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McElrath v. Kalanick

Supreme Court of Delaware

January 13, 2020

LENZA H. MCELRATH, III, derivatively on behalf of UBER TECHNOLOGIES, INC., Plaintiff Below, Appellant,
v.
TRAVIS KALANICK, GARRETT CAMP, RYAN GRAVES, ARIANNA HUFFINGTON, YASIR AL-RUMAYYAN, WILLIAM GURLEY, DAVID BONDERMAN, Defendants Below, Appellees. And UBER TECHNOLOGIES, INC., Nominal Defendant Below, Appellee.

          Submitted: October 30, 2019

          Court Below: Court of Chancery C. A. No. 2017-0888.

         Upon appeal from the Court of Chancery.

          Michael J. Barry, Esq. (argued), John C. Kairis, Esq., Kimberly A. Evans, Esq., GRANT & EISENHOFER P.A., Wilmington, Delaware; Jeffrey Reeves, Esq., Atlanta, Georgia; Attorneys for Plaintiff-Appellant Lenza H. McElrath, III, derivatively on behalf of Uber Technologies, Inc.

          R. Judson Scaggs, Jr., Esq., Susan W. Waesco, Esq., Sabrina M. Hendershot, Esq., MORRIS, NICHOLS, ARSHT & TUNNELL LLP, Wilmington, Delaware; Susan S. Muck, Esq., Kevin P. Muck, Esq., Marie C. Bafus, Esq., FENWICK & WEST LLP, San Francisco, California; Attorneys for Defendants-Appellees Garrett Camp, Ryan Graves, Arianna Huffington, Yasir Al-Rumayyan, William Gurley and David Bonderman.

          Donald J. Wolfe, Jr., Esq., T. Brad Davey, Esq., J. Matthew Belger, Esq., Jacob R. Kirkham, Esq., POTTER ANDERSON & CORROON LLP, Wilmington, Delaware; Joseph G. Petrosinelli, Esq., Kenneth J. Brown, Esq., WILLIAMS & CONNOLLY LLP, Washington, D.C.; Attorneys for Defendant-Appellee Travis Kalanick.

          A. Thompson Bayliss, Esq., Michael A. Barlow, Esq., ABRAMS & BAYLISS LLP, Wilmington, Delaware; Mark Gimbel, Esq. (argued), C. William Phillips, Esq., COVINGTON & BURLING, LLP, New York, New York; Bryant Pulsipher, Esq., COVINGTON & BURLING, LLP, San Francisco, California; Attorneys for Nominal Defendant-Appellee Uber Technologies, Inc.

          Before SEITZ, Chief Justice; VALIHURA, and TRAYNOR, Justices.

          Seitz, Chief Justice.

         In 2016, Uber Technologies, Inc. acquired Ottomotto LLC to gain more traction in the autonomous vehicle space. The acquisition was high risk from the start. Although Uber ostensibly bought a company, and paid only $100, 000 up front, it hired key employees from Google's more mature autonomous vehicle program. Uber took some steps to ensure the former Google employees did not misuse Google's confidential information, but the transaction ended in embarrassment. Uber fired its key hire from Google after it came to light Google's proprietary information had been misused. It also ended up settling Google's misappropriation claims by issuing additional Uber stock to Google valued at $245 million.

         The plaintiff, an Uber stockholder and former Uber employee, filed suit in the Court of Chancery against the directors who approved the Otto acquisition. The plaintiff claimed that the directors ignored the alleged theft of Google's intellectual property and failed to investigate pre-closing diligence that would have revealed problems with the transaction. According to the plaintiff, the board should not have relied on the CEO's representations that the transaction had the necessary protections because he and Uber had a history of misusing the intellectual property of others.

         The defendants responded by moving to dismiss the complaint under Court of Chancery Rule 23.1. As they asserted, the plaintiff first had to make a demand on the board of directors before pursuing litigation on the corporation's behalf. The Court of Chancery found that a majority of the Uber board of directors could have fairly considered the demand, and dismissed the complaint. The plaintiff has appealed the Court of Chancery's decision.

