Pleading Standards and the Test for Independent Directors under Delaware Law

In discussing the approach used by Delaware courts to address independence, let’s look at the pleading standards. Most independence cases arise in the context of demand excusal. If a majority of the board is independent, demand will generally be excused under Aronson. The issue of demand excusal comes up on motions to dismiss, before any discovery has occurred. Plaintiffs, therefore, are left with whatever information can be found in the public domain.

Delaware courts claim that they assume all facts in the complaint are true and that they draw all reasonable inferences in favor of the plaintiff. After uttering these paeans to fairness, however, they typically turn to the particularity requirement under Chancery Court Rule 23.1   Plaintiffs must present facts that show a "reasonable doubt" about a director's independence and must do so with particularly. 

In examining the cases, it is clear that the higher pleading standards are merged with a gloss that reflects judicial antagonism towards derivative suits. See Brehm v. Eisner, 746 A.2d244, 254-255 (Del. 2000)(higher standards are necessary to prevent shareholder from causing “the corporation to expend money and resources in discovery and trial in the stockholder's quixotic pursuit of a purported corporate claim based solely on conclusions, opinions or speculation.”). As a result, the courts articulate a variety of rules that permit quick dismissal, without allowing for the use of discovery to truly determine whether the director in fact lacks independence. 

The pleading requirements are “stringent.” Vague or conclusory allegations won’t be enough. Allegations must be sufficient to overcome a “director’s presumption of independence.”  Add in that the the courts have added a whole host of obligations that make adducing the necessary facts all but impossible. So, for example, independence can be lost by a material financial relationship with the company. But because materiality is subjective, it’s not enough to show the amount of income. Plaintiffs must also present facts showing the materiality of the income to a particular director, something that, without discovery, is often impossible.

This approach allows Delaware courts to routinely dismiss derivative suits, even where there is considerable information suggesting a lack of independence on the part of the board of directors. For more on this subject, go here.  Tomorrow we will  look at some specific examples where the courts have used the pleading standards as an excuse to dismiss derivative suits despite evidence that directors lacked independence.