Delaware law sets a very high bar that a shareholder-plaintiff must clear to bring a derivative suit on behalf of a company. But that bar is not insurmountable, as recognized by the Delaware Court of Chancery’s opinion in In re: Oracle Corporation Derivative Litigation (No. 2017-0337-SG), decided March 19, 2018.
Vice Chancellor Glasscock began by noting that “[a] court must be wary of permitting shareholders, rather than directors, to control litigation assets of the company,” as “directors are generally in the best position to determine if pursuit of litigation is in the corporate interest.” But in considering a derivative lawsuit alleging that Oracle’s $9.3 billion acquisition of NetSuite was made at an unfairly high price, the Vice Chancellor found that the plaintiff had met its burden of pleading particularized facts leading to a reasonable doubt that Oracle’s directors were able to exercise business judgment, and therefore, the court found that demand on the board was excused under Rule 23.1.
Oracle is a technology company that provides an integrated array of software applications, servers, storage and cloud technologies. Larry Ellison founded Oracle in 1977, owns 28% of its common stock, and serves as Chairman of the Board and Chief Technology Officer. NetSuite, Inc. provides internet-based management software and cloud-based services. Ellison founded NetSuite, Inc. in 1998 and owns 39.2% of its common stock.
Plaintiff alleged that Ellison’s plan was to have NetSuite provide software suites for medium sized business with no meaningful competition from larger players such as Oracle, SAP and Microsoft, and for Oracle to eventually acquire NetSuite. While initially successful, by 2015, NetSuite faced increasing competition in cloud-based software, with Oracle identified as NetSuite’s biggest competitive threat. According to plaintiff, Ellison came up with a solution for Oracle to acquire NetSuite “rather than compete NetSuite’s value away.”
Ellison instructed Oracle’s co-CEO Safra Catz to lead a discussion with the Oracle board regarding a potential acquisition of NetSuite. While Oracle had an Independence Committee of outside directors to consider such conflicted transactions, the entire board heard an oral presentation and ultimately told management to consider the acquisition. The board authorized Catz to approach NetSuite to determine if there was an indication of interest, but to refrain from discussing price.
Catz reached out to NetSuite to express Oracle’s interest, but in contravention to the board’s instruction, and allegedly at Ellison’s behind-the-scenes direction, she discussed a potential acquisition price range of $100–$125 per share (42%–78% above NetSuite’s closing stock price). At the next board meeting, Catz told the board about her discussions, but concealed her secret price discussion. The board decided to form a Special Committee of three outside directors to negotiate, approve or reject a transaction with NetSuite. Ultimately, the Special Committee and NetSuite agreed that Oracle would acquire NetSuite at the price of $109 per share.
Because Oracle’s charter exculpated its directors from monetary liability for breaches of the duty of care, plaintiff alleged that at least six of Oracle’s twelve directors faced a serious likelihood of personal liability by breaching their duty of loyalty. While plaintiff raised numerous alleged infirmities with respect to the Special Committee’s process, including its alleged failure to adequately consider alternatives to acquiring NetSuite, the $17 million contingent fee its financial advisor would earn if the transaction completed, and errors in the valuation analysis that Oracle provided the committee, “an extreme set of facts is required to sustain a disloyalty claim premised on the notion that disinterested directors were intentionally disregarding their duties,” and the court found that plaintiff failed to meet its burden of demonstrating that a majority of the Oracle board faced a substantial likelihood of liability.
On the other hand, Vice Chancellor Glasscock found that plaintiff had adequately alleged that a majority of the board lacks independence from Ellison. Although no longer the CEO, Ellison was still Oracle’s largest shareholder and plaintiff alleged that he still “called all the shots.” Ellison was described by former Oracle executives as a “spiritual guru, and Oracle is like a cult.” Ellison had no successor or heir apparent, and the board never discussed succession. Upon appointment as one of Oracle’s new co-CEOs, Catz made clear on an earnings call that there “will actually be no changes. Okay? Not no significant changes. I just want to clarify. No changes whatsoever.” Catz herself explained that she “came in with absolutely no agenda other than to help Larry” and that “if Larry left—is it in one of his fancy cars? —I would be in the passenger seat.”
Plaintiff noted that Ellison had a history of removing directors and officers who disagreed with him, and of awarding himself “massive overcompensation” despite stockholder’s rejection of five straight say-on-pay votes. Although a majority of Oracle’s shareholders had repeatedly withheld support for members of Oracle’s Compensation Committee, the only reason they were not forced to resign from Oracle’s board was Ellison’s continuing support.