         By any reasonable measure, the Uber board of directors approved a flawed transaction. But we, like the Court of Chancery, do not decide the merits of the claims at this stage of the proceedings. Instead, we consider the gating issue of the demand requirement in a derivative action. Under Delaware law, the board of directors manage the business and affairs of the corporation. That responsibility normally includes deciding whether to bring litigation on the corporation's behalf. When the board is disabled from making the decision, however-whether because of interestedness or lacking independence from those who are interested-a stockholder can control the litigation decision.

         We find, as did the Court of Chancery, that a majority of the board was disinterested because it had no real threat of personal liability due to Uber's exculpatory charter provision. And a majority of the board was also independent of the one interested director. Thus, the board, and not the plaintiff, controlled the decision whether to bring litigation on Uber's behalf, which meant the plaintiff had to make a demand on the board that Uber bring the litigation. He did not. The Court of Chancery's judgment dismissing the complaint with prejudice is affirmed.

         I.

         According to the allegations of the complaint, Uber operates a leading "ride share" mobile application.[1] In 2015, Travis Kalanick, Uber's founder, feared Uber was falling behind in the race to develop an autonomous vehicle-an "existential" threat to the company.[2] To regain lost ground, in June 2015 Uber recruited Anthony Levandowski, then the Engineering Manager of Google's autonomous vehicle project, to leave Google and join Uber.[3] Kalanick communicated extensively with Levandowski. They developed an "extremely close" relationship.[4]

         On January 15, 2016, Levandowski founded Otto while still employed by Google.[5] At the end of January, Levandowski left Google and hired over a dozen former Google employees at Otto. Weeks later, Uber and Otto signed a term sheet for Uber to acquire Otto.[6] According to the plaintiff, Otto had no real operations and was run from Levandowski's house.[7] Kalanick testified in another proceeding that the acquisition was "basically [] hiring [Levandowski] and his team."[8]

         After signing the term sheet, Uber and its outside counsel hired Stroz Friedberg, LLC, a computer forensic investigation firm, to conduct an independent investigation into whether Otto employees took with them Google's proprietary information or might breach non-solicitation, non-compete, or fiduciary obligations if they moved from Google to Otto.[9] The board was aware that Stroz had been hired to conduct an investigation.[10]

         In early April, Stroz delivered its preliminary report to Uber's outside counsel, Uber's general counsel, and Otto's counsel. The complaint contained little detail about the contents of the report, except a finding that some Otto employees "possessed substantial files containing confidential and proprietary Google information, and surreptitiously tried to delete more on the eve of the Stroz interviews."[11] Uber's general counsel knew of the preliminary findings by April 10, 2016, and, as alleged, expressed "serious reservations" to Kalanick about the Otto acquisition, but did not otherwise inform the board.[12]

         On April 11, 2016, the board-then composed of Kalanick, Garrett Camp, Ryan Graves, William Gurley, and David Bonderman-met to approve the acquisition. When Kalanick presented the transaction to the board, according to the plaintiff, Kalanick "failed to present the preliminary findings of the Stroz investigators."[13] Also, as alleged, none of the other directors asked to see the report.[14] Otherwise, the record reflects that diligence was discussed and represented to be "okay."[15]

         The board also discussed what the plaintiff characterizes as atypical indemnification provisions of the merger agreement that "were clearly explained in the presentations to the [b]oard regarding the transaction."[16] Otto would not indemnify Uber post-closing for Otto's breaches of representations and warranties.[17]Also, certain Otto employees, including Levandowski, would have limited indemnification rights for pre-signing misconduct disclosed during the Stroz investigation, but not for undisclosed pre-signing or any post-signing misconduct.[18]After discussion, the board approved the transaction.

         On August 5, 2016, Stroz delivered its final report, which described how some Otto employees had retained, accessed, or deleted confidential Google information on their personal devices after their departure from Google. The plaintiff did not, however, allege that the report found any Google confidential information transferred to Otto or Uber.[19] And while the plaintiff relied on a list of findings in the final Stroz report, it is unclear whether they differ from the preliminary report.[20]Also, the plaintiff does not allege that the directors knew that the final report differed from the preliminary report.

