McElrath v. KalanickMcElrath v. Kalanick
Submitted: October 30, 2019
Decided: January 13, 2020
Before SEITZ, Chief Justice; VALIHURA, and TRAYNOR, Justices.
Upon appeal from the Court of Chancery. AFFIRMED.
Michael J. Barry, Esq. (argued), John C. Kairis, Esq., Kimberly A. Evans, Esq., GRANT & EISENHOFER P.A., Wilmington, Delaware; Jeffrey Reeves, Esq., Atlanta, Georgia; Attorneys for Plaintiff-Appellant Lenza H. McElrath, III, derivatively on behalf of Uber Technologies, Inc.
R. Judson Scaggs, Jr., Esq., Susan W. Waesco, Esq., Sabrina M. Hendershot, Esq., MORRIS, NICHOLS, ARSHT & TUNNELL LLP, Wilmington, Delaware; Susan S. Muck, Esq., Kevin P. Muck, Esq., Marie C. Bafus, Esq., FENWICK & WEST LLP, San Francisco, California; Attorneys for Defendants-Appellees Garrett Camp, Ryan Graves, Arianna Huffington, Yasir Al-Rumayyan, William Gurley and David Bonderman.
Donald J. Wolfe, Jr., Esq., T. Brad Davey, Esq., J. Matthew Belger, Esq., Jacob R. Kirkham, Esq., POTTER ANDERSON & CORROON LLP, Wilmington, Delaware; Joseph G. Petrosinelli, Esq., Kenneth J. Brown, Esq., WILLIAMS & CONNOLLY LLP, Washington, D.C.; Attorneys for Defendant-Appellee Travis Kalanick.
A. Thompson Bayliss, Esq., Michael A. Barlow, Esq., ABRAMS & BAYLISS LLP, Wilmington, Delaware; Mark Gimbel, Esq. (argued), C. William Phillips, Esq., COVINGTON & BURLING, LLP, New York, New York; Bryant Pulsipher, Esq., COVINGTON & BURLING, LLP, San Francisco, California; Attorneys for Nominal Defendant-Appellee Uber Technologies, Inc.
In 2016, Uber Technologies, Inc. acquired Ottomotto LLC to gain more traction in the autonomous vehicle space. The acquisition was high risk from the start. Although Uber ostensibly bought a company, and paid only $100,000 up front, it hired key employees from Google‘s more mature autonomous vehicle program. Uber took some steps to ensure the former Google employees did not misuse Google‘s confidential information, but the transaction ended in embarrassment. Uber fired its key hire from Google after it came to light Google‘s proprietary information had been misused. It also ended up settling Google‘s misappropriation claims by issuing additional Uber stock to Google valued at $245 million.
The plaintiff, an Uber stockholder and former Uber employee, filed suit in the Court of Chancery against the directors who approved the Otto acquisition. The plaintiff claimed that the directors ignored the alleged theft of Google‘s intellectual property and failed to investigate pre-closing diligence that would have revealed problems with the transaction. According to the plaintiff, the board should not have relied on the CEO‘s representations that the transaction had the necessary protections because he and Uber had a history of misusing the intellectual property of others.
The defendants responded by moving to dismiss the complaint under
Court
By any reasonable measure, the Uber board of directors approved a flawed transaction. But we, like the Court of Chancery, do not decide the merits of the claims at this stage of the proceedings. Instead, we consider the gating issue of the demand requirement in a derivative action. Under Delaware law, the board of directors manage the business and affairs of the corporation. That responsibility normally includes deciding whether to bring litigation on the corporation‘s behalf. When the board is disabled from making the decision, however—whether because of interestedness or lacking independence from those who are interested—a stockholder can control the litigation decision.
We find, as did the Court of Chancery, that a majority of the board was disinterested because it had no real threat of personal liability due to Uber‘s exculpatory charter provision. And a majority of the board was also independent of the one interested director. Thus, the board, and not the plaintiff, controlled the decision whether to bring litigation on Uber‘s behalf, which meant the plaintiff had to make a demand on the board that Uber bring the litigation. He did not. The Court of Chancery‘s judgment dismissing the complaint with prejudice is affirmed.
I.
