Sandys ex rel. Zynga Inc. v. Pincus

for the Majority:

I.

This appeal in a derivative suit brought by a stockholder of Zynga, Inc. turns on whether the Court of Chancery correctly found that a majority of the Zynga board could impartially consider a demand and thus corr.ectly dismissed the complaint for failure, to plead demand excusal under Court of Chancery Rule 23.1. This case again highlights the wisdom of the representative plaintiff bar heeding the repeated admonitions of this Court and the Court of Chancery to make a diligent pre-suit investigation into the board’s independence so that a complaint can be filed satisfying the burden to plead particularized facts supporting demand excusal. Here, the derivative plaintiffs lack of diligence compounded the already difficult task that the Court of Chancery faces when making close calls about pleading stage independence. Fortunately for the derivative plaintiff, however, he was able to plead particularized facts regarding three directors that create a reasonable doubt that these directors can impartially consider a demand. First, the plaintiff pled a powerful and unusual fact about one director’s relationship to Zynga’s former CEO and controlling stockholder which creates a reasonable doubt that she can impartially consider a' demand adverse to his interests. That fact is that the controlling stockholder and the director and her husband co-own an unusual asset, an airplane, which is suggestive of an extremely intimate personal friendship between their families. Second, the plaintiff pled that two other directors are partners at a prominent venture capital firm and that they and their firm not only control 9.2% of Zynga’s equity as a result of being early-stage investors, but have other interlocking relationships with the controller and another selling stockholder outside of Zyn-ga. Although it is true that entrepreneurs like the controller need access to venture capital, it is also true that venture capitalists compete to fund the best entrepreneurs and that these relationships can generate ongoing economic opportunities. There is nothing wrong with that, as that is how commerce often proceeds, but these relationships can give rise to human motivations compromising the participants’ ability to act impartially toward each other on a matter of material importance. Perhaps for that reason, the Zynga board itself determined that these two directors did not qualify as independent under the NASDAQ rules, which have a bottom line standard that a director is not independent if she has “a relationship which, in the opinion of the Company’s board of directors, would interfere with the exercise of independent judgment ....”^[1] Although the plaintiffs lack of diligence made the determination as to these directors perhaps closer than necessary, in our view, the combination of these facts creates a pleading stage reasonable doubt, as to .the ability of these directors to act independently on a demand adverse to the controller’s interests. When these three directors are considered incapable of impartially considering a demand, a majority of the nine member Zynga board is compromised for Rule 23.1 purposes and demand is excused. Thus, the dismissal of the complaint is reversed.

II.

The plaintiff alleges two derivative claims, each centering on allegations that certain top managers and directors at Zyn-ga—including its former CEO, Chairman,

The defendants moved to dismiss this action under Court of Chaheery Rule 23.1 for plaintiffs failure to make a pre-suit demand on the board.^[3] The Court of Chancery’s decision turned on its evaluation of the pleading stage independence of the Zynga board at the time the complaint was filed,^[4] which was comprised of the following nine directors: Mark Pincus, Reid Hoffman, Jeffrey Katzenberg, Stanley J. Meresman, William Gordon, John Doerr, Ellen Siminoff, Sunil Paul, and Don Mat-trick. In addressing demand excusal, the Court of Chancery applied the standard set forth in this Court’s decision in Rales v. Blasband^[5] to determine if at least five of Zynga’s nine directors were independent for - pleading stage purposes. The Court of Chancery first determined that the two directors who participated in the transaction, Pincus and Hoffman, were interested in the transaction, and therefore could not impartially consider a demand.^[6] The Court of Chancery then examined the independence of directors Katzenberg,

The Court of Chancery properly determined that directors Pincus and Hoffman were interested in the transaction. Furthermore, Mattrick is Zynga’s CEO. Zyn-ga’s controlling stockholder, Pincus, is interested in the transaction under attack, and therefore, Mattrick cannot be considered independent. Thus, the question for us is whether the plaintiff pled particularized facts that create a reasonable doubt about the independence of two of the remaining six Zynga directors.^[8] If the plaintiff convinces us that he did, then we must reverse the Court of Chancery’s dismissal under Rule 23.1. We review this question de novo.^[9]

