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Class Action Dismissed as Demand was Not Excused as Futile; Plaintiff Failed to Allege Facts Sufficient to Establish that a Majority of the Board Faced Substantial Likelihood of Liability for Non-Exculpated Claims

In Lenois, et al. v. Lawal, et al., and Erin Energy Corporation, C.A. No. 11963-VCMR (Del. Ch. November 7, 2017), plaintiff Robert Lenois (“Plaintiff”) on behalf of himself and other stockholders brought a class action for breach of fiduciary duty against controllers and the board of directors of Erin Energy Corporation (“Erin”) for approving what was claimed to be an unfair transaction. The Delaware Court of Chancery dismissed the class action suit under Court of Chancery Rule 23.1, holding that the directors were protected by an exculpatory charter, and Plaintiff failed to meet the heightened pleading standard for demand futility set by the second prong of Aronson v. Lewis, 473 A.2d 805 (Del. 1984). Although Plaintiff pled with particularity that one director acted in bad faith, the complaint did not allege facts sufficient to establish that a majority of the board faced a substantial likelihood of liability for non-exculpated claims.

This case arises out of transactions between an oil and gas exploration company Erin Energy Corporation (“Erin”), a Delaware corporation. Plaintiff was a stockholder of Erin. Defendant Lawal was Erin’s Chairman and Chief Executive Officer. Lawal and CAMAC Energy Holdings Limited (“CEHL”), a holding company controlled by Lawal and his family, were Erin’s controlling stockholders. The other defendant directors were members of Erin’s board.

In the contested transaction, Public Investment Corporation Limited (“PIC”), a third-party entity, invested in Erin in exchange for Erin stock. Erin then transferred to a different Lawal-affiliated company, Allied Energy Plc (“Allied”), the majority of PIC’s cash investment, Erin stock, and other consideration in exchange for select Allied oil mining rights (the “Transactions”). The other Erin stockholders received additional shares.  Plaintiff brought a derivative class action alleging breach of fiduciary duty claims against Lawal, CEHL, and the board of directors for approving the allegedly unfair Transactions. Before filing suit, Plaintiff did not make a demand on the board under Court of Chancery Rule 23.1. Instead, Plaintiff contended that demand was futile under the second prong of Aronson because Lawal acted in bad faith, or in the alternative, because the board was inadequately informed and breached its duty of care. In the complaint, Plaintiff claimed that Erin allegedly overpaid by between $86.2 million and $198.8 million for Allied’s assets. In addition, Lawal not only initiated the transaction process and acted as Erin’s sole negotiator with PIC, but also acted as Allied’s sole negotiator with Erin as a counterparty. Lawal was a controller of both Erin and Allied at the time through CEHL, which had 100% ownership of Allied and 58.85% ownership of Erin before the Transactions. Plaintiff also asserted direct action for breach of fiduciary duties against the board and Lawal separately, arguing that Lawal aided and abetted the board’s breach of the duty of disclosure through disclosure violations in the transaction proxy.

The defendants agreed that the case fell under the second prong of Aronson. The defendants countered, however, that the Rule 23.1 demand requirement was not excused for futility merely because Lawal was an interested controller at the time the Transactions were approved. The defendants argued that a showing of demand futility requires a holistic assessment of the board’s culpability in light of the exculpatory provision in Erin’s charter. The defendants contended that Plaintiff failed to plead non-exculpated claims concerning a majority of the board, offering instead only non-exculpatory claims against a single director—Lawal. The defendants also moved to dismiss the direct disclosure claims under Court of Chancery Rule 12(b)(6), arguing that the alleged disclosure claims damaged the Company, not the stockholders.

The Court granted the defendants’ motion to dismiss as to both the derivate and direct breach of fiduciary duty claims. The Court reached this conclusion by first clarifying the Court of Chancery’s demand futility jurisprudence, including the Delaware Supreme Court’s decisions in both Rales v. Blasband, 634 A.2d 927 (Del. 1993) and Aronson. The Court explained that the Aronson and Rales tests are complementary versions of the same inquiry: whether the board’s capacity for impartiality was compromised by the threat of liability, more specifically, whether there was reason to doubt the directors’ ability to exercise their business judgment in responding to a demand because those directors face a substantial likelihood of personal liability from litigation. In light of this analysis, the Court held first that where an exculpatory charter provision protects the board, demand futility must be established under the Aronson second prong by pleading that a majority of directors would have faced a substantial likelihood of liability for non-exculpated claims had they considered demand. Neither breach of fiduciary duties by the board nor a self-dealing and controlling stockholder alone is sufficient to establish demand futility.

Applying this standard, the Court found that the complaint failed to plead particularized facts showing that a majority of individual directors could not consider demand impartially. Although the complaint sufficiently alleged that Lawal acted in bad faith, Plaintiff failed to raise a reason to doubt the honesty and good faith of the reaming defendant directors. The defendant directors established a special committee to push back on Lawal’s timeline, hired and relied on the expert advice of an investment banker and legal counsel, and negotiated more favorable terms for the Erin stockholders at several points. In addition, the special committee sought approval from the entire Board (excluding the controller and a conflicted director), issued a proxy statement to stockholders, and received a majority-of-the-minority stockholder approval. The Court found that these actions did not evince conscious and intentional disregard of fiduciary duty rising to the level of bad faith. Because Plaintiff failed to plead bad faith violations by a majority of the Erin board, the Court dismissed the claims for failing to meet the demand futility threshold under Rule 23.1.

The Court similarly dismissed the direct breach of fiduciary duty claims under Rule 12(b)(6). Plaintiff requested rescissory damages to be paid to the Erin stockholders for the alleged duty of disclosure violations. The Court denied the direct claim and ruled that the alleged injury and the damages belonged to Erin and not the Erin stockholders .

Robert Lenois, et al., v Kase Lukman Lawal, et al., and Erin Energy Corp…

Copyright 2017 K & L Gates

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About this Author

Annette E. Becker, Practice Area Leader, Corporate Lawyer, Securities Compliance Attorney
Practice Area Leader – Corporate & Transactional

Annette Becker has over 20 years experience practicing corporate law with an emphasis on U.S. and cross border mergers and acquisitions for emerging, middle market, and Fortune 500 companies. Ms. Becker advises her company clients and their boards as to corporate governance issues and general corporate matters. Ms. Becker’s transactional experience also includes joint ventures and other complex strategic relationships, securities offerings and securities compliance issues, strategic and venture capital investments, financing transactions, recapitalizations and...

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William Smith, KL Gates Law Firm, Venture Capital Attorney
Associate

Will Smith is an associate in the firm’s Seattle office.

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