         The board-having added Arianna Huffington and Yasir Al-Rumayyan-met before closing the transaction. The directors discussed the risk of Google suing, the critical nature of the diligence, and the details of the indemnification provision.[21] The plaintiff alleges they did not, however, specifically read or inquire about the Stroz report.[22]

         After the transaction closed, in December 2016, Google mistakenly received an email intended for Uber from one of its vendors. The email contained drawings of a circuit board for autonomous vehicle technology that allegedly resembled Google's internal engineering drawings. Google sued Uber and Otto in February 2017 for misappropriation of proprietary information. Uber eventually settled the lawsuit by issuing additional Uber stock to Google valued at $245 million.[23] Uber also terminated Levandowski's employment.[24]

         After Uber announced the settlement, the plaintiff filed this derivative suit against the directors who decided to proceed with the Otto transaction, the directors who decided to close the transaction, and two Uber officers.[25] According to the plaintiff, making a demand on the Uber board before filing suit was futile because a majority of the Uber directors at the time he filed his complaint-Kalanick, Graves, Camp, Huffington, Al-Rumayyan, Matt Cohler, David Trujillo, Ursula Burns, and John Thain-were interested or not independent of those who were interested.[26] Uber and the individual defendants moved to dismiss for failure to make a demand under Court of Chancery Rule 23.1. They argued that the Uber board could have fairly considered whether to pursue the litigation brought by the plaintiff. The Court of Chancery found that Kalanick was the only interested director, and a majority of the board was independent from him at the time of the complaint. Thus, Rule 23.1 required the plaintiff to demand the board pursue litigation on Uber's behalf. Because the plaintiff did not, the Court of Chancery dismissed the complaint.

         II.

         We review de novo the Court of Chancery's decision to dismiss the complaint.[27] At this stage, we must accept as true any "particularized allegations of fact."[28] And while we must draw all reasonable inferences in the plaintiff's favor, we do not draw unreasonable inferences.[29] Under Rule 23.1, the plaintiff has "a heightened burden to plead particularized facts establishing a 'reasonable doubt that . . . the board of directors could have properly exercised its independent and disinterested business judgment in responding to a demand.'"[30]

         A.

         Under Delaware law, the board of directors manages the business and affairs of the corporation, which includes deciding whether the corporation should pursue litigation against others.[31] To protect the directors' managerial authority, a stockholder must comply with Court of Chancery Rule 23.1 before pursuing derivative litigation.[32] A stockholder must first make a demand on the board to pursue the claim, and, if the board declines, "attempt to demonstrate that the directors wrongfully refused the demand."[33] The demand requirement affords "the corporation the opportunity to address an alleged wrong without litigation and to control any litigation which does occur."[34] Further, it "insure[s] [sic] that a stockholder exhausts his intracorporate remedies" and "safeguard[s] against strike suits."[35]

         A stockholder can bypass the demand requirement if he "can allege with sufficient particularity that demand is futile and should be excused due to a disabling conflict by a majority of the directors to consider the demand."[36] The demand futility test is highly dependent on the particularity of the facts alleged in the complaint.[37]When a majority of directors at the time of the challenged conduct have been replaced, the demand futility test articulated in Rales v. Blasband applies.[38] The Rales test considers "whether the board that would be addressing the demand can impartially consider its merits without being influenced by improper considerations."[39] The plaintiff satisfies the demand futility pleading requirements under Rales if his allegations "create a reasonable doubt that . . . the board of directors could have properly exercised its independent and disinterested business judgment in responding to a demand."[40]

         First, the court must consider whether any directors were interested. A director is interested if, in this instance, she would face a substantial likelihood of personal liability for the conduct alleged in the complaint.[41] Second, if any directors were interested, the court considers whether any other directors were not independent of an interested director. Independence turns on whether "the director's ability to act impartially on a matter important to the interested party can be doubted because that director may feel either subject to the interested party's dominion or beholden to that interested party."[42] After tallying the results, if a majority of the board in place when the complaint was filed was disinterested and independent, the stockholder must first make a demand on the board before pursuing litigation on the corporation's behalf.

         B.