On appeal, neither party contests the applicability of the Rales standard employed by the Court of Chancery. Therefore, we use it in our analysis to determine whether the Court of Chancery erred in finding that a majority of the board was independent for pleading stage purposes. To plead demand excusal under Rales, the plaintiff must plead particularized factual allegations that “create a reasonable doubt that, as of the time the complaint [was] filed, the board of directors could have properly exercised its independent and disinterested business judgment in responding to a demand.”^[10] At the pleading stage, a lack of independence turns on “whether the plaintiffs have pled facts from which 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.”^[11] “Our law requires that all the pled facts regarding a director’s relationship to the interested party be considered in full context in making the, admittedly imprecise, pleading stage determination of independence.”^[12] “[Although the plaintiff is bound to plead particularized facts in pleading a derivative complaint, so too is the court bound to draw all inferences from those particularized facts in favor of the plaintiff, not the defendant, when dismissal of a derivative complaint is sought.”^[13]

For many years, this Court and the Court of Chancery have advised derivative plaintiffs to take seriously their obligations to plead particularized facts justifying demand excusal.^[14] This case presents the unusual situation where a plaintiff who

A.

In conducting this analysis, we first focus on director Ellen Siminoff. The Court of Chancery found that Siminoff was independent even though she and her husband co-own a private airplane^[18] with Pincus.^[19] In his complaint, the plaintiff pled that “Siminoff and her husband have an existing business relationship with defendant Pincus as co-owners of a private airplane,”^[20] and in his briefing in the Court of Chancery, the plaintiff characterized Siminoff as a “close family friend” of Pincus,^[21] which the Court of Chancery took into account as if it was a pled fact.^[22] Had the plaintiff been more thorough in his research by using all of the “tools at hand,”^[23] including the tool provided by the

Although we acknowledge the difficult position that the Court of Chancery was placed in, we reach a different conclusion. The Siminoff and Pincus families own an airplane together. Although the plaintiff made some strained arguments below, it made one argument in relation to this unusual fact that does create a pleading stage inference that Siminoff cannot act independently of Pincus. That argument is that owning an airplane together is not a common thing, and suggests that the Pincus and Siminoff families are extremely close to each other and are among each other’s most important and intimate friends. Co-ownership of a private plane involves a partnership in a personal asset that is not only very expensive, but that also requires close cooperation in use, which is suggestive of detailed planning indicative of a continuing, close personal friendship. In fact, it is suggestive of the type of very close personal relationship that, like family ties, one would expect to heavily influence a human’s ability to exercise impartial judgment.^[26] As we noted recently, although a plaintiff has a pleading stage burden that is elevated in the demand excusal context, that standard does not require a plaintiff to plead a detailed calendar of social interaction to prove that directors have a very substantial personal relationship rendering them unable to act independently of each other.^[27] A plaintiff is only required to plead facts supporting an inference^[28] —or in the words of Rales, “create a reasonable doubt”^[29] —that a director cannot act impartially. Here, the facts support an inference that Siminoff would not be able to act impartially when deciding whether to move forward with a suit implicating a very close friend with

B.

We next turn to the plaintiffs argument that he created a reasonable doubt that two other directors—William Gordon and John Doerr—are not independent for pleading stage purposes. In his complaint, the plaintiff included the following facts pertaining to Gordon and Doerr: both are partners at Kleiner Perkins Caufield & Byers,^[30] which controls approximately 9.2% of Zynga’s equity;^[31] and, Kleiner Perkins is also invested in One Kings Lane, a company that Pincus’s wife co-founded.^[32] Not only that, defendant Reid Hoffman—an outside director of Zynga who was one of the directors and officers given an exemption to sell in the secondary offering—and Kleiner Perkins both have investments in Shopkick, Inc., and Hoffman serves on that company’s board along with yet another partner at Kleiner Perkins.^[33] These relationships, suggest the plaintiff, indicate that Gordon and Doerr have a mutually beneficial network of ongoing business relations with Pincus and Hoffman that they are not likely to risk by causing Zynga to sue them. Amplifying this argument, says the plaintiff, is the voice of Gordon’s and Doerr’s fellow Zynga directors who did not consider them to be independent directors. According to its own public disclosures, the Zynga board determined that Gordon and Doerr do not qualify as independent directors under the NASDAQ Listing Rules.^[34] Importantly, however, Zynga did not disclose why its board made this determination,^[35] and the plaintiff failed to request this information in its books and records demand.^[36]

