Demand Futility Allegations Fail to Overcome High Bar Where Outside Directors are Insulated from Monetary Liability

On April 13, 2020, Justice Scarpulla of the New York County Commercial Division issued a decision in Barrientos v. Salmirs, 2020 NY Slip Op. 30933(U), holding that a shareholder's demand futility allegations failed to overcome the high bar that exists where outside directors are insulated from monetary liability, explaining:

Further, the Board Members are insulated from monetary liability for breach of the fiduciary duty claims by an exculpation provision in ABM's restated certificate of incorporation. Under Delaware law, to survive a motion to dismiss on demand futility grounds made by an independent director protected by an exculpation clause, the plaintiff must plead facts supporting a rational inference that 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.

Plaintiffs generically claim that the Board advanced their own self-interest above that of the ABM shareholders because they paid themselves lavishly. Plaintiffs however, have failed adequately to state specific facts showing that the Board members' alleged lavish compensation caused them to fail properly to oversee ABM's cybersecurity. Moreover, Plaintiffs do not allege that any of the Individual Defendants personally profited from the Board's alleged failure to oversee ABM's cybersecurity.

Plaintiffs have also failed to plead facts sufficient to show that the Board Members acted with bad faith. The allegations in the amended verified complaint concerning alleged bad faith deal mostly with the Board's alleged failure adequately and correctly to disclose the data breaches to the shareholders and in public filings. Plaintiffs, however, do not plead any underlying facts showing that the Board took any specific action to misreport or underreport the data breaches. Instead, Plaintiffs broadly allege that ABM's public statements and disclosures were insufficient or too general, and therefore false and misleading. Plaintiffs' broad allegations concerning inadequate disclosure are not adequately pled with the specificity demanded by Chancery Rule 23.1.

Likewise, Plaintiffs' allegation that the Board, in bad faith, caused ABM to violate federal securities regulations on disclosure, as well as state privacy laws, are impermissibly broad. While Plaintiffs allege that Board Members willfully violated the data breach notification laws of several states, they do not make any particularized allegations as to what type of violation occurred, or as to which Board Member caused the alleged violations. The same impermissible generality affects Plaintiffs' allegations of violations of federal security regulations. Plaintiffs provide no particularized facts to support the assertion that a security law violation even occurred, let alone which Board Member acted to cause the violation.

At bottom, Plaintiffs lack standing to prosecute the amended verified complaint because they have not made the requisite demand on ABM's Board and have failed adequately to allege the futility of demand on the Board.

(Internal quotations and citations omitted).

This decision illustrates one of the special pleading requirements for derivative actions (where a shareholder brings an action on behalf of a corporation): alleging that it would be futile to demand that the board take action. Contact Schlam Stone & Dolan partner John Lundin at jlundin@schlamstone.com if you or a client have questions regarding bringing an action on behalf of a corporation or other business entity.