Derivative Claims of Improper Demand Refusal for Grossly Negligent Investigations and Bad Faith Must Be Adequately Pled

By: Megan Wotherspoon and Calvin Kennedy

The court found that a board of directors’ decision to refuse demand in connection with a stockholder derivative claim satisfies the business judgment rule if the board’s investigation is reasonable and the board acts in good faith.  By this opinion, the court granted the defendants’ motion to dismiss under Court of Chancery Rule 23.1 in light of plaintiff’s failure to adequately plead improper demand refusal.

In Andersen v. Mattel, et al., the plaintiff Robert C. Andersen (“Andersen”) brought a derivative action through nominal defendant Mattel, Inc. (“Mattel”) against the Board of Directors of Mattel (the “Board”) and Bryan Stockton, Mattel’s former CEO (“Stockton”), among others. In a letter dated April 17, 2015, Andersen demanded that the Board, among other things, investigate severance payments made by Mattel to Stockton following Stockton’s separation from Mattel earlier in 2015.Andersen alleged that Stockton was not entitled to the severance payments and therefore also demanded that the Board  essentially claw back the benefits which had been paid to Stockton. The Board unanimously determined to reject Andersen’s demands, and explained in a refusal letter to Andersen the Board’s basis for determining that the severance payments were properly made to Stockton and noted that pursuing litigation with regard to the matter would have an adverse impact on Mattel’s business. In response to a subsequent letter received from Andersen, the Board’s counsel responded with details that outlined the internal investigation which the Board undertook with regard to the matter.

Andersen, claiming that his demand was wrongfully refused, filed a verified stockholder derivative complaint. The defendants moved to dismiss on the grounds that Andersen failed to state a claim upon which relief could be granted. As stated by the court, “a stockholder seeking to assert derivative claims on behalf of a Delaware corporation in this [c]ourt must satisfy the demand requirement in Court of Chancery Rule 23.1.” Rule 23.1 requires that derivative complaints “allege with particularity the efforts, if any, made by the plaintiff to obtain the action the plaintiff desires … and the reasons for the plaintiff’s failure to obtain the action or for not making the effort.” In this case, Andersen claimed that (1) the Board conducted a grossly negligent investigation and (2) the Board’s refusal of his demand was in bad faith.

With respect to Andersen’s first claim, the court stated that “[a] grossly negligent investigation is one where the board did not investigate at all or pursued ‘such an inadequate investigation, in light of the seriousness of the demand, that a court may reasonably infer a breach of the duty of care.’” Here, the Board conducted an investigation, which included a review of 12,400 documents, but the Board did not comply with Andersen’s request to provide him with the complete results of the investigation. Though Andersen had the option to obtain the report, he chose not to. Thus, based on the Board’s explanation of the investigation which it undertook, the court found that Andersen failed to plead particularized facts alleging that the Board was grossly negligent.

With respect to Andersen’s second claim, the court stated that “[i]n order to adequately allege bad faith demand refusal, a complaint must plead particularized facts showing that ‘the directors … acted with scienter, i.e., with a motive to harm, or with indifference to harm that will necessarily result from the challenged decision—here, that decision being rejection of the [p]laintiff’s demand.” The court referenced similar cases and noted that “[t]he question is not whether the [b]oard’s conclusion was wrong; the question is whether the [b]oard intentionally acted in disregard of [Mattel’s] best interests in deciding not to pursue the litigation the [p]laintiff demanded.” Here, the Board’s justifications for refusing Andersen’s demands were determined to be reasonable and thus the court found that Andersen failed to plead particularized facts alleging that the Board acted in bad faith. Thus, the court granted the defendants’ motion to dismiss under Court of Chancery Rule 23.1 in light of plaintiff’s failure to adequately plead improper demand refusal.

Andersen v. Mattel et al., No. 11816-VCMR (Del. Ch. Ct. January 19, 2017)