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Solak v. Welch

Court of Chancery of Delaware

October 30, 2019

JOHN SOLAK, derivatively on behalf of ULTRAGENYX PHARMACEUTICAL INC., Plaintiff,
v.
DANIEL G. WELCH, EMIL D. KAKKIS, M.D., Ph.D., WILLIAM ALISKI, DEBORAH DUNSIRE, M.D., LARS EKMAN, M.D., Ph.D., MATTHEW K. FUST, MICHAEL NARACHI and CLAY B. SIEGALL, Ph.D., Defendants, and ULTRAGENYX PHARMACEUTICAL INC., a Delaware corporation, Nominal Defendant.

          Date Submitted: August 1, 2019

          Blake A. Bennett, COOCH AND TAYLOR, P.A., Wilmington, Delaware; Jeffrey M. Norton, NEWMAN FERRARA LLP, New York, New York; Werner R. Kranenburg, KRANENBURG, London, United Kingdom; Counsel for Plaintiff John Solak.

          Edward B. Micheletti, Lilianna Anh P. Townsend, Mary T. Reale, SKADDEN, ARPS, SLATE, MEAGHER & FLOM LLP, Wilmington, Delaware; Counsel for Defendants Ultragenyx Pharmaceutical Inc., Daniel G. Welch, Emil D. Kakkis, William Aliski, Deborah Dunsire, Lars Ekman, Matthew K. Fust, Michael Narachi, and Clay B. Siegall.

          MEMORANDUM OPINION

          McCORMICK, V.C. JUDGE.

         As interpreted by the Delaware Supreme Court in Spiegel v. Buntrock, [1] Court of Chancery Rule 23.1 gives a stockholder wishing to file a derivative lawsuit two mutually exclusive options. The stockholder may either make a pre-suit demand on the board or plead with particularity the reasons it would have been futile to do so. If a stockholder elects to make a pre-suit demand, then the stockholder may not allege that demand would have been futile in a subsequent complaint concerning the subject matter of the demand. Rather, the stockholder is limited to making the more difficult claim that the board wrongfully refused the demand. Making a pre-suit demand, therefore, carries significant downsides affecting the viability of a derivative claim.

         The parties in this case dispute whether a pre-suit communication constitutes a pre-suit demand for purposes of Rule 23.1. Before commencing this litigation, the plaintiff-stockholder sent a letter requesting that the defendant-company's board of directors take remedial action to address allegedly excessive non-employee director compensation. This lawsuit ensued after the board rejected the letter's request. The plaintiff portrays the letter as no more than an informal, good faith attempt to educate the board and encourage it to make changes to the company's compensation policies. He argues that demand futility is the appropriate standard and that the complaint demonstrates that demand is excused. The defendants have moved to dismiss the complaint under Rule 23.1. They argue that the letter constitutes a pre-suit demand and that the plaintiff failed to plead wrongful demand refusal.

         Revealing the proverbial wolf in sheep's clothing, this decision finds that what the plaintiff describes as a harmless letter seeking prospective board action is something with far more legal bite-a pre-suit demand. Because the plaintiff fails to allege wrongful demand refusal, the action is dismissed.

         I. FACTUAL BACKGROUND

         The facts are drawn from the Complaint, [2] documents it incorporates by reference, and relevant pre-suit communications.[3]

         Plaintiff John Solak ("Plaintiff") is a current stockholder of Ultragenyx Pharmaceutical Inc. ("Ultragenyx" or the "Company"), a biopharmaceutical company incorporated under Delaware law and headquartered in Novato, California. In June 2018, Plaintiff's counsel sent a letter on his behalf (the "Letter") addressed to the Ultragenyx Board of Directors (the "Board").[4]

         The Letter states that its purpose is "to suggest that the [Board] take corrective action to address excessive director compensation as well as compensation practices and policies pertaining to directors."[5] The Letter focuses on the Company's updated compensation policy disclosed in its Definitive Proxy Statement filed with the United States Securities and Exchange Commission on April 27, 2018 (the "Compensation Policy"), which "the Board approved" and in which all non-employee directors participate.[6]

