The Delaware Chancery Court recently dismissed, without leave to amend, a derivative action brought by shareholders of Affiliated Computer Services, Inc. (“ACS”) arising out of a failed deal between Cerberus Capital Management LP (“Cerberus”) and ACS to take ACS private. In Re Affiliated Computer Services, Inc. Shareholders Litig., Consol. C.A. No. 2821-VCL (Del. Chan. Ct. February 6, 2009).
On March 20, 2007, Darwin Deason, founder, chairman and significant shareholder of ACS, in conjunction with Cerberus, announced a plan by Cerberus to buy-out all of the ACS outstanding stock. A few months earlier, Deason recommended, and the board of directors agreed, to a three-week due diligence project in connection with Cerberus, then a potential private equity sponsor. Cerberus increased its purchase offer and included a provision by Cerberus that there be a 40-day “go shop” period following the signing of a merger agreement between the two companies. A special committee formed by the board of directors, expressed “serious concerns” regarding the company’s ability to attract other buyout contenders during a “go shop” period, given Deason’s lock-up agreement with Cerberus. Accordingly, Cerberus executed a waiver permitting Deason to discuss potential buyout proposals with other bidders. As a result of the credit crisis, the deal fell through and Cerberus withdrew its buyout offer in October 2007 and Deason demanded the outside directors’ resignations. The outside directors agreed to resign but indicated that they would first review Deason’s proposed nominees to replace them. On November 21, 2007 the outside directors resigned.
ACS shareholders filed the first purported class action challenging the Cerberus buyout proposal a few days after the March 20, 2007 announcement of the proposal. After the withdrawal of the proposal, but prior to the resignations of the outside directors, the class action plaintiffs amended their complaint to assert derivative claims.
The shareholders filed a second amended complaint in response to the defendants’ motion to dismiss the first amended complaint. The defendants then renewed their various motions to dismiss for failure to make a demand.
The first issue before the court was whether demand futility should be tested against the “old board” that was in place at the time the plaintiffs first amended their complaint to assert derivative claims, or against the “new board” that was in place at the time they filed the second amended complaint. The plaintiffs conceded that they could not establish demand futility with respect to the “new board” but argued that demand futility should be tested against the old one in place at the time they filed their first amended complaint, which initially asserted the derivative claims. The court noted that the standard under Delaware law is whether the claims alleged by the second amended complaint, filed after the new board was seated, were already “validly in litigation” when the first derivative allegations were made at the time the old board was in place, The court noted that the Delaware Supreme Court in Braddock v. Zimmerman, 906 A.2d 776 (Del. 2006) held that the term “validly in litigation” means a proceeding that can or has survived a motion to dismiss. The court held that for the plaintiffs to establish that the first amended complaint “can” survive a motion to dismiss would require the two-part test for demand futility under Aronson: (i) whether a reasonable doubt is created that the directors are disinterested or, alternatively, (ii) whether the pleading creates a reasonable doubt that the challenged transaction was anything other than the product of a valid exercise of business judgment.
As to the first prong of the test, the court found that the plaintiffs did not plead sufficient facts to support a conclusion that the old board of directors abandoned their fiduciary duties prior to resignation, such that making a demand upon them would be futile. Instead, the Court noted as evidence of their independence the outside directors’ insistence on approving their replacements in order to ensure that the board would maintain a majority of independent directors who would protect the minority shareholders.
With regard to the second prong of the test, the court held that the business judgment rule could not be rebutted due to plaintiff’s failure to plead facts that would undermine the presumption that the old board of directors, in particular the special committee, fully informed themselves on how to best proceed during the search for potential buyout bidders.
In conclusion, the court held that plaintiffs were required to either make a demand at the time they filed their second amended complaint or to plead that a demand was futile and, therefore, excused at the time they filed their first derivative claims. The plaintiffs’ failure to fulfill either requirement compelled a dismissal of the action with prejudice.