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In re China Agritech, Inc. - No. 7163-VCL, 2013 Del. Ch. LEXIS 132 (Ch. May 21, 2013)

Rule:

A two-part reasonable doubt test applies when a derivative plaintiff challenges an earlier board decision made by the same directors who remain in office at the time suit is filed. The court must decide whether, under the particularized facts alleged, a reasonable doubt is created that: (1) the directors are disinterested and independent; and (2) the challenged transaction was otherwise the product of a valid exercise of business judgment. The first of the two inquiries examines the independence and disinterestedness of the directors with respect to the decision that the derivative action would challenge. Certainly, if this is an interested director transaction, such that the business judgment rule is inapplicable to the board majority approving the transaction, then the inquiry ceases. If the underlying transaction was approved by a disinterested and independent board majority, then the court moves to the second inquiry: whether the plaintiff has alleged facts with particularity which, if taken as true, support a reasonable doubt that the challenged transaction was the product of a valid exercise of business judgment. A plaintiff might allege sufficiently, for example, that the directors were grossly negligent in approving the transaction.

Facts:

Plaintiff stockholder filed a stockholder derivative complaint against nominal defendant corporation and defendants, the cofounders and directors of the corporation. The cofounders filed a motion to dismiss pursuant to Del. Ch. Ct. R. 23.1, for failure to plead that demand was made on the corporate board of directors or would have been futile, and Del. Ch. Ct. R. 12(b)(6), for failure to state a claim. Alternatively, they filed a motion to stay. The stockholder conceded that he did not make a litigation demand on the demand board of the corporation's directors and that the corporation opposed his efforts to pursue litigation. The fundamental question presented by the Del. Ch. Ct. R. 23.1 motion was whether the demand board could have validly considered a litigation demand. 

Issue:

Did the complaint fail to plead that demand was made on the board?

Answer:

No

Conclusion:

The court noted that the complaint challenged at least three events that involved actual decisions: a corporate transaction, the terminations of outside auditors, and a special committee's determination to take no action. Five of the seven members of the demand board were directors at the time those decisions were made. The litigation also alleged a systematic lack of oversight at the corporation. Therefore, the stockholder was excused from making a demand because the directors were not disinterested. In addition, the complaint stated a claim against the directors for purposes of Del. Ch. Ct. R. 12(b)(6). The directors also could not, under Del. Code Ann. tit. 8, § 102(b)(7) invoke the exculpatory provision in the corporation's certificate of incorporation as a defense. Finally, proceeding with the litigation was appropriate.

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