         According to the Letter, non-employee directors have been "compensated at an extraordinarily high level - averaging in excess of $400, 000 per annum each since 2014" under the Compensation Policy.[7] The Letter compares the median compensation for non-employee directors at the "Top 200" companies in the S&P 500 against the median total compensation for non-employee directors at Ultragenyx, describing the latter as comparatively excessive.[8]

         The Letter references In re Investors Bancorp, Inc. Stockholder Litigation, in which the Delaware Supreme Court revived claims challenging director compensation decisions a board made pursuant to a stockholder-approved, discretionary equity incentive plan.[9] In reversing the Court of Chancery decision dismissing those claims, the Delaware Supreme Court held: "[W]hen it comes to the discretion directors exercise following stockholder approval of an equity incentive plan, ratification cannot be used to foreclose the Court of Chancery from reviewing those further discretionary actions when a breach of fiduciary duty claim has been properly alleged."[10] Citing Investors Bancorp, the Letter states: "The Compensation Policy lacks any meaningful limitations with regard to cash and equity awards, allows for too much discretion by the Board, and . . . is not subject to shareholder approval."[11] The Letter then warns: "The Company is more susceptible than ever to shareholder challenges unless it revises or amends its director compensation practices and policies."[12]

         The Letter concludes by "suggesting" that the Board "take[] immediate remedial measures to address these issues, including, but not limited to, reducing retainer fees, reducing the awards of options and restricted stock units, moving to full-value equity grants, adopting mandatory stock-ownership guidelines, and setting meaningful limits or targets for overall compensation."[13] The Letter does not expressly request that the Board initiate any litigation, but it states that if the Board did not respond within thirty days, Plaintiff would consider "all available shareholder remedies."[14]

         The Letter includes the following footnote:

Please be advised that nothing contained herein shall be construed as a pre-suit litigation demand under Delaware Chancery Rule 23.1. This letter is intended only as a good-faith attempt to encourage corrective action by the Board. We do not seek or expect the Board to initiate any legal action against its members. Further, any rights and/or remedies our client or any other Ultragenyx shareholder may have are specifically reserved and nothing contained herein shall be deemed a waiver of those rights and/or remedies.[15]

         In October 2018, the Board responded to the Letter through counsel (the "Response").[16] The Response first states that the Board viewed Plaintiff's Letter as a demand pursuant to Rule 23.1.[17] It then explains that the Board conducted an investigation with the assistance of counsel, which included a review of public and private documents, as well as interviews with the Chairman of the Compensation Committee and the Compensation Committee's independent compensation consultant.[18] The Response also describes the approach used to set Ultragenyx's compensation policies and explains that "the Board unanimously resolved that it would be in the best interests of the Company to not authorize commencement of a civil action or further changes to the Compensation Policy in response to the Demand."[19]

         Plaintiff commenced this derivative action on November 7, 2018, asserting claims stemming from the Board's allegedly excessive non-employee director compensation practices. The Complaint names as defendants the eight individual directors who served on the Board at the time the Complaint was filed (the "Defendants"). The Complaint asserts three causes of action against Defendants: breach of fiduciary duty, unjust enrichment, and corporate waste. Defendants moved to dismiss the Complaint on December 26, 2018. The parties fully briefed the motion by April 8, 2019, [20] and the Court heard oral argument on August 1, 2019.

         II. LEGAL ANALYSIS

         Defendants have moved to dismiss the Complaint pursuant to Rule 23.1(a), which derives from the bedrock principle that directors, rather than stockholders, manage the business and affairs of the corporation.[21] "By its very nature the derivative action impinges on the managerial freedom of directors," whose authority includes decisions to pursue or refrain from pursuing litigation on behalf of the corporation.[22]

         As part of this board-centric model, Rule 23.1 requires that a stockholder wishing to bring a derivative action first demand that the board of directors take action.[23] If a stockholder chooses not to make pre-suit demand, the stockholder must plead with particularity the reasons it would have been futile to present the matter to the board such that pre-suit demand should be excused.[24] This requirement "exists at the threshold, first to insure that a stockholder exhausts his intracorporate remedies, and then to provide a safeguard against strike suits."[25]