Despite these factual allegations, the Court of Chancery found that Gordon and Doerr were independent for pleading stage purposes because the plaintiff failed to specifically allege why Gordon and Doerr lack independence under the NASDAQ rules, and the other circumstances pled by the plaintiff were “insufficient to question their independence • under Delaware law.”^[37] In so ruling, the Court of Chancery seemed to place heavy weight on the presumptive independence of directors under our law.^[38] But, to have a derivative suit dismissed on demand excusal grounds because of the presumptive independence of directors whose own colleagues will not accord them the appellation of independence creates cognitive dissonance that our jurisprudence should not ignore.

We agree with the Court of Chancery that the Delaware independence standard is context specific and does not perfectly many with the standards of the stock exchange in all cases,^[39] but the criteria NASDAQ has articulated as bearing on independence are relevant under Delaware law and likely influenced by our law.^[40] The

(A) a director who is, or at any time during the past three years was, employed by the Company;

(B) a director who accepted or who has a Family Member who accepted any compensation from the Company in excess of $120,000 during any period of twelve consecutive months within the three years preceding the determination of independence, other than the following:

(i) compensation for board or board committee service;

(ii) compensation paid to a Family Member who is an employee (other than an Executive Officer) of the Company; or

(iii) benefits under a tax-qualified retirement plan, or non-discretionary compensation.

Provided, however, that in addition to the requirements contained in this paragraph (B), audit committee members are also subject to additional, more stringent requirements under Rule 5605(c)(2).

(C) a director who is a Family Member of an individual who is, or at any time during the past three years was, employed by the Company as an Executive Officer;

(D) a director who is, or has a Family Member who is, a partner in, or a controlling Shareholder or an Executive Officer of, any organization to which the Company made, or from which the Company received, payments for property or services in the current or any of the past three fiscal years that exceed 5% of the recipient’s consolidated gross revenues for that year, or $200,000, whichever is more, other than the following:

(i) payments arising solely from investments in the Company’s securities; or

(ii) payments under non-discretionary charitable contribution matching programs.

(E) a director of the Company who is, or has a Family Member who is, employed as an Executive Officer of another entity where at any time during the past three years any of the Executive Officers of the Company serve on the compensation committee of such other entity; or

(F) a director who is, or has a Family Member who is, a current partner of the Company’s outside auditor, or was a partner or employee of the Company’s outside auditor who worked on the Company’s audit at any time during any of the past three years.

(G) in the case of an investment company, in lieu of paragraphs (A)-(F), a director who is an “interested person” of the Company as defined in Section 2(a)(19) of the Investment Company Act of 1940, other than in his or her capacity as a member of the board of directors or any board committee.^[41]

Most importantly, under the NASDAQ rules there is a fundamental determination that a board must make to classify a director as independent, a determination

We presume that the Zynga board did not lightly classify Gordon and Doerr as having a “relationship which, in the opinion of the Company’s board of directors, would interfere with the exercise of independent judgment in carrying out the responsibilities of a director.”^[44] And, although we do not know the exact reason the board made this determination,^[45] we do know this. In the case of a company like Zynga, which has a controlling stockholder, Pincus, who wields 61% of the voting power, if a-director cannot be presumed capable of acting independently because the director derives material benefits from her relationship with the company that could weigh on her mind in considering an issue before the board, she necessarily cannot be presumed capable of acting independently of the company’s controlling stockholder. That a director sits on a controlled company board is not, and cannot of course, be determinative of director independence at the pleading stage, as that would make the question of independence tautological. But, our courts cannot blind themselves to that reality when considering whether a director on a controlled company board has other ties to the controller beyond her relationship at the controlled company.

