A recent Delaware Chancery Court decision dismissing derivative fiduciary duty claims has significance for public companies with board members who are associated with venture capital firms. The decision affirms the principle that such directors are entitled to the presumption of independence, even where stockholder plaintiffs attempt to assail the directors on the theory that the VC firms have historical ties to a company founder (who was interested in the challenged transaction), have profited as a result, or would not act objectively for fear of being “deprived of future opportunities” to invest in companies associated with that founder.

The Delaware Chancery Court Decision In Greater Pennsylvania Carpenters’ Pension Fund v. Giancarlo, et al., C.A. No. 9833-VCP

In a September 1, 2015 transcript ruling, Vice Chancellor Donald F. Parsons of the Delaware Chancery Court dismissed derivative claims asserted against the directors of Imperva, Inc. (“Imperva” or the “Company”) arising from its 2014 acquisition of an Israeli start-up company, Skyfence Networks Ltd. (“Skyfence”), for a mix of cash and stock worth approximately $60 million. Imperva’s co-founder, Chairman and then-Chief Executive Officer owned approximately 43% of Skyfence at the time of the acquisition. Although the CEO was recused entirely from the consideration of the transaction and approval process, plaintiff brought suit, claiming that the transaction approved by the Company’s disinterested directors was “unfair” to Imperva and violated the directors’ fiduciary duties. The central claim was that Imperva had “overpaid” for a start-up that had yet to generate revenues.

In an effort to establish its standing to bring derivative claims under the Delaware Supreme Court’s standard articulated in Aronson v. Lewis, 473 A.2d 805 (Del. 1984), plaintiff needed to show that a majority of the board lacked independence from the CEO, or that the transaction was not otherwise a valid exercise of business judgment. Plaintiff assailed the independence of four of the Company’s directors, three of whom are associated with venture capital firms and one of whom is alleged to be a “prominent angel investor” and a former partner in one of the VC firms. Plaintiff’s primary contentions were that:

  1. the Company’s CEO was a well-known and highly regarded data security guru who had been the founder or early investor in several enormously successful companies, including Imperva, which had gone public and now have substantial market value or were sold at substantial profits;
  2. the VC firms had profited by virtue of their investments in Imperva and a number of these other companies, and one VC firm and the CEO were active investors in the Israeli start-up community;
  3. certain of the VC firms had made complimentary statements about the CEO, including his insights into data security and his ability to find a “diamond in the rough,” or had included flattering statements by the CEO on the VC firm websites (referring, for example, to the VC director as a “go to” investor for data security); and
  4. the directors would be “eager” to invest in future start-ups formed by the CEO (which plaintiff alleged could be his “next multi-billion dollar start-up”), and would therefore be unwilling to take actions that would “deprive” them of the opportunity to invest in any such companies.

The Court rejected these allegations, finding that they were either unsupported by particularized facts or insufficient as a matter of law to create a reasonable inference that the directors lacked independence. The Court noted the absence of facts establishing the materiality of these putative relationships to the venture capital firms themselves, much less to the challenged directors, who individually owned approximately $12 million of Imperva equity at the time of the Skyfence transaction, thus aligning their interests with those of the Company’s stockholders. The Court further noted that the CEO’s history of forming or investing in highly successful data security start-ups, if anything, supported the acquisition, and that the directors had substantial expertise analyzing start-up companies in the data security industry and otherwise. The Court also found that other alleged entanglements, including serving on an advisory board or being co-investors in other companies, were insufficient.  As a result, the Court found that the directors were not beholden to the CEO, and would not be more willing to risk their reputations than their relationship with the CEO as was needed to show a lack of independence. 

With respect to the exercise of business judgment, the Court found that plaintiff had failed to allege bad faith or even gross negligence by the directors. The board or its acquisitions committee had met nine times over an eight month period to evaluate the transaction and alternatives, and understood the strategic benefit of the acquisition to the Company. While plaintiff had complained that the directors had relied on management to evaluate alternatives and to negotiate a non-binding term sheet, the Court found that the board was adequately informed and exercised appropriate oversight, and that the management team was sufficiently independent and reported to the board (and not the CEO) in this process. The Court also held that the board’s receipt of a fairness opinion from a financial advisor that had co-managed the Company’s initial public offering was appropriate (and that engagement of a financial advisor was not even necessary in this context), and that plaintiff’s criticisms of the advisor’s work or the “aggressive” projections on which it relied did not give rise to a claim of bad faith against the board.