United States: Delaware Chancery Court Throws Out Claims Over $10 Million Severance Payment To CEO

Seyfarth Synopsis: A Delaware Chancery Court judge last week dismissed a derivative complaint seeking to recover a $10 million severance payment made to a corporation’s former CEO because he found that plaintiff shareholder failed to adequately plead the demand was wrongfully refused. The opinion reaffirms the high bar plaintiffs face under Delaware law to successfully allege a board acted negligently or in bad faith when it refuses a demand.

Background

Plaintiff shareholder of Mattel, Inc. (“Mattel” or the “Company”) sent a demand letter to Mattel’s board of directors in April 2015, which among other things requested an independent internal investigation be conducted after he learned that the Company’s former CEO was paid $10 million under a severance plan and would be paid $125,000 per month for the next 12 months pursuant to a consulting agreement with the Company. In September 2015, the board’s counsel sent plaintiff a letter unanimously rejecting the demand because it found no evidence to support a claimed breach of fiduciary duties. Plaintiff shortly thereafter requested the documents reviewed in Mattel’s internal investigation or a list of such documents, a list of the individuals interviewed, any report the board had produced, and any written summaries of the interviews. The board did not provide the requested documents but stated that the board’s counsel had interviewed 24 people and reviewed 12,400 documents. In December 2015, plaintiff filed a suit against director defendants, the former CEO and the CFO alleging a breach of fiduciary duty against all defendants, an unjust enrichment claim against the former CEO and a claim for waste against the director defendants. Vice Chancellor Tamika Montgomery-Reeves in dismissing the complaint ruled that the plaintiff had not shown the board acted negligently or in bad faith in refusing the demand.

Takeaways

1. Failing to Disclose a Written Report of an Investigation or the Identities of the Witnesses Interviewed May Not Raise a  Reasonable Inference of Gross Negligence. Plaintiff argued that the board conducted a grossly negligent investigation because it did not provide plaintiff with the written report of the investigation or the identities of the witnesses interviewed. In rejecting this argument, the Court of Chancery relied on longstanding Delaware precedent stating that “[w]hile a board of directors has a duty to act on an informed basis in responding to a demand . . . there is obviously no prescribed procedure that a board must follow.”¹ The Court found the Plaintiff had not pled sufficient facts to reasonably infer gross negligence given the amount of effort that went into the board’s investigation and plaintiff’s affirmative decision not to make a Section 220 demand for the report.

2. Failing to Form a Special Committee May Not Raise a Reasonable Inference of Gross Negligence. Plaintiff further argued that the board’s investigation was flawed because the board did not form a special committee. The Court of Chancery found plaintiff had not pled any facts supporting this claim, including any evidence showing that the board became interested or beholden to the former CEO or acted without independence. Importantly, the Court noted that by making a demand on the board the plaintiff had already conceded that the board was independent at the time of the demand.

3. Discrepancies in Disclosures Regarding the CEO’s Departure May Not Support a Finding of Bad Faith. The plaintiff alleged that disclosures connected with the CEO’s departure were inconsistent. Mattel’s initial press release stated that the former CEO “resigned,” while its proxy statement stated that he was “terminated.” Plaintiff argued that the disclosures could not both be true and correct. The Court of Chancery in rejecting plaintiff’s bad faith allegation noted that plaintiff was inappropriately focusing on the merits of its underlying claim and had not cast a reasonable doubt as to whether the board refused the demand in good faith. Here, plaintiff had not adequately pled that the board’s determination that the “resignation” qualified as a termination without cause was inexplicable. The Court additionally noted the board had provided other reasons why it refused the demand in its refusal letter, including the high cost of litigation and the fact that the litigation would be an unnecessary distraction at a time when senior management was attempting to turn the Company around.

For a full copy of the opinion, click here.

Footnotes

1 Levine v. Smith, 591 A.2d 194, 214 (Del. 1991), overruled on other grounds by Brehm v. Eisner, 746 A.2d 244 (Del. 2000).

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