Given Ellison’s conflict of interest and his control, the court readily found that plaintiff had created a reasonable doubt that Ellison and the other three inside directors could exercise independent business judgment on whether to pursue a lawsuit against Ellison. As for the outside directors, the court found the following directors also lacked independence:
George Conrades lacked independence because he (i) was one of the directors who served on Oracle’s Compensation Committee and thus served at Ellison’s pleasure given the withholding of support by a majority of non-Ellison shareholders, (ii) is affiliated with two venture capital firms that operate in areas dominated by Oracle, (iii) has an important role at a company whose Chief Technology Officer serves at Oracle’s pleasure, and (iv) has high level positions at another company that does substantial business with Oracle. “[T]he combined effect of Conrades’s business ties and the threat of losing his directorship is to create reasonable doubt that he could impartially consider whether to sue Ellison.”
Renée James lacked independence because she (i) sits on the boards of two companies that have significant business relationships with Oracle, (ii) openly desires to serve as the head of another large technology company (after serving as President of Intel), which “career ambitions would weigh heavily on her if she were asked to consider suing Ellison,” (iii) received nearly $550,000 in board compensation, which alone is insufficient but “alongside the other allegations bearing on James independence . . . , create reasonable doubt about James’s ability to objectively consider a demand.”
Naomi Seligman lacked independence because she (i) served on Oracle’s Compensation Committee and served at Ellison’s pleasure given the withholding of support by a majority of non-Ellison shareholders, (ii) founded a private-sector think tank and a technology consulting firm with events that Ellison frequently attended and presented, and (iii) had a 30-year friendship with numerous close interactions with Ellison at his Silicon Valley estate and on a Hawaiian island 98% owned by Ellison where she owned two condominiums. “[I]f Seligman agreed to sue Ellison, she would potentially jeopardize not only her decades-long friendship with Ellison, but also Ellison’s willingness to shore up her consulting firm and ensure she keeps her position on Oracle’s board.”
Thus, Vice Chancellor Glasscock “found that demand is futile because the facts allege raise a pleading-stage inference that a majority of the Oracle board—including two out of three members of the Special Committee that approved the acquisition [Conrades and James]—lacks independence.”
Key Take Aways from the Oracle Opinion
The Vice Chancellor noted that it is an “unusual case where the plaintiff can plead specific facts leading to a reasonable doubt that the directors are able to exercise business judgment, therefore, demand is excused under Rule 23.1, and the litigation (to the extent the complaint otherwise states a claim) may proceed derivatively. In my view, this is such a case.”
Given Ellison’s dominance and control over Oracle and its officers and directors, the composition of Oracle’s board and Special Committee, and Ellison’s self-interested yet continuing behind-the-scenes involvement in the transaction, plaintiff in the Oracle case had an easier time meeting its pleading burden than is typically the case.
As an initial take away, the composition of Oracle’s board was problematic, with one third of the board composed of inside directors. That leaves little margin for error. In addition, three of the outside directors had significant ties to Oracle’s founding and largest shareholder, who served as Chairman of the Board and essentially exercised control over the company. Board composition is critical when a company has a shareholder who is arguably exercising control (whether by dint of stock ownership, force of personality, or status as founder).
It is unclear whether a different result could have been reached given Oracle’s board composition, Ellison’s conflicts, and his de facto control, but Oracle certainly could have taken steps to avoid creating additional facts that supported an inference of a lack of independence.
For example, while Vice Chancellor Glasscock did not analyze the independence of all outside directors, he “concluded that none of them face a substantial likelihood of liability for acting in bad faith in connection with the challenged acquisition.” At least four of these outside directors were not in a position where their continuing board service was at Ellison’s pleasure. Such directors would have been more appropriate candidates for service on the Special Committee than the two directors who served on the Compensation Committee and whose continuing service was thus at Ellison’s pleasure given the non-Ellison shareholders’ repeated lack of support.
Companies should also ensure that officers and directors are not permitted participate in negotiations of transactions where they have a conflict of interest, whether directly or behind the scenes. As Vice Chancellor Glasscock observed: “Not only did [Ellison] stand on both sides of the transaction; he also directed his chief lieutenant to manipulate the sale process so that he could monetize his investment in Net Suite before it lost much of its value.”
To view the opinion, click here.