COURT OF CHANCERY DISMISSES DERIVATIVE BREACH OF FIDUCIARY DUTY CLAIMS FOR FAILURE TO MAKE A PRE-SUIT DEMAND OR DEMONSTRATE DEMAND FUTILITY

Oct 13 2017

In Chester Cty. Emp. Ret. Fund v. New Residential Inv. Corp., C.A. No. 11058-VCMR (Del. Ch. Oct. 6, 2017), the Delaware Court of Chancery granted the defendants’ motion to dismiss the stockholder plaintiff’s direct and derivative claims for breach of fiduciary duties under the Court of Chancery Rules 23.1 and 12(b)(6), because the plaintiff failed to make a pre-suit demand or demonstrate that doing so would be futile. The Court found that although the facts alleged gave rise to a derivative claim, the plaintiff failed to make a pre-suit demand or plead particularized facts sufficient to raise a reasonable doubt that a majority of the directors on the New Residential Corp. (“New Residential”) board could have exercised their independent and disinterested business judgment in responding to a demand.

On February 22, 2015, New Residential entered into a merger agreement (the “Initial Merger Agreement”) with Home Loan Servicing Solutions, Ltd. (“HLSS”) to acquire 71 million outstanding shares of HLSS stock for approximately $1.3 billion in addition to the assumption of all liabilities of HLSS. The Initial Merger Agreement was later terminated pursuant to a termination agreement that mutually released all claims related to the Initial Merger Agreement. The parties negotiated a subsequent acquisition agreement (the “Subsequent Agreement”) for the purchase of substantially all of HLSS’ assets in exchange for cash and shares of New Residential common stock, for a total purchase price of approximately $1,441,200,000, which provided for the payment by HLSS of all debt prior to closing.

Plaintiff, Chester County Employees’ Retirement Fund (the “Plaintiff”), a minority stockholder of New Residential, brought direct and derivative claims for breach of fiduciary duty against members of the New Residential board of directors (the “Board”), New Residential’s manager FIG LLC (“FIG”), FIG’s owner Fortress Operating Entity I LP (“FOE I”), and Fortress Investment Group LLC (“Fortress”), which allegedly controls New Residential, FIG, and FOE I (collectively, the “Defendants”). Plaintiff alleged that the Defendants caused New Residential to overpay, by at least $100 million, for the assets of HLSS under the Subsequent Agreement in order to advantage other Fortress assets and to maximize management fees, incentive compensation, and stock option awards to Fortress and its affiliates. Plaintiff also sought a declaratory judgment that a termination agreement between HLSS and New Residential purporting to release all New Residential stockholder claims against HLSS is not a valid defense.

Defendants moved to dismiss the complaint under Court of Chancery Rules 23.1 and 12(b)(6) arguing that a majority of the Board was disinterested and independent and that Fortress was not interested in the underlying transactions. Furthermore, Defendants argued the Plaintiff’s demand for declaratory judgment was not ripe because Defendants had not raised the termination agreement as a defense.

Under Chancery Court Rule 23.1, a plaintiff must plead particularized facts showing that its demand of the board to bring a derivative suit is futile in order to avoid dismissal. In Aronson v. Lewis, the Supreme Court of Delaware provided a two-part test to show the futility of the demand: (i) “the directors are disinterested and independent” and (ii) “the challenged transaction was otherwise the product of a valid exercise of business judgment.” Under the first prong, the Court concluded that the Plaintiff failed to raise a reasonable doubt as to the impartiality of the majority of the Board. Under the second prong, the Court concluded that the Plaintiff failed to demonstrate that the Subsequent Agreement between New Residential and HLSS was so egregious that board approval could not be a valid exercise of business judgment or that it was entered into in bad faith. The Court further held that the Plaintiff’s declaratory judgment claim was not ripe for judicial review and granted Defendants’ motions to dismiss.