         Examining first the Uber directors the plaintiff alleges were interested because of the substantial likelihood of personal liability for wrongdoing, Uber's Certificate of Incorporation exculpates its directors from monetary liability for fiduciary duty breaches to the fullest extent permitted by the Delaware General Corporation Law.[43]Given this protection from due care violations, the plaintiff must plead with particularity that the directors "acted with scienter, meaning 'they had actual or constructive knowledge that their conduct was legally improper.'"[44] In other words, directors are liable for "subjective bad faith" when their conduct is motivated "by an actual intent to do harm," or when there is an "intentional dereliction of duty, a conscious disregard for one's responsibilities."[45] Pleading bad faith is a difficult task and requires "that a director acted inconsistent with his fiduciary duties and, most importantly, that the director knew he was so acting."[46] Gross negligence, without more, is insufficient to get out from under an exculpated breach of the duty of care.[47]

         Of the eleven directors on the board when the plaintiff filed his complaint, the plaintiff alleges that five were interested because they faced a substantial likelihood of liability for approving and closing the deal-Kalanick, Camp, Graves, Huffington, and Al-Rumayyan.[48] While the defendants claim they dispute the Court of Chancery's finding that Kalanick was interested, [49] they make no serious argument on appeal to challenge the finding. Thus, we start from the Court of Chancery's finding that Kalanick was interested and unable to fairly consider a demand.[50]

         The plaintiff challenges the Court of Chancery's finding that the directors did not act in bad faith when approving the Otto transaction.[51] First, the plaintiff argues that, because Kalanick as CEO was the one who brought the transaction to the board and was involved with diligence, the directors should have been wise enough not to rely on someone with a reputation as a law breaker. In support, the plaintiff points to one of Kalanick's prior businesses, Scour, which offered music and film releases. Scour was eventually shut down for copyright violations and sued for $250 billion. Further, the plaintiff alleges that Uber had a practice of hiring employees from competitors to steal trade secrets and a general practice of ignoring and violating regulations.[52] When these allegations are combined, the plaintiff argues that the board was on notice that Kalanick might be ignoring intellectual property laws in the Otto acquisition.

         Second, the plaintiff argues that the allegedly unusual indemnification clauses in the merger agreement put the board on notice that Kalanick wanted to steal Google's proprietary information. The agreement indemnified certain Otto employees for pre-signing misconduct disclosed during the Stroz investigation, but prevented Uber from seeking indemnification from Levandowski for violating non-compete and infringement claims. And, as the plaintiff alleged, Uber hired Stroz to investigate whether Otto employees stole Google's intellectual property, but the board approved the transaction without personally reviewing the preliminary or final Stroz reports. The plaintiff argues that, viewed holistically, these facts entitle him "to a reasonable inference that the [b]oard's failure to inquire or inform themselves about the scope of potential legal and financial risk faced by Uber in connection with the [Otto] [t]ransaction amounts to bad faith."[53]

         We agree, however, with the Court of Chancery that the plaintiff did not meet his particularized burden of alleging that the board in place when the plaintiff filed his complaint, besides Kalanick, acted in bad faith. As noted before, a showing of bad faith in the context of demand excusal is a high hurdle, and essentially requires the plaintiff to demonstrate intentional wrongdoing by the board. The complaint alleges, however, that Uber's directors heard a presentation that summarized the transaction, reviewed the risk of litigation with Google, generally discussed due diligence, asked questions, and participated in a discussion.[54] The inference from these allegations shows a functioning board that did more than rubberstamp the transaction presented by Uber's CEO.

         Further, Kalanick might have a background that would lead a reasonable board member to dig deeper into representations he made about the transaction. But, as the Court of Chancery found, there were no allegations that Kalanick had a history of lying to the board.[55] And the record supports the conclusion that the diligence presented to the board was, in fact, "okay."[56] The complaint's allegations do not lead to a reasonable inference that the board intentionally ignored the risks of the transaction.[57] On the contrary, it appears that the directors considered the risks and nonetheless proceeded with the transaction. As we have noted before, "there is a vast difference between an inadequate or flawed effort to carry out fiduciary duties and a conscious ...


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