         Of the two potential routes presented by Rule 23.1-pleading demand futility with particularity or making pre-suit demand-the former is a steep road, but the latter is "steeper yet."[26] The Delaware Supreme Court steepened this incline in Spiegel by holding that a stockholder who makes pre-suit demand "tacitly concedes" that the board was able to properly consider that demand.[27] The board's affirmative decision to refuse the demand, therefore, is subject to the business judgment rule.[28]

         A stockholder's options under Rule 23.1 are mutually exclusive. As explained in Spiegel, after making pre-suit demand, a stockholder plaintiff may not pursue claims challenging the subject matter of that demand.[29] Rather, the stockholder is limited to a claim that the board wrongfully refused the demand.[30] Put differently, a stockholder may not pursue demand refusal and demand excusal strategies simultaneously in order to "cover all the bases."[31] The Delaware Supreme Court has broadly interpreted this limitation to apply to all derivative claims arising from the subject matter of the demand, even legal theories not expressly identified by the stockholder or considered by the board.[32] In light of these principles, "a judicial determination that a plaintiff has made a demand carries with it significant legal consequences."[33]

         In this case, the parties dispute whether Plaintiff, in fact, made a pre-suit demand on the Board. Defendants construe the Letter as a pre-suit demand and argue that the demand refusal analysis applies. Plaintiff responds that the Letter does not constitute a pre-suit demand and argues that the demand excusal analysis applies. This decision first confronts this gating issue before applying the relevant standard.

         A. The Letter Constitutes a Pre-Suit Demand Under Rule 23.1.

         The burden of demonstrating that a pre-suit stockholder communication qualifies as a demand under Rule 23.1 lies with the party asserting as much-here, Defendants.[34] There are no "'magic words' establishing that a communication is a demand."[35] Nor is there an "all-inclusive legal formula" serving such a purpose.[36]Rather, "[t]hat determination is essentially fact-driven."[37] In Yaw, then-Vice Chancellor (later Justice) Jacobs helpfully distilled a series of decisions to three criteria for determining whether a pre-suit communication constitutes a pre-suit demand.[38] Under Yaw, a pre-suit communication is a demand for purposes of Rule 23.1 if it provides "(i) the identity of the alleged wrongdoers, (ii) the wrongdoing they allegedly perpetrated and the resultant injury to the corporation, and (iii) the legal action the shareholder wants the board to take on the corporation's behalf."[39]

         Plaintiff first argues that this Court need not review the substance of the Letter under Yaw because of the Letter's footnote disclaimer, which states: "nothing contained herein shall be construed as a pre-suit demand under Delaware Chancery Rule 23.1."[40] Vice Chancellor Glasscock has coined this argument the "Magritte defense," a term referencing a 1929 painting by surrealist artist René Magritte titled "The Treachery of Images."[41] That painting portrays a smoking pipe, but it bears the caption: "This is not a pipe."[42]

         Plaintiff's footnote disclaimer does not obviate the Court's review of the Letter's substance for obvious reasons, namely that "Delaware law is quite strict as to the application of Chancery Rule 23.1."[43] As discussed above, Delaware law prohibits a stockholder from both making a demand and pleading demand futility "to, in essence, cover all the bases."[44] That prohibition would become a virtual nullity if a stockholder could avoid a judicial determination that pre-suit demand was made by simply stating "this is not a demand" in his pre-suit communication. For this reason, the test for determining whether a pre-suit communication constitutes a demand under Rule 23.1 cannot look to the subjective intent of the sender.[45] Rather, in applying the three Yaw criteria, the Court must evaluate the substance of the communication objectively to determine whether it would place a recipient "on notice of possible wrongdoing" in a manner that would enable that person to take "corrective intracorporate action."[46]

         Turning to an application of Yaw in this case, the parties' dispute concerns whether the Letter satisfies the third criterion, which requires that the communication identify the legal action the stockholder wants the board to take on the company's behalf.[47] Plaintiff's argument is straightforward: because the Letter does not expressly demand that Defendants commence litigation, it cannot be construed as a pre-suit litigation demand for purposes of Rule 23.1.[48]

