Kalanick. The suit alleged that the board of directors failed to adequately oversee the acquisition of Ottomotto LLC, leading to the misuse of Google's proprietary information and subsequent financial liabilities for Uber.

The central issues in the case revolved around the application of the demand requirement under Delaware Court of Chancery Rule 23.1, which mandates that shareholders must first request the board to address alleged wrongdoings before pursuing litigation on behalf of the corporation. The defendants contended that the plaintiff did not fulfill this prerequisite, leading to the dismissal of the complaint.

Summary of the Judgment

The Supreme Court of Delaware upheld the decision of the Court of Chancery to dismiss the plaintiff's derivative suit. The Court affirmed that the plaintiff failed to make the requisite demand on the board of directors to pursue litigation before filing the lawsuit. The judgment emphasized that the majority of Uber's board was both disinterested and independent, thereby maintaining their authority to manage the corporation's affairs without undue interference from shareholders.

Analysis

Precedents Cited

The judgment extensively referenced several key Delaware cases to underpin its reasoning:

  • RALES v. BLASBAND, 634 A.2d 927 (Del. 1993): Established the demand futility test, requiring plaintiffs to demonstrate that the board could not impartially consider the demand.
  • ARONSON v. LEWIS, 473 A.2d 805 (Del. 1984): Outlined the necessity of the demand requirement to protect managerial authority.
  • In re Walt Disney Co. Derivative Litig., 906 A.2d 27 (Del. 2006): Provided a contrast where bad faith by directors was successfully alleged.
  • In re Caremark Int’l Inc. Derivative Litig., 698 A.2d 959 (Del. Ch. 1996): Highlighted the difficulty in proving bad faith or conscious disregard by directors.

These precedents collectively reinforced the court’s stance on the high burden plaintiffs bear when seeking to bypass the board through derivative actions.

Legal Reasoning

The Court conducted a de novo review of the Court of Chancery's dismissal, accepting the factual allegations as true while scrutinizing the legal sufficiency of the plaintiff’s claims. Central to the reasoning was the application of Rule 23.1, which necessitates that shareholders must request the board to address potential wrongdoing before initiating litigation.

The Court assessed whether the board was "disabled" from pursuing litigation, a condition that would exempt the plaintiff from making a demand. This involved evaluating the independence and disinterest of the board members, considering factors such as the certificate of incorporation’s exculpatory clause and the presence of disinterested directors.

The Court concluded that a majority of the Uber board was both disinterested and independent, thereby negating the plaintiff's argument that demand was futile. Additionally, the plaintiff failed to demonstrate that the board acted in bad faith, as required to bypass the demand requirement under Rule 23.1.

Impact

This judgment reinforces the stringent application of the demand requirement in Delaware derivative suits, underscoring the protective measures in place for corporate boards against unwarranted shareholder litigation. By affirming the dismissal, the Court emphasized the importance of respecting managerial authority and the necessity for plaintiffs to meet high evidentiary standards when alleging director misconduct.

Future cases will likely reference this decision when evaluating the sufficiency of demand futility claims, particularly in scenarios where the board is largely independent. Corporations can take assurance from this ruling that as long as most of their directors are disinterested and independent, the demand requirement serves as an effective gatekeeper against frivolous or strategic litigation.

Additionally, the case highlights the challenges plaintiffs face in derivative suits, particularly the necessity to prove bad faith—a demanding standard that requires clear and convincing evidence of intentional wrongdoing by directors.

Complex Concepts Simplified

  • Derivative Action: A lawsuit brought by a shareholder on behalf of the corporation against third parties, often insiders like directors or executives, for harm caused to the corporation.
  • Demand Requirement: A procedural step requiring shareholders to first ask the board to address alleged wrongdoings before filing a lawsuit themselves.
  • Demand Futility: A situation where making a demand on the board is unlikely to result in the board taking action, thereby allowing the shareholder to bypass this requirement.
  • Disinterested Director: A board member who does not have a personal stake or conflict of interest in the matter at hand, ensuring impartial decision-making.
  • Bad Faith: Intentional wrongdoing or a conscious disregard for responsibilities, which plaintiffs must prove to bypass the demand requirement under certain circumstances.

Conclusion

The Supreme Court of Delaware’s affirmation in McElrath v. Uber Technologies underscores the judiciary's commitment to maintaining the integrity of corporate governance structures through the strict enforcement of the demand requirement in derivative actions. By requiring plaintiffs to meticulously demonstrate the futility of making a demand or the bad faith of directors, the ruling protects boards from unwarranted litigation and promotes responsible managerial discretion. This case serves as a critical reference point for both corporate directors and shareholders, delineating the boundaries and responsibilities inherent in derivative litigation under Delaware law.

Case Details

Year: 2020
Court: SUPREME COURT OF THE STATE OF DELAWARE

Judge(s)

SEITZ, Chief Justice

Attorney(S)

Michael J. Barry, Esq. (argued), John C. Kairis, Esq., Kimberly A. Evans, Esq., GRANT & EISENHOFER P.A., Wilmington, Delaware; Jeffrey Reeves, Esq., Atlanta, Georgia; Attorneys for Plaintiff-Appellant Lenza H. McElrath, III, derivatively on behalf of Uber Technologies, Inc. R. Judson Scaggs, Jr., Esq., Susan W. Waesco, Esq., Sabrina M. Hendershot, Esq., MORRIS, NICHOLS, ARSHT & TUNNELL LLP, Wilmington, Delaware; Susan S. Muck, Esq., Kevin P. Muck, Esq., Marie C. Bafus, Esq., FENWICK & WEST LLP, San Francisco, California; Attorneys for Defendants-Appellees Garrett Camp, Ryan Graves, Arianna Huffington, Yasir Al-Rumayyan, William Gurley and David Bonderman. Donald J. Wolfe, Jr., Esq., T. Brad Davey, Esq., J. Matthew Belger, Esq., Jacob R. Kirkham, Esq., POTTER ANDERSON & CORROON LLP, Wilmington, Delaware; Joseph G. Petrosinelli, Esq., Kenneth J. Brown, Esq., WILLIAMS & CONNOLLY LLP, Washington, D.C.; Attorneys for Defendant-Appellee Travis Kalanick. A. Thompson Bayliss, Esq., Michael A. Barlow, Esq., ABRAMS & BAYLISS LLP, Wilmington, Delaware; Mark Gimbel, Esq. (argued), C. William Phillips, Esq., COVINGTON & BURLING, LLP, New York, New York; Bryant Pulsipher, Esq., COVINGTON & BURLING, LLP, San Francisco, California; Attorneys for Nominal Defendant-Appellee Uber Technologies, Inc.

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