On March 23, 2018, Justice Charles E. Ramos of the Commercial Division of the New York Supreme Court dismissed with prejudice a purported derivative suit alleging that the board of Intercept Pharmaceuticals, Inc. (“Intercept”) breached their duty of loyalty and good faith and squandered corporate assets by approving, without a stockholder vote, a non-employee director compensation policy. Solak v. Fundaro, No. 655205 (N.Y. Sup. Ct. Mar. 23, 2018). Though plaintiff sent a letter to Intercept prior to filing suit, demanding that the company take “all action necessary” to remedy the waste allegedly caused by the directors’ compensation policy, plaintiff argued that the letter was not a demand within the meaning of Delaware Court of Chancery Rule 23.1, and that demand would have been futile because self-compensation decisions are inherently conflicted transactions. The Court held that plaintiff’s letter fulfilled all the requirements of a demand under Delaware law and that the board’s investigation of and response to the demand was sound under the business judgment rule.
Following the board’s February 2016 adoption of a compensation policy granting non-employee directors awards of options and restricted stock, plaintiff wrote a letter in March 2017 to the board expressing concerns about the magnitude of compensation, requesting that the board take “all action necessary” to revise the policy and submit it for shareholder approval, and threatening to consider “available actions and remedies” to coerce the board to act if they refused to do so. The Intercept board retained a law firm to advise the compensation committee, engaged a consultant to review the policy, and assessed peer companies’ compensation of their respective boards. Thereafter, the board responded to plaintiff’s letter in July 2017, explaining the scope of review undertaken and the board’s conclusion that initiating litigation to change the compensation policy would not be in the best interests of the company and its stockholders.
In evaluating defendants’ motion to dismiss, the Court first determined that plaintiff’s letter met the criteria to constitute a demand: the letter (i) identified the board as the alleged wrongdoers, (ii) identified the allegedly excessive compensation as the wrongdoing that harmed the company, and (iii) requested the board to take “all action necessary,” which impliedly included a request to take legal action (in particular, plaintiff’s request that the board cancel options and restricted stock already awarded would likely have required legal action against certain of the directors). Regarding the board’s response, the Court applied the business judgment rule (rather than the entire fairness standard for which plaintiff advocated) because the decision of whether to pursue legal action “concern[ed] the management of the corporation, which is evaluated based on the business judgment rule.” The Court found the board’s conduct was appropriate under the business judgment rule, noting that the board relied in good faith on the consultant’s guidance in responding to plaintiff’s demand. Accordingly, the Court dismissed the suit in its entirety.