According to the allegations of the complaint, Uber operates a leading “ride share” mobile application.1 In 2015, Travis Kalanick, Uber‘s founder, feared Uber was falling behind in the race to develop an autonomous vehicle—an “existential” threat to the company.2 To regain lost ground, in June 2015 Uber recruited Anthony Levandowski, then the Engineering Manager of Google‘s autonomous vehicle project, to leave Google and join Uber.3 Kalanick communicated extensively with Levandowski. They developed an “extremely close” relationship.4
On January 15, 2016, Levandowski founded Otto while still employed by Google.5 At the end of January, Levandowski left Google and hired over a dozen former Google employees at Otto. Weeks later, Uber and Otto signed a term sheet for Uber to acquire Otto.6 According to the plaintiff, Otto had no real operations and
was run from Levandowski‘s house.7 Kalanick testified in another proceeding that
After signing the term sheet, Uber and its outside counsel hired Stroz Friedberg, LLC, a computer forensic investigation firm, to conduct an independent investigation into whether Otto employees took with them Google‘s proprietary information or might breach non-solicitation, non-compete, or fiduciary obligations if they moved from Google to Otto.9 The board was aware that Stroz had been hired to conduct an investigation.10
In early April, Stroz delivered its preliminary report to Uber‘s outside counsel, Uber‘s general counsel, and Otto‘s counsel. The complaint contained little detail about the contents of the report, except a finding that some Otto employees “possessed substantial files containing confidential and proprietary Google information, and surreptitiously tried to delete more on the eve of the Stroz interviews.”11 Uber‘s general counsel knew of the preliminary findings by April 10, 2016, and, as alleged, expressed “serious reservations” to Kalanick about the Otto acquisition, but did not otherwise inform the board.12
On April 11, 2016, the board—then composed of Kalanick, Garrett Camp, Ryan Graves, William Gurley, and David Bonderman—met to approve the acquisition. When Kalanick presented the transaction to the board, according to the plaintiff, Kalanick “failed to present the preliminary findings of the Stroz investigators.”13 Also, as alleged, none of the other directors asked to see the report.14 Otherwise, the record reflects that diligence was discussed and represented to be “okay.”15
The board also discussed what the plaintiff characterizes as atypical indemnification provisions of the merger agreement that “were clearly explained in the presentations to the [b]oard regarding the transaction.”16 Otto would not indemnify Uber post-closing for Otto‘s breaches of representations and warranties.17 Also, certain Otto employees, including Levandowski, would have limited indemnification rights for pre-signing misconduct disclosed during the Stroz
investigation, but not for undisclosed pre-signing or any post-signing misconduct.18 After discussion, the board approved the transaction.
On August 5, 2016, Stroz delivered its final report, which described how some
The board—having added Arianna Huffington and Yasir Al-Rumayyan—met before closing the transaction. The directors discussed the risk of Google suing, the critical nature of the diligence, and the details of the indemnification provision.21
The plaintiff alleges they did not, however, specifically read or inquire about the Stroz report.22
After the transaction closed, in December 2016, Google mistakenly received an email intended for Uber from one of its vendors. The email contained drawings of a circuit board for autonomous vehicle technology that allegedly resembled Google‘s internal engineering drawings. Google sued Uber and Otto in February 2017 for misappropriation of proprietary information. Uber eventually settled the lawsuit by issuing additional Uber stock to Google valued at $245 million.23 Uber also terminated Levandowski‘s employment.24
After Uber announced the settlement, the plaintiff filed this derivative suit against the directors who decided to proceed with the Otto transaction, the directors who decided to close the transaction, and two Uber officers.25 According to the plaintiff, making a demand on the Uber board before filing suit was futile because a majority of the Uber directors at the time he filed his complaint—Kalanick, Graves, Camp, Huffington, Al-Rumayyan, Matt Cohler, David Trujillo, Ursula Burns, and John Thain—were interested or not independent of those who were interested.26
Uber and the individual defendants moved to dismiss for failure to make a demand under
II.
We review de novo the Court of Chancery‘s decision to dismiss the complaint.27 At this stage, we must accept as true any “particularized allegations of fact.”28 And while we must draw all reasonable inferences in the plaintiff‘s favor, we do not draw unreasonable inferences.29 Under
A.
