On August 21, 2012, Judge Richard G. Andrews of the United States District Court for the District of Delaware dismissed without prejudice a shareholder derivative action alleging that a corporation's 2010 proxy statement contained false and misleading statements concerning compliance with Internal Revenue Code (IRC) § 162(m).

The plaintiff claimed that the proxy statement instructed shareholders that if they voted to reapprove the performance goals of the Long-Term Performance Plan (LTPP), the performance goals of the Stock Incentive Plan (SIP), and the amendment and restatement of the SIP, performance-based compensation under those plans would be tax-deductible under IRC § 162(m). However, because the plans do not allow for such tax deductions, the plaintiff alleged that the proxy statement disclosures were false and misleading and brought derivative claims for breach of duties under § 14(a) of the Exchange Act, breach of the duty of loyalty, waste and unjust enrichment.

A shareholder bringing a derivative action in federal court must file a complaint that states with particularity (i) any effort by the plaintiff to obtain the desired action from the directors of the corporation or comparable authority, and (ii) the reasons for not obtaining the action or not making the effort. However, federal courts hearing shareholders' derivative actions involving state law claims apply the substantive laws of the relevant state to determine whether the facts demonstrate that demand would have been futile and can be excused. The Delaware Supreme Court has stated that, in determining whether a demand made on the corporation by the plaintiff would be futile, the court considers whether, under the particularized facts alleged, a reasonable doubt is created that (a) the directors are disinterested and independent, and (b) the challenged transaction was otherwise the product of a valid exercise of business judgment. Aronson v. Lewis, 473 A.2d 805, 814 (Del. 1984).

Regarding Aronson's first prong, the court held that the plaintiff's allegations that the outside directors were interested in the proxy statement's representations concerning restricted stock did not create a reasonable doubt as to whether the outside directors were interested in the representations concerning performance-based compensation under the SIP and the LTPP. As such, the plaintiff failed to plead that demand was excused.

Regarding Aronson's second prong, the court rejected the plaintiff's position that derivative claims based on a proxy statement nondisclosure do not need to meet Aronson's second prong in the context of a Delaware Court of Chancery Rule 23.1 motion. The court also rejected the blanket proposition that a shareholder need only allege violation of a compensation agreement to excuse demand, without additional allegations of knowledge and intent.

Finally, the court rejected the plaintiff's position that demand is excused because the claim of waste, based on the inability to take tax deductions under the LTPP and SIP, does not invoke the business judgment rule. In order to excuse demand, a waste claim still requires the pleading of particularized facts to create a reasonable doubt that the board's decisions were the product of a valid exercise of business judgment.

Abrams v. Wainscott, DC Del., CA No. 11-297, RGA, Aug. 21, 2012

See http://articles.law360.s3.amazonaws.com/0372000/372263/August%2022%202012%20Order%20Granting%20MTD.PDF