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Demonstrating that directors have breached their duty of loyalty by acting in bad faith goes far beyond showing a questionable or debatable decision on their part. In order to adequately allege bad faith demand refusal under Del. Ch. Ct. R. 23.1, 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. The merits of the underlying claim are relevant only for purposes of ascertaining whether the board's decision was so inexplicable that a court may reasonably infer that the directors must have been acting for a purpose unaligned with the best interest of the corporation; that is, in bad faith. Finally, the court takes into account not only the defendants' countervailing legal arguments, but also the other relevant factors considered by the board - e.g., whether the costs of pursuing the claims outweigh the expected recovery.
On June 30, 2009, Bryan Stockton entered into a letter agreement with Mattel under which he became a participant in the Mattel Executive Severance Plan (the "Severance Plan"). The Severance Plan entitles Stockton to severance benefits in the event that his departure from Mattel qualifies as a "Covered Termination." Section 2(e) of the Severance Plan defines a Covered Termination as follows: “"Covered Termination" shall mean that, at any time after a Participant's Eligibility Date, either (i) the Participant has resigned from Mattel for Good Reason, or (ii) the Participant's employment with Mattel is involuntarily terminated by Mattel without Cause.” Section 2(i) of the Severance Plan defines "Good Reason" as (1) a material diminution in Stockton's duties, authority, or responsibility, (2) a material diminution in or failure to pay Stockton's base salary, (3) a failure to make certain executive compensation plans available to Stockton, (4) a modification to the Severance Plan that is materially adverse to Stockton, or (5) the failure of a Mattel successor to assume the Severance Plan. After two years of growth with Stockton as CEO, Mattel's stock price dropped substantially in 2014. In light of the poor performance, on January 25, 2015, Stockton ceased to be chairman and CEO of Mattel. The next day, Mattel announced in a press release that Stockton had "resigned as Mattel's Chairman and Chief Executive Officer and resigned from the Board of Directors." On April 9, 2015, Mattel filed and distributed its 2015 proxy statement. The proxy statement stated that "[o]n January 25, 2015, Mr. Stockton ceased to be Chairman of the Board and CEO and his employment was terminated. His termination of employment qualified as a termination by Mattel without cause under the Severance Plan, and he received severance benefits and payments." As a result of Stockton's separation from Mattel, he allegedly was paid $10 million under the Severance Plan. The April 2015 proxy statement also revealed that Stockton would be paid $125,000 per month under a twelve-month consulting agreement with Mattel.
Because of the discrepancies in Mattel's disclosures regarding whether Stockton resigned or was terminated, Plaintiff Robert C. Andersen, a stockholder, sent a demand letter to the board of directors. The letter demanded that the board: undertake an independent internal investigation into Mattel’s violations of law; commence a civil action against the members of Mattel’s management to recover damages as a result of the said members’ breach of fiduciary duties; terminate Stockton’s consultancy agreement; and “enter into a "freeze" or standstill agreement with Stockton until the actions demanded in this letter have concluded.” The Mattel board responded to Andersen’s demand through counsel and requested evidence of his stock ownership in Mattel, which he provided. Thereafter, the board's counsel sent a second letter stating that "the Board has unanimously determined to reject [the Demand]" (the "Refusal Letter"). The Refusal Letter explained that "there is no evidence to support a claimed breach of fiduciary duties." Further, it acknowledged that "Stockton did, in fact, resign from his positions at the company." But because the public disclosures made clear that Stockton did not leave voluntarily, "the disclosures . . . concerning Bryan Stockton's departure from the company were true and correct." The letter also stated that "the severance benefits paid to Stockton were validly owed to him"; "the consulting agreement . . . would allow for an amicable transition"; and "litigation would be a distraction for the Board and senior management and would likely have an adverse impact on Mattel's business during a period in which Mattel is trying to navigate a turnaround." Andersen responded to the Refusal Letter, requesting the documents reviewed in Mattel's internal investigation (or alternatively a list of the documents reviewed), a list of the individuals interviewed, any report that the board had produced, and any written summaries of the interviews. The board's counsel responded on September 30, 2015, stating that counsel for the board "interviewed twenty-four people, including all of the current members of the board, the relevant current and former officers of the company, and the advisors who played a role in the underlying events." According to the letter, the board's counsel "also reviewed approximately 12,400 documents, including the relevant board materials" in the investigation. Mattel did not provide the requested documents or the report.
Thus, Andersen filed the instant Complaint alleging three derivative claims. Count I is a claim for breach of fiduciary duty against all Defendants; count II is a claim for unjust enrichment against Stockton; and count III is a claim for waste against the Director Defendants. Andersen asserted that his demand was wrongfully refused, giving him standing to bring these derivative claims. Defendants moved to dismiss, arguing that the board's demand refusal was a proper exercise of business judgment and that the Complaint failed to state a claim upon which relief can be granted.
Was the Mattel board’s demand refusal done in bad faith?
Andersen failed to allege particularized facts raising a reasonable inference that Defendants acted in bad faith. Andersen argued that in this case, the parties defined an involuntary resignation by contract through the definition of Good Reason. He asserted that because Defendants did not contend that Stockton resigned for Good Reason, his "resign[ation]" was not involuntary, and Stockton was not entitled to the severance. But Andersen conceded that the Severance Plan actually did not define "involuntary resignation" or "involuntary termination." And Andersen has not identified any other provision in the Severance Plan that purportedly contracted around the Delaware case law holding that a forced resignation was an involuntary termination. Thus, the issue before the Mattel board was no different from Friedman where this Court held that the board's determination that Khosrowshahi did not leave voluntarily was not made in bad faith. Even if the court were to credit Andersen’s interpretation of the Severance Plan as the most reasonable interpretation, that would not suffice to find the Board had wrongfully refused the demand. Like in Friedman, the question under Del. Ch. Ct. R. 23.1 is not whether the board's conclusion was wrong; the question is whether the board intentionally acted in disregard of the corporation's best interests in deciding not to pursue the litigation the plaintiff demanded. The fact that the board's justifications for refusing the demand fall within "the bounds of reasonable judgment" is fatal to the claim that the refusal was made in bad faith. As such, Andersen has not adequately pled that the Mattel board's determination that Stockton's "resign[ation]" "qualified as a termination by Mattel without cause under the Severance Plan" was inexplicable. In addition to addressing Andersen’s substantive claims, the Refusal Letter provided several other reasons why the board refused the demand. The Refusal Letter, like the refusal letter in Friedman, cited the high cost of litigation. It also explained that the board believed that this type of litigation would be an unnecessary distraction at a time when senior management was attempting to turn around the company's performance and could have an adverse impact on executive recruitment and retention. Andersen thus failed to allege that the Mattel board improperly refused demand in this case