Under Delaware law, the board of directors manages the business and affairs of the corporation, which includes deciding whether the corporation should pursue litigation against others.31 To protect the directors’ managerial authority, a stockholder must comply with
A stockholder can bypass the demand requirement if he “can allege with sufficient particularity that demand is futile and should be excused due to a disabling
conflict by a majority of the directors to consider the demand.”36 The demand futility test is highly dependent on the particularity of the facts alleged in the complaint.37 When a majority of directors at the time of the challenged conduct have been replaced, the demand futility test articulated
First, the court must consider whether any directors were interested. A director is interested if, in this instance, she would face a substantial likelihood of personal liability for the conduct alleged in the complaint.41 Second, if any directors were interested, the court considers whether any other directors were not
independent of an interested director. Independence turns on whether “the director‘s ability to act impartially on a matter important to the interested party can be doubted because that director may feel either subject to the interested party‘s dominion or beholden to that interested party.”42 After tallying the results, if a majority of the board in place when the complaint was filed was disinterested and independent, the stockholder must first make a demand on the board before pursuing litigation on the corporation‘s behalf.
B.
Examining first the Uber directors the plaintiff alleges were interested because of the substantial likelihood of personal liability for wrongdoing, Uber‘s Certificate of Incorporation exculpates its directors from monetary liability for fiduciary duty breaches to the fullest extent permitted by the Delaware General Corporation Law.43 Given this protection from due care violations, the plaintiff must plead with particularity that the directors “acted with scienter, meaning ‘they had actual or constructive knowledge that their conduct was legally improper.‘”44 In other words, directors are liable for “subjective bad faith” when their conduct is motivated “by an actual intent to do harm,” or when there is an “intentional dereliction of duty, a
conscious disregard for one‘s responsibilities.”45 Pleading bad faith is a difficult task and requires “that a director acted inconsistent with his fiduciary duties and, most importantly, that the director knew
Of the eleven directors on the board when the plaintiff filed his complaint, the plaintiff alleges that five were interested because they faced a substantial likelihood of liability for approving and closing the deal—Kalanick, Camp, Graves, Huffington, and Al-Rumayyan.48 While the defendants claim they dispute the Court of Chancery‘s finding that Kalanick was interested,49 they make no serious argument
on appeal to challenge the finding. Thus, we start from the Court of Chancery‘s finding that Kalanick was interested and unable to fairly consider a demand.50
The plaintiff challenges the Court of Chancery‘s finding that the directors did not act in bad faith when approving the Otto transaction.51 First, the plaintiff argues that, because Kalanick as CEO was the one who brought the transaction to the board and was involved with diligence, the directors should have been wise enough not to rely on someone with a reputation as a law breaker. In support, the plaintiff points to one of Kalanick‘s prior businesses, Scour, which offered music and film releases. Scour was eventually shut down for copyright violations and sued for $250 billion. Further, the plaintiff alleges that Uber had a practice of hiring employees from competitors to steal trade secrets and a general practice of ignoring and violating regulations.52 When these allegations are combined, the plaintiff argues that the board was on notice that Kalanick might be ignoring intellectual property laws in the Otto acquisition.
Second, the plaintiff argues that the allegedly unusual indemnification clauses in the merger agreement put the board on
We agree, however, with the Court of Chancery that the plaintiff did not meet his particularized burden of alleging that the board in place when the plaintiff filed his complaint, besides Kalanick, acted in bad faith. As noted before, a showing of bad faith in the context of demand excusal is a high hurdle, and essentially requires the plaintiff to demonstrate intentional wrongdoing by the board. The complaint alleges, however, that Uber‘s directors heard a presentation that summarized the
transaction, reviewed the risk of litigation with Google, generally discussed due diligence, asked questions, and participated in a discussion.54 The inference from these allegations shows a functioning board that did more than rubberstamp the transaction presented by Uber‘s CEO.
