Chancery Court Dismisses Uber Derivative Suit for Failure to Make Demand or Plead Demand Futility
In McElrath v. Kalanick, C.A. No. 2017-0888-SG (Ch. Del. April 1, 2019), the Delaware Court of Chancery (the “Court”) dismissed a derivative suit brought by a stockholder of Uber Technologies, Inc. (“Uber”) for damages arising from its acquisition of Ottomotto, LLC (“Otto”), an autonomous vehicle technology company. Plaintiff did not make demand on the defendant board of directors of Uber (the “Board”) for action prior to pursuing litigation. The Court dismissed the derivative suit finding that a majority of the Board that would have evaluated a demand was disinterested and independent, and therefore, had plaintiff made demand of the Board, such a demand would not have been futile.
This case arose from Uber’s acquisition of Otto in 2016, Alphabet Inc. (“Alphabet”) sued Uber after the acquisition of Otto, alleging that an Otto employee had stolen trade secrets from Alphabet’s subsidiary Google, Inc. (“Google”). Uber settled with Alphabet for an equity payout of roughly $245 million. Uber had acquired Otto at the recommendation of then-CEO Travis Kalanick (“Kalanick”), and the acquisition was approved by the Board—but without the Board reading the final report of the investigation that outlined risks associated with the deal (the “Stroz report”). Following the settlement with Alphabet, plaintiff filed suit on behalf of Uber against Kalanick and Uber’s directors, alleging that the Board was derelict in its fiduciary duties because the Board did not adequately evaluate the intellectual property risks of the Otto acquisition.
Plaintiff alleged that that the Board acted in bad faith because the directors had a fiduciary duty to rely on more than Kalanick’s recommendation, and therefore each of the directors faced potential liability. Plaintiff argued that the Board should not have listened to Kalanick, whom he characterized as a “scofflaw,” and ought to have been skeptical of Kalanick’s promotion of the Otto merger. The Court found that while plaintiff had pled facts sufficiently indicating that Kalanick faced a substantial likelihood of liability, plaintiff had failed to sufficiently plead bad faith by the other directors on the Board. While the other directors did not ask about the findings in the Stroz report, the Court found that such an oversight indicates (at most) a lack of care or failure to follow best practices, and not bad faith or a breach of fiduciary duty.
The Court also found that seven of Kalanick’s ten fellow directors on the board were independent from him or any other individual that had a substantial likelihood of personal liability. Plaintiff had the burden of demonstrating that a majority of the board lacked independence. Although plaintiff alleged that six of the eleven Board members (including Kalanick) lacked the requisite independence, the Court disagreed, and only found three directors that could lack independence: John Thain, Ursula Burns, and Arianna Huffington. Even if these three directors did lack independence, a majority of the Board was sufficiently impartial that plaintiff needed to make a demand on them prior to initiating litigation under Rule 23.1.
Applying the test for demand futility set forth in Rales v. Blasband 634 A.2d 927, 933–34 (Del. 1993), the Court evaluated each of the individual Board directors to determine whether Rule 23.1 applied. The Court found that none of the directors (other than Kalanick) had a substantial likelihood of facing liability for the alleged breach of fiduciary duty, and that only a minority of them could be associated with the one who did face such liability. Therefore, because the Board was capable of considering a demand by plaintiff and would have had the ability to exercise business judgment concerning the matter. Because plaintiff failed to make such a demand, the Court dismissed the suit.