Plaintiffs, shareholders of Citigroup, Inc., brought a shareholder derivative action against the current and former directors and officers of Citigroup alleging, among other things, that the defendants breached their fiduciary duties by failing to oversee and manage the risks Citigroup faced from problems in the subprime lending market and for failing to properly disclose Citigroup’s exposure to subprime assets. The plaintiffs alleged that the defendants should have noticed extensive “red flags” alerting them to the problems in the real estate and credit markets, and that they ignored these warnings to pursue short-term profits.
The Delaware Chancery Court dismissed the breach of fiduciary duty claims, holding that the defendants did not adequately plead facts showing that demand on the board of directors to initiate a lawsuit on behalf of the corporation (which is ordinarily required to bring a derivative suit under Delaware law) would have been futile. Before evaluating the plaintiffs’ allegations relating to demand futility, the court noted that the plaintiffs’ claim that the directors did not fulfill their oversight obligations was an extremely difficult claim in light of the well-established business judgment rule, which was designed to prevent judges from second-guessing rational business decisions that were made in good faith. The court emphasized that under this rule, directors are not to be held personally liable for making poor business decisions.
Turning to the plaintiffs’ “demand futility” allegations, the court rejected the plaintiffs’ argument that demand should be excused because a majority of the director defendants faced a substantial likelihood of personal liability if the claims proceeded, and therefore would be unable to exercise independent and disinterested business judgment in responding to a demand. The court reasoned that the plaintiffs’ allegations that the defendant directors ignored “red flags” at most evidenced bad business decisions. The court further concluded that the plaintiffs failed to allege with sufficient specificity that the directors were or should have been aware of any wrongdoing at Citigroup or were consciously disregarding a duty to prevent Citigroup from suffering losses. Accordingly, the court ruled that the plaintiff’s factual allegations were not sufficient to demonstrate that the defendants faced a substantial likelihood of liability that would prevent them from impartially considering a demand to bring a derivative suit and, consequently, dismissed the plaintiffs’ breach of fiduciary duty claims. (In Re Citigroup Inc. Shareholder Derivative Litigation, 2009 WL 481906 (Del. Ch. Feb. 24, 2009))