In City of Tamarac Firefighters’ Pension Trust Fund v. Corvi, et. al, C.A. No. 2017-0341-KSJM, the Delaware Chancery Court issued a Memorandum Opinion granting a motion to dismiss under Chancery Rule 23.1 for failing to prove that pre-litigation demand of the Board was wrongfully refused. The City of Tamarac Firefighters’ Pension Trust Fund (“Plaintiff”), a stockholder of United Continental Holdings, Inc., the owner and operator of United Airlines (collectively, “United”), brought derivative claims against United and its board of directors (the “Board”) (collectively with United, “Defendants”) demanding either a claw-back of an allegedly excessive separation compensation award or the rescission of the separation agreement altogether. The Court found that Plaintiff failed to plead particularized facts raising a reasonable doubt that Defendants acted with due care and in good faith in rejecting Plaintiff’s demand.

In 2011, when David Samson (“Samson”) was chairman of the Port Authority of New York and New Jersey, he and then-chief executive officer of United Jeffery Smisek (“Smisek”) entered into an arrangement where United would re-institute a retired route that traveled between Newark, NJ and Columbia, SC (the “Route”). The Route had historically operated at a loss, but Samson owned a vacation home there that he wished to travel to more easily. In exchange for the Route’s resurrection, Samson approved several development projects at United’s regional hub. The renewed Route generated losses for United of approximately $1 million.

Three years later, a federal investigation into an unrelated Port Authority scandal uncovered the Route arrangement, prompting further probes into the organization. In the midst of these investigations, Smisek and United entered into a separation agreement negotiated by a special committee (the “Committee”) made up of nine independent and disinterested directors. The separation agreement netted Smisek benefits in the amount of $37M, including almost $5M in cash.  By its terms, the separation agreement permitted United to claw-back the benefits if Smisek failed to cooperate with the federal investigations, pleaded guilty to a felony, or was convicted of a felony. Eventually, United settled the case with the SEC, and paid a $2.4M penalty.

In 2016, Plaintiff sent the Board a litigation demand letter seeking to claw-back Smisek’s separation compensation or rescind the separation agreement. Thereafter, the Board delegated consideration of the demand to the Committee. The Committee rejected Plaintiff’s demand, citing the fact that the circumstances under which United was empowered to claw back the award had not occurred. The Committee also stated that it had considered potential disruption to or distraction from the business, the efficacy of the requested action, and the actions United had already taken responsive to the federal investigations.

In 2017, Plaintiff filed this action. Subsequent to Defendants’ original motion to dismiss, Plaintiff sent a supplemental demand adding a request that the Board institute legal action to rescind the separation agreement. The Board again delegated consideration of this demand to the Committee, who in turn formed a subcommittee (the “Subcommittee”) made up of the five members of the Committee that were added after the approval of the separation agreement with Smisek. The Subcommittee rejected Plaintiff’s second demand for essentially the same reasons as the first demand. Subsequently, Plaintiff filed an amended complaint and Defendants renewed their motion to dismiss.

In deciding Defendants’ motion to dismiss, the Court considered Rule 23.1 and how it applied to derivative suits where a plaintiff makes a demand. The Court considered the long-standing rule that making a pre-suit demand constitutes a “tacit” concession that the board is sufficiently disinterested and independent to consider the demand. Refusal, therefore, is subject to the business judgment rule. The Court cited Spiegel v. Buntrock, 571 A.2d 767 (Del. 1990) for the proposition that the two ways in which a plaintiff can show that the board acted outside of its business judgement are raising a reasonable doubt that (1) the board acted with due care, or (2) the board acted in good faith.

Plaintiff argued that the Committee and Subcommittee members were conflicted, and thus the Board acted with gross negligence in relying on them to consider the demands. Defendants relied on Spiegel for the proposition that the Court is precluded from analyzing conflicts at the committee level, as the plaintiff’s tacit concession of disinterestedness flows to the committees as well. The Court acknowledged Defendants’ reasonable interpretation of Spiegel, but turned to Grimes v. Donald, 673 A.2d 1207 (Del. 1996) and Scattered Corp. v. Chi. Stock Exch., Inc., 701 A.2d 70 (Del. 1997) [hereinafter Scattered III] for a discussion on the distinction between directors’ status as disinterested or independent and directors’ actions relating to disinterestedness or independence. Specifically, the Court cited Scattered III for the proposition that even where pre-suit demand is made, the Court should inquire into the good faith and reasonableness of the actions of any committee making up less than the full board.

The Court concluded that “Grimes and Scattered III demonstrate that a tacit concession does not establish for all purposes the disinterest and independence of every member of the board.” While acknowledging that the Court should consider arguments that individual members or committees might not have acted independently, it found that all of Plaintiff’s arguments of conflict within the Committee and Subcommittee fail. Plaintiff argued that members of the Committee had been involved in the negotiation of the separation agreement, which would leave them unable to fairly decide whether to claw-back the award. The Court dismissed this argument because Plaintiff failed to allege any actual involvement, other than that some were on the board when the claw-back provisions were decided. Plaintiff also argued that Jenner & Block’s “dual-representation” of the Committee and United was a conflict. The Court acknowledged that while “dual-representation” can be a conflict, it would only be triggered here if it was alleged that Smisek was also represented by Jenner & Block. Lastly, Plaintiff argued that the Committee approved the separation agreement before the federal investigations concluded, but the Court found that Plaintiff would have had to allege particularized facts that approving the separation agreement at that time constituted gross negligence.

Plaintiff’s arguments that the Board acted in bad faith were quickly dismissed by the Court. Plaintiff would have had to plead with particularity that the Board intentionally acted in disregard of the Company’s best interest. Instead, the Court noted that Plaintiff merely characterized the decisions as “egregious,” “irrational” and “inexplicable.” Ultimately, the Court found that Plaintiff failed to show that demand was wrongfully refused and granted Defendants’ motion to dismiss.

Tom Sperber contributed to this post.