Further, Kalanick might have a background that would lead a reasonable board member to dig deeper into representations he made about the transaction. But, as the Court of Chancery found, there were no allegations that Kalanick had a history of lying to the board.55 And the record supports the conclusion that the diligence presented to the board was, in fact, “okay.”56 The complaint‘s allegations do not lead to a reasonable inference that the board intentionally ignored the risks of the transaction.57 On the contrary, it appears that the directors considered the risks and nonetheless proceeded with the transaction. As we have noted before, “there is a vast difference between an inadequate or flawed effort to carry out fiduciary duties and a conscious disregard for those duties.”58 It is not enough to allege that the
directors should have been better informed—a due care violation exculpated by the corporation‘s charter provision.59
Turning to the indemnification provisions, while unusual, those provisions were “clearly explained to the board” and did
The plaintiff attempts to analogize the allegations here to In re Walt Disney Co. Derivative Litigation, where the Court of Chancery found that “the facts alleged . . . suggest that the defendant directors consciously and intentionally disregarded their responsibilities . . .” and the plaintiff sufficiently pleaded bad faith.62 In Disney,
the board approved a high profile hiring decision before the details were negotiated and assigned the responsibility to the CEO to negotiate the employment contract with the new hire who was his friend of many years.63 The court explained:
Less than one and one-half pages of the fifteen pages of Old Board minutes were devoted to discussions of Ovitz‘s hiring as Disney‘s new president. . . . No presentations were made to the Old Board regarding the terms of the draft agreement. No questions were raised, at least so far as the minutes reflect. At the end of the meeting, the Old Board authorized Ovitz‘s hiring as Disney‘s president. No further review or approval of the employment agreement occurred. Throughout both meetings, no expert consultant was present to advise the compensation committee or the Old Board. Notably, the Old Board approved Ovitz‘s hiring even though the employment agreement was still a “work in progress.” The Old Board simply passed off the details to Ovitz and his good friend, Eisner.64
Here, like the Court of Chancery, we find the Disney allegations different. Unlike Disney, where the directors devoted very little time, had no presentations, and asked no questions, the Uber board met to consider the Otto acquisition. Outside counsel and an investigative firm assisted with due diligence. Kalanick made a presentation, and the board discussed the terms of the deal and its risks. Although there might have been reason to dig deeper into Kalanick‘s representations about the transaction, the board‘s failure to investigate further cannot be characterized fairly as an “intentional dereliction” of its responsibilities.
The plaintiff also argues that the directors who decided to close the deal acted in bad faith because they should have reviewed the final Stroz report before allowing the transaction to close. Besides relying on the same argument that approving the transaction was done in bad faith, the plaintiff argues only that the final Stroz report showed that Uber could have terminated the deal because Otto breached a representation.65 But the plaintiff did not
C.
Having found only one interested director, Kalanick, we turn to the allegations that a majority of directors were not independent of Kalanick. Because Uber‘s board consisted of eleven directors when the plaintiff filed his complaint, dismissal depends on whether we find that at least six directors were independent of Kalanick. The plaintiff does not challenge the independence of three directors—Martello, Khosrowshahi, and Al-Rumayyan. And he does not challenge Cohler‘s or Trujillo‘s independence from Kalanick.68 Thus, if one additional director was independent of Kalanick, the plaintiff failed to plead demand futility.
A director‘s independence turns on “whether the plaintiffs have [pleaded] facts from which the director‘s ability to act impartially on a matter important to the interested party can be doubted because that director may feel either subject to the interested party‘s dominion or beholden to that interested party.”69 We must consider the full context of “all the [pleaded] facts regarding a director‘s relationship to the interested party,”70 and decide whether the relationship is “of a bias-producing nature.”71 Importantly, being nominated or elected by a director who controls the
outcome is insufficient by itself to reasonably doubt a director‘s independence because “[t]hat is the usual way a person becomes a corporate director.”72
The plaintiff challenged Thain‘s independence because Kalanick appointed Thain “during a power struggle within Uber” after the board ousted Kalanick as CEO and an investor had sued Kalanick for
We agree with those determinations. The plaintiff challenged Thain‘s independence, in part, because Kalanick had the ability to appoint and remove him. Otherwise, the plaintiff relied only on the circumstances surrounding Thain‘s appointment and the allegation that Kalanick sought to use Thain as a means of retaining control. But appointment to the board is an insufficient basis for challenging Thain‘s independence.75 And the context of Thain‘s appointment—that
Kalanick appointed him in a power struggle and that Thain might be loyal to him—without more does not allow a reasonable inference that Thain and Kalanick‘s relationship was of a “bias-producing nature.”76 Otherwise, a director would be automatically disqualified if appointed during a board conflict. We agree with the Court of Chancery that Thain was independent of Kalanick.77
III.
We stop here because we find that six directors—a majority of the board at the time the plaintiff filed the complaint—were disinterested and independent. Thus, the plaintiff was required to demand that the board pursue the claim. Because the plaintiff did not make a demand before filing suit, we affirm the Court of Chancery‘s decision to dismiss the complaint.