         Delaware law does not construe the third Yaw criterion as narrowly as Plaintiff suggests, and this Court has deemed pre-suit communications that do not expressly demand litigation sufficient to constitute pre-suit demand. On this point, two cases are instructive. In In re Riverstone National, Inc. Stockholder Litigation, the Court held that a pre-suit communication constituted demand even though it did not "specifically request that the board commence litigation" because it asked the board to transfer equity owned by the company's officers, directors, and employees back to the company itself.[49] The Court reasoned that by "clearly articulat[ing] the remedial action to be taken by the board," the letter met the third Yaw criterion.[50]Similarly, in Herd v. Major Realty Corp., the Court considered two pre-suit communications: one demanding termination of a merger agreement and another demanding that the board postpone the stockholders' meeting at which the merger was to be considered.[51] The Court concluded that the letters "clearly demanded corporate action" sufficient to satisfy Rule 23.1, despite the fact that they did not demand that the board pursue litigation on behalf of the company.[52]

         Similar to the pre-suit communications in Riverstone and Herd, although the Letter avoids expressly demanding that the Board commence litigation, the Letter clearly articulates the need for "immediate remedial measures," proposes remedial action, and requests that the Board take such action.[53] The Letter further states that "the Company is more susceptible than ever to shareholder challenges unless it revises or amends its director compensation practices and policies," identifies the legal basis for such challenges, and warns that, absent a response from the Board within thirty days, Plaintiff would "consider all available shareholder remedies."[54]Although Plaintiff says "this is not a demand," these strong overtures of litigation very much make it look like one. Thus, the Letter satisfies the third criterion of Yaw.

         Beyond a mechanical application of Yaw, numerous other observations inform this Court's conclusion that the Letter constitutes a pre-suit demand. For starters, the Letter reads like a complaint. In fact, the Complaint in this action is nearly a carbon copy of the Letter. Not only does the Complaint allege the same wrongdoing using similar verbiage as the Letter, [55] but it also adopts the Letter's method of illustrating the alleged wrongdoing by drawing comparisons between the Company's compensation levels and those of other companies.[56] The similarities between the Letter and the Complaint are relevant because a pre-suit demand is supposed to fulfill a notice function-notifying a board of the alleged wrongs to be corrected through litigation.[57] Thus, the more closely a complaint tracks the pre-suit communication in question, the more likely the communication will have provided the notice required of a pre-suit demand.[58] The similarities between the Letter and the Complaint in this case therefore weigh in favor of deeming the Letter a pre-suit demand.

         In the same vein, the remedial measures requested in the Letter support a determination that the Letter is a demand. The Letter seeks relief that would benefit Ultragenyx stockholders and the Company as a whole, rather than just Plaintiff personally.[59] And the Letter's requested remedial measures resemble therapeutic benefits commonly achieved in derivative lawsuits challenging non-employee director compensation.[60] Where a communication demands action that stockholders commonly achieve through derivative litigation challenging similar conduct, it is more likely that the communication will be construed as a demand for the purposes of Rule 23.1.

         Warranting mention, Plaintiff makes one other argument based on another aspect of Yaw. Citing policy considerations, then-Vice Chancellor Jacobs directed that ambiguous stockholder communications "ought not to be considered a demand within the meaning of Rule 23.1."[61] He reasoned that "[t]o interpret an ambiguous communication as a demand would discourage a shareholder from bringing potential wrongdoing to the corporation's attention in a forum other than the courtroom, for fear that his position, should he later decide to sue derivatively, would procedurally be more difficult to support."[62] Plaintiff argues that there is ambiguity in the Letter and requests that the Court construe that ambiguity in his favor.[63]

         Unique circumstances of this action, however, warrant a departure from the otherwise sound policy requiring this Court to construe ambiguity in favor of a stockholder. In Solak v. Fundaro, a New York state court held that Plaintiff's pre-suit communication to the board of another company in which he owned stock constituted a pre-suit demand.[64] In dismissing that lawsuit, the New York court observed that Plaintiff's request that the board take "all action necessary" to address allegedly excessive compensation satisfied the demand requirement because it necessarily included taking requisite legal action.[65]Fundaro involved not only the same plaintiff as this case, but also the same New York law firm representing Plaintiff in this case. And the letter in Fundaro made allegations nearly identical to the Letter in this action.[66] The players in this litigation were thus aware of the risk involved in sending a pre-suit communication like the Letter.[67] Nonetheless, Plaintiff and ...


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