Albert H. Manwaring IV.

Uber Technologies' board approved the acquisition of Google's more mature autonomous vehicle program. The transaction was high risk and flawed from its inception, ending in embarrassment after Uber learned that key employees hired from Google had misappropriated Google's proprietary information in the autonomous vehicle program. Uber issued $245 million in its stock to settle Google's misappropriation claims. An Uber stockholder brought derivative claims against the Uber directors who approved the acquisition of Google's autonomous vehicle program.

Under Delaware corporate law, the board of directors manages the business and affairs of a corporation, which includes the decision whether a corporation harmed in a transaction should on its own behalf assert breach of fiduciary duty claims against the directors and officers who approved or were responsible for the transaction. To safeguard the board's management authority, a stockholder, asserting derivative claims on behalf of the corporation, must first make a demand on the board to pursue claims on the corporation's own behalf under Delaware Court of Chancery Rule 23.1. The demand requirement gives the board the opportunity to decide whether to address the alleged wrong to the corporation without litigation, and to control any suit that the board decides that the corporation should bring on its own behalf. Pursuant to Court of Chancery Rule 23.1, a stockholder can bypass the demand requirement for derivative claims by pleading "with sufficient particularity that demand is futile and should be excused due to a disabling conflict by a majority of the directors," who would consider the demand at the time the derivative complaint is filed; see City of Birmingham Retirement and Relief System v. Good, 177 A.3d 47, 55 (Del. 2017). When a majority of the directors at the time of the challenged conduct are no longer on the board at the time the derivative complaint is filed, demand futility is assessed under the Rales v. Blasband test. To satisfy demand futility under Rales, a plaintiff stockholder must plead allegations that "create a reasonable doubt that … the board of directors could have properly exercised its independent and disinterested business judgment in responding to a demand," see Rales v. Blasband, 634 A.2d 927, 934 (Del. 1993).

In McElrath v. Kalanick, No. 2017-0888 (Del. January 13, 2020), the Delaware Supreme Court affirmed the Court of Chancery's dismissal of the alleged derivative claims against the Uber directors who approved the acquisition of Google's autonomous vehicle program because the plaintiff failed to adequately plead that a majority of the Uber directors in place at the time that the derivative complaint was filed were interested or lacked independence to properly exercise their business judgment to assess a pre-suit demand. The court reasoned that aside from Uber's CEO, the Uber directors were not interested because they did not face a substantial likelihood of personal liability for breach of the duty of good faith for their approval of the acquisition. The court emphasized that a showing of bad faith essentially requires the plaintiff to demonstrate intentional misconduct or dereliction of duty, which is a "high hurdle" to meet. Here, in contrast to merely rubberstamping the acquisition presented by Uber's CEO, who had a history of intellectual property violations, the Uber board heard a presentation that summarized the terms of the acquisition, reviewed and considered the risks of the acquisition, including potential litigation with Google, discussed due diligence, asked questions and participated in a discussion. All these board actions showed a functioning board. The court noted that "there is a vast difference between an inadequate or flawed effort to carry out fiduciary duties and a conscious disregard for those duties." In short, while there may have been reason to dig deeper into the CEO's representations about the acquisition given his history of intellectual property violations, the court concluded that the board's failure to investigate further did not qualify as an "intentional dereliction" of its duties. Lastly, the court found that the majority of the directors were independent or not beholden to the alleged interested Uber CEO, who faced potential liability for bad faith in the acquisition. The court reasoned that the CEO's ability to appoint and remove a director without further allegations that the director had a personal or financial connection to the CEO, or that the directorship was of "substantial material importance" to the director, was insufficient to reasonably doubt the director's independence. Since plaintiff did not challenge the independence of five other directors, at least six or a majority of the directors of the eleven-director board were independent of the CEO.

In sum, the plaintiff failed to adequately plead demand futility as to majority of the Uber directors in place at the time that the derivative complaint was filed. Thus, the plaintiff was required to make a pre-suit demand on the Uber board to pursue these claims. Accordingly, because the plaintiff had not made a pre-suit demand upon the board, the court affirmed the dismissal of the derivative complaint with prejudice under Court of Chancery Rule 23.1.

Albert H. Manwaring IV ([email protected]) is a corporate governance and fiduciary litigation partner at Morris James in Wilmington.