Chancery Applies 'Rales' in Dismissing Derivative Claim

In Sandys v. Pincus, C.A. No. 9512-CB, (Del. Ch. Feb. 29, 2016), the Delaware Court of Chancery considered the uncommon scenario of analyzing whether a demand made upon Zynga Inc.’s board of directors pursuant to Rule 23.1 would have been futile when the actions being challenged occurred at a time when Zynga’s board was composed of several different directors. While a majority of the Zynga directors had not turned over between the time of the challenged actions and the time the litigation, enough of the interested directors were replaced in that period so that, at the time the derivative litigation was initiated, the Zynga board was populated by a majority of disinterested and independent directors. In considering whether demand on the Zynga board should be excused, the court analyzed this novel issue when determining what test should apply.

In 2011, Zynga’s initial public offering (IPO) hit the market. As a condition to the IPO, certain Zynga executives and directors agreed to sale restrictions on their Zynga shares. In April 2012, Zynga issued a secondary offering of shares. Notwithstanding the sale restrictions, Zynga’s underwriters, the board’s audit committee and a majority of the board agreed to waive the restrictions in order to allow the Zynga executives and directors to sell their shares in the secondary offering. Subsequent to the approval of the secondary offering, the Zynga board was expanded from eight directors to nine directors. In addition, two of the directors who benefited from selling their shares in the secondary offering left the board and were replaced prior to the initiation of the derivative litigation. In April 2014, the derivative litigation was commenced, asserting claims against (1) the Zynga directors who participated in the secondary offering for breach of fiduciary duties for misusing confidential information when engaging in the secondary offering, (2) the Zynga directors for approving the secondary offering and allowing certain directors and executives to participate despite sale restrictions on their shares, and (3) the Zynga directors and executives at the time of the secondary offering for failing to put controls in place to ensure adequate public disclosures while avoiding material omissions in those disclosures.