Director Independence and Demand Futility: A Holistic Inquiry of the Pleading
In In re BGC Partners, Inc. Derivative Litigation, Civil Action No. 2018-0722-AGB (Del. Ch. Sep. 30, 2019), the Delaware Court of Chancery denied motions to dismiss for (i) failure to establish demand futility and (ii) failure to state a claim for relief (the “Motions”) filed by nominal defendant BGC Partners, Inc. (“BGC”), its affiliates CF Group Management, Inc. (“CF”) and Cantor Fitzgerald L.P. (“Cantor”), Howard Lutnick, the CEO, Chairman of the Board, and controlling stockholder of BGC (“Lutnick”), and four “independent” members of the Board of Directors of BGC (the “Special Committee Defendants” and all of which, together, are the “Defendants”). In denying the Motions in this stockholder derivative litigation, the court primarily discussed and applied recent guidance from the Delaware Supreme Court on the Aronson test for demand futility. In re BGC Partners, Inc. puts controlling stockholders on notice that their professional and personal ties to board members may undermine the purported independence of those board members.
The underlying stockholder action stems from the BGC’s purchase of Berkeley Point Financial LLC (“Berkeley”) from another Cantor affiliate, Cantor Commercial Real Estate Company, L.P. (“CCRE”), for $875 million and a $100 million investment in CCRE (collectively, the “Transaction”). At all relevant times, Lutnick controlled, either directly or indirectly, BGC, Cantor, and CF. Plantiffs alleged that Lutnick held a much larger ownership interest in Cantor (60%) than in BGC (13.2%), motivating him to cause BGC to overpay for the transfer between the affiliates. Roofers 149 Pension Fund and Norther California Pipe Trades Trust Funds (the “Plaintiffs”) are stockholders of BGC, which is a publicly traded Delaware corporation under Lutnick’s control through his 100% beneficial ownership of BGC’s Class B super-voting common stock. Based on the facts described above, the Plaintiffs alleged that BGC substantially overpaid for Berkeley and that the Defendants breached their fiduciary duties in approving the Transaction.
The Special Committee Defendants comprised the special committee (the “Special Committee”) formed by BGC’s board of directors (the “Board”) to evaluate the Transaction. BGC and its subsidiary, Newmark, had been originating business for Berkeley since 2011, and Lutnick proposed acquiring Berkeley and then spinning it out with Newmark in a future IPO. When he first approached the Board, Lutnick estimated a purchase price for Berkeley in the low $700 million range. Although the Special Committee retained independent legal and financial advisors to evaluate the Transaction, it immediately authorized Lutnick–who the Committee recognized had a conflict–to negotiate the Transaction and, during the course of those negotiations, the proposed price rose to $880 million. Despite an analysis by its financial advisors concluding that Berkeley was overvalued and that the Transaction structure favored Cantor (and thus Lutnick), the Special Committee approved an $875 million price and the Transaction closed on September 8, 2017. The planned spin-out and IPO of Berkeley and Newman took place on October 23, 2017, and the IPO price implied a value of only $563 million for Berkeley on a stand-alone basis. The Plaintiffs brought the derivative suit shortly thereafter arguing that demand on the Board to bring suit on behalf of the Company would be futile.
The court analyzed demand futility under the test articulated in Aronson v. Lewis, 466 A.2d 375, 380 (Del. Ch. 1983), which is applicable when a decision made by the Board is being challenged (as opposed to when a board’s failure to make a decision is being analyzed). Under the Aronson test, the court analyzes whether the alleged facts create a reasonable doubt that (i) the directors are disinterested and independent or(ii) the challenged transaction was otherwise a product of a valid exercise of business judgment.Turning first to the second prong, Plaintiffs argued, unsuccessfully, that demand should be excused as a matter of law because the Transaction is subject to entire fairness review (stemming from Lutnick standing on both sides of the Transaction) and not the business judgment standard. The court had previously rejected this argument in Teamsters Union 25 Health Services & Insurance Plan v. Baiera, 119 A.3d 44 (Del. Ch. 2015). The court explained that Teamsters does not hold that the presence of a controller is irrelevant to the director-based focus of the demand futility inquiry but rather that the second prong of Aronson is not automatically satisfied when the challenged transaction would be subject to entire fairness review. In practice, the court stated that “the presence and influence of a controller is an important factor that should be considered in the director-based focus of the demand futility inquiry under the first prong of Aronson,” particularly on the issue of independence.
Turning to the first prong of the Aronson test, the question of “independence” turns on whether the director’s decision resulted from that director being controlled by another, which may occur through close personal and professional relationships, by sheer force of will, or where the director is beholden to a controller for a material benefit, the loss of which might create reason to question whether the controlled director is able to consider the corporate merits of the challenged transaction objectively. The court noted that the Delaware Supreme Court had recently reversed findings of director independence in the demand futility context under a general theory that “the plaintiff’s factual allegations should be considered holistically and [afford] the plaintiff all reasonable inferences.” The court analyzed the relationship of each of the Special Committee Defendants with Lutnick, including ties between spouses and family members, joint or shared charity work, and support of and affiliation with Haverford College, Lutnick’s alma mater. The court also noted that each of the Special Committee Defendants was as “go-to” member of Lutnick-affiliated boards and derived a considerable portion of their income from those boards. The court found that, when considered holistically, these relationships create a reasonable doubt as to the independence of the three Special Committee Defendants who remained on the Board at the time litigation was commenced. Thus, demand was excused as futile because a majority of the Board was then interested.
The Special Committee Defendants also sought to dismiss for failure to state a claim under Rule 12(b)(6). Since the Special Committee Defendants were protected by an exculpatory provision in BGC’s certificate of incorporation, the Court applied the test set forth in In re Cornerstone Therapeutics Inc., Shareholder Litigation, 115 A.3d 1173 (Del. 2015), which held that “a plaintiff can survive a motion to dismiss by that director defendant by pleading facts supporting a rational inference that the director harbored self-interest adverse to the stockholders’ interests, acted to advance the self-interest of an interested party from whom they could not be presumed to act independently, or acted in bad faith.” For reasons explained in its examination of the independence of the Special Committee Defendants, the court concluded that there was a rational inference that the three Special Committee Defendants who remained on the Board had acted to advance the interest of Lutnick, “an interested party from whom they could not be presumed to act independently.” The court noted that, with respect to the fourth Special Committee Defendant, the Plaintiffs had not plead sufficient facts to overcome the presumption of independence under the heightened standards of a demand futility inquiry (if he were subject to such analysis), but had met the lower standard to survive a 12(b)(6) motion set forth in In re Cornerstone.
In re BGC Partners reiterates several points from earlier Delaware cases: (i) even when the Delaware courts grant board members a presumption of independence in a demand futility analysis, the courts will take a holistic view of the relationships between directors and interested parties, (ii) the fact that a transaction is subject to an entire fairness review will not automatically satisfy the second prong of the test set forth in Aronson and hence excuse plaintiffs from making a demand on a company’s board, and (iii) the standard for analyzing director independence in a motion to dismiss for failure to state a claim is lower than that in a demand futility analysis.