As to this reality, we consider it likely that the other facts pled by the plaintiff were taken into account by the Zynga board in determining that Gordon and Doerr were not independent directors. These facts include that: Gordon and Doerr are partners at Kleiner Perkins, which controls 9.2% of Zynga’s equity; Kleiner Perkins is also invested in One Kings Lane, a company co-founded by Pincus’s wife; and, Hoffman and Kleiner Perkins are both invested in Shopkick, and Hoffman serves on its board with another

Finally, consistent with our prior admonition, why the Zynga board determined that Gordon and Doerr are non-independent is precisely the sort of issue for which the use of a targeted request for books and records would have been helpful to the plaintiff, and thereby to both the Court of Chancery and us. The plaintiffs lack of diligence put the Court of Chancery in a compromised and unfair position to make an important determination regarding these directors’ pleading stage independence. That is regrettable, and the plaintiff is fortunate that his failure to do a pre-suit investigation has not resulted in dismissal.

Because we have determined that the plaintiff has met his pleading stage burden to create a reasonable doubt that a majority of the Zynga board could act impartially in considering a demand impheating Zyn-ga’s CEO and controlling stockholder, we reverse the Court of Chancery’s dismissal under Rule 23.1 and remand the matter for further proceedings consistent with this opinion.^[46]

dissenting:

In a thoughtful forty-two page opinion, the Chancellor determined that the plaintiff had failed to demonstrate that demand would have been futile with respect to the claims in the Complaint. For the reasons set forth herein, I would affirm his well-reasoned decision.

This is a close case, and the plaintiff did not aid his cause in failing to direct a books and records request to the issues bearing on the board’s independence.^[1] De

The plaintiffs arguments as to Gordon and Doerr’s alleged lack of independence arise from their positions as partners at Kleiner Perkins Caufield & Byers (“Klein-er Perkins”). The plaintiff alleged that Kleiner Perkins has (i) invested alongside Hoffman in a company co-founded by Pincus’s wife; (ii) invested in. a company of which Hoffman is a director; and (iii) completed two financings with Hoffman’s venture capital firm.^[4] As the Court of Chancery recognized, the plaintiff failed to plead any facts about the size, profits, or materiality to Gordon and Doerr of these investments or interests. Absent more, the relationships among these venture capitalists and entrepreneurs, as alleged, are not sufficient to raise a reasonable doubt as to Gordon and Doerr’s independence. Thus, I agree with the Chancellor’s view that their relationships and- overlapping investments do not rise to the level of creating a reasonable doubt as to their independénce.

As to Gordon’s and Doerr’s designation as “not independent” under the NASDAQ rules, the Court of Chancery correctly observed that independence under the NASDAQ rules is relevant to our analysis here but not dispositive.^[5] The plaintiff candidly acknowledged that he failed to allege why Gordon and Doerr lack independence under NASDAQ rules.^[6] As the trial court

In the demand futility context, directors are presumed independent,^[10] and it is the plaintiffs burden to plead facts “with particularity” showing that a demand on the board would have been futile.^[11] Given this burden of proof, the presumption of independence, and the lack of any explanation as to why Gordon and Doerr were identified as “not independent” for NASDAQ purposes, I do not believe that plaintiffs are entitled to an inference that Gordon and Doerr lack independence for purposes of the fact-specific demand futility determination here. This is particularly true given that the allegations concerning Gordon and Doerr’s interlocking business relationships fall short of suggesting that they are of a “bias-producing” nature.

As to director Paul, the plaintiff argues that Paul lacked independence from Pincus because they co-founded a company over twenty years ago and Pincus serves in an advisory role and is an investor in Paul’s company, SideCar.^[12] There are no allegations that demonstrate the materiality or magnitude of the present business relationship, which the plaintiff conceded could have been “[s]omewhere between 10 cents and $10 billion.”^[13] He also did not dispute the trial court’s statement that the company Paul and Pincus co-founded was sold approximately 15 years ago.^[14] Thus, based upon my review of the record,^[15] I would

Although I would not need to reach issues concerning Siminoffs independence had my view prevailed, I believe that a few points are worth making. The sum total of the allegations as to Siminoffs alleged lack of independence appear in paragraph 117(h) of the Complaint, which states that “Siminoff and her husband have an existing business relationship with defendant Pincus as co-owners of a private airplane and, therefore, Siminoff would not initiate litigation against her business partner defendant Pincus as it would substantially and irreparably harm, their ongoing business relationship.”^[16]

