TVI Corp. v. Gallagher, C.A. No., 7798-VCP (Del. Ch. Oct. 28, 2013) (Parsons, V.C.)

In this memorandum opinion, the Court of Chancery denied defendants’ motion to dismiss a derivative action in part and granted it in part, holding, among other things, that plaintiffs had satisfactorily alleged demand futility and had satisfactorily alleged a claim for breach of the fiduciary duty of loyalty.

Plaintiffs are shareholders of iCueTV (the “Company”).  Four plaintiffs also formerly served as directors on the Company’s board of directors (the “Board”) but were removed from their positions after raising concerns regarding certain defendants’ financial dealings with the Company.  Plaintiffs asserted this derivative action against the seven members of the Board at the time of the filing of the complaint.  Three members of the Board founded the Company:  defendants Gallagher, Huegel, and Singley (the “Founders”).  The remaining members of the Board were defendants Fernandez, Gates, Thornton, and DeBenedictis (the “Non-Founders”).  Defendant Huegel served as the Company’s President and Chief Technology Officer.  Defendant Singley served as the Company’s Chief Operating Officer and General Counsel.  Defendant Gates served as the Company’s Chief Executive Officer.

Plaintiffs alleged that the Board breached its fiduciary duties by (1) entering into wasteful employment agreements with defendants Huegel, Singley, and Gates; (2) retroactively giving preferential treatment to monetary advances Gallagher made to the Company; (3) wrongfully removing certain plaintiffs from the Company’s Board; (4) misappropriating and diverting the Company’s assets; and (5) failing to exercise proper oversight over the Company.  Plaintiffs did not make a demand on the Board prior to instituting suit.  Defendants moved to dismiss the complaint for failure to establish demand futility under Rule 23.1 and also moved to dismiss for failure to state a claim under Rule 12(b)(6).

The Court granted defendants’ motion to dismiss in part and denied it in part.  The Court first held that plaintiffs had established demand futility under Rule 23.1 as to all claims.  The Court explained that plaintiffs’ claims challenging the Board’s actions would be analyzed under Aronson v. Lewis, 473 A.2d 805 (Del. 1984) and its progeny, which require plaintiffs to demonstrate either (i) that a majority of the board is interested or lacks independence or (ii) that the challenged transactions could not be an exercise of valid business judgment.  The Court found that plaintiffs alleged that the Founders and Gallagher were interested in the challenged transactions.  The Court also found that plaintiffs had adequately pled that Gates and the remaining Non-Founders were controlled and dominated by the Founders because it was alleged that these directors feared being removed from their positions by the Founders for raising concerns regarding the Founders’ financial transactions with the Company, as the four plaintiff-directors had been.  The Court thus did not consider the Aronson analysis’s second prong.

As to plaintiffs’ Board-inaction claims, the Court explained that the relevant test was that under Rales v. Blasband, 634 A.2d 927 (Del. 1993) and its progeny, which require a plaintiff  to allege that there was a reasonable doubt that the board could have properly exercised its independent and disinterested business judgment in responding to the demand as of the time the complaint was filed.  The Court similarly found that plaintiffs alleged that the Founders and Gates were interested and that the Non-Founders lacked independence because they were dominated or controlled by the Founders for the same reasons as under the Aronson analysis.

The Court next considered whether plaintiffs’ claims were sufficiently alleged under Rule 12(b)(6).  The Court held that plaintiffs had sufficiently stated a claim for breach of the fiduciary duty of loyalty.  The Court explained that directors who are interested in a challenged transaction or who lack independence will be required to prove the entire fairness of the challenged transaction.  The Court further explained that this test is co-extensive with the first prong of the Aronson analysis.  For the reasons articulated in its demand futility analysis, the Court thus concluded that plaintiffs’ allegations sufficiently stated a claim for breach of the duty of loyalty.  The Court then held that plaintiffs had failed to satisfy the Rule 12(b)(6) standard on their remaining claims.

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