Before the trial court, both parties referred to statements in Zynga’s public filings with the Securities and Exchange Commission, although the Complaint did not expressly incorporate these statements by reference.^[17] In briefing on the defendants’ motion to dismiss or stay, the defendants attached a proxy statement in which Zynga disclosed the “relationship between Ms. •Siminoff and ¡her spouse and Mr. Pincus, who co-own a small private airplane, which was not used for Company travel.”^[18] The Chancellor also acknowledged an unsupported reference in the plaintiffs brief describing Siminoff as a “close personal friend” of Pincus. At oral argument on the defendants’ motion to dismiss, the Chancellor offered counsel for Sandys an opportunity to expand on the nature of the relationship, but counsel was unable to do so.^[19]

Given the plaintiffs failure to allege any specific facts as to the materiality of the co-owned asset (apparently a small plane, not a jet),^[20] whether there were other owners, or the nature of the Siminoff/Pincus relationship,^[21] I am sympathetic to the Chancellor’s view that “Plaintiffs allegations concerning co-ownership of an asset and friendship do not reveal a sufficiently

The Majority states that “the most likely inference” to draw from co-ownership of the small plane is “not that the private airplane was a business venture” but that there was “an extremely close, personal bond between Pincus and Siminoff’ and that “the Pincus and Siminoff families are extremely close to each other and are among each other’s most important and intimate friends.”^[23] 1 respectfully disagree given that the plaintiff has chosen to plead only a business relationship. Nothing more is alleged, let alone facts suggesting that kind of familial loyalty and intimate friendship.

To render a director unable to consider demand, a relationship must be of a “bias-producing nature.”^[24] In Beam, this Court reaffirmed that a reasonable inference cannot be made that a particular friendship raises a reasonable doubt “without specific factual allegations to support such a conclusion.”^[25] In Beam, this Court affirmed dismissal of a complaint that had pled that certain directors were a “longtime personal friend,” a “longstanding friend[,]” and had a “longstanding personal relationship with defendant Stewart.”^[26] Given this plaintiffs decision to allege the existence of a business relationship only, he is left to argue that co-ownership of a small airplane is simply the kind of fact that, in and of itself, creates a reasonable doubt as to Siminoff s independence from Pincus. This is a close call. Although it may be reasonable to infer some kind of collaborative relationship given the nature of the asset, I do not believe the bare allegation in the Complaint rises to the level of creating a reasonable doubt as to Siminoff s ability to carry out her fiduciary duties, to properly consider a demand, and to put at risk her reputation by disregarding her duties.

Thus, this case stands in contrast to Sanchez,^[27] for example, where the plaintiff pled that the director had a fifty-year friendship with the interested party, that the director’s primary employment (and that of his brother) was as an executive of a company over which the interested party had substantial influence, and the director made thirty to forty percent of his annual income from his directorship.^[28] Here, the bare reference to a “close friendship” appears only as an unsupported assertion in a brief.^[29] This unsupported and unverified reference should not be considered and should not serve as a basis upon which to draw any inferences. For me, this is not a mere technicality. Court of Chancery Rule 3(aa) requires that all complaints “be verified.”^[30] This means that every pleading

In Sanchez, we warned that, “[i]t is not fair to the defendants, to the Court of Chancery, or to this Court, nor is it proper under the rules of either court, for the plaintiffs to put facts outside the complaint before us.”^[32] We further cautioned that “this approach hazards dismissal with prejudice on the basis of a record the plaintiffs had the fair chance to shape and that omitted facts they could have, but failed to, plead.”^[33] Here, the plaintiff failed to heed that warning and unnecessarily complicated the task of both courts in exercising their best efforts to reach a just result.^[34] Even assuming that our law cannot “ignore the social nature of humans[,]”^[35] there is no equity here in asking the reviewing courts to speculate that the pleaded Siminoff/Pincus business relationship is of such a nature to render her beholden to him or so under his influence that her directorial discretion is sterilized.

Accordingly, because I would affirm the Court of Chancery’s decision, I respectfully dissent.