In In re Kraft Heinz Demand Refused Derivative Stockholder Litigation, C.A. No. 2022-0398-LWW (Del. Ch. July 19, 2024), the Court of Chancery granted a motion to dismiss a derivative complaint filed by stockholders of Kraft Heinz who alleged fiduciary duty claims arising out of: (i) the company's February 2019 disclosure of a $15.4 billion non-cash impairment to goodwill and intangible assets; and (ii) a stock sale by a significant stockholder of the company, which preceded the impairment disclosure by approximately six months. The stockholders sought to pursue these claims notwithstanding the board's rejection of their litigation demands, following a two-year investigation by the administrative working group formed in response to the demand. The Court of Chancery dismissed the complaint pursuant to Rule 23.1, holding that the stockholders had failed to carry their heavy burden of establishing wrongful refusal.
Background
The Kraft case arose out of an August 2018 stock sale by a significant stockholder of the company (3G), which was followed, six months later, by the company's February 2019 disclosure of a $15.4 billion impairment charge. Months prior to the impairment disclosure, the company had received: (i) a July 2018 document preservation request from the SEC about procurement and impairment-related issues; and (ii) an October 2018 subpoena from the SEC relating to the company's procurement practices.
In the wake of the impairment disclosure, a federal securities class action complaint was filed against certain of the company's officers/directors (which had survived a motion to dismiss before a settlement was reached). A prior derivative action had also been filed in the Court of Chancery in July 2019, which was dismissed for failure to plead demand futility. See generally In re Kraft Heinz Co. Deriv. Litig., 2021 WL 6012632 (Del. Ch. Dec. 15, 2021), aff'd, 282 A.3d 1054 (Del. 2022) (TABLE).
The litigation demands are refused after the working group's two-year investigation
The stockholders in the demand-refusal action delivered their litigation demands to the board before the resolution of the prior demand-futility action. The stockholders demanded that the board investigate (and, if appropriate) pursue fiduciary duty claims against 3G and certain officers/directors of the company in connection with 3G's stock sale and the subsequent impairment disclosure.
In response to the demands, the board formed an administrative working group comprised of two outside directors (Pope & Mulder) to investigate the stockholders' allegations. The working group engaged in a two-year investigation, aided by legal advisors (Simpson Thatcher and Young Conaway) and a forensic accounting advisor (AlixPartners). After this extensive investigation, the working group refused the demands, concluding it was not in the company's best interests to pursue the claims alleged therein. The working group determined there was no evidence that applicable law had been violated, with the "potential exception" of two executives against whom some "more colorable" allegations had been made; even respect to these executives, the working group concluded that it would be imprudent to assert claims against them, based on practical considerations.
The stockholders attempt (but fail) to establish wrongful refusal of their demands
Following the refusal of their demands, the stockholdersfiled suit, asserting: (i) fiduciary-based claims (including aiding and abetting claims) against 3G for allegedly trading on the basis of material, non-public information, on the theory that 3G constitutes a controlling stockholder who owes fiduciary duties; and (ii) oversight- and disclosure-based fiduciary claims against officers/directors of the company.
To avoid dismissal pursuant to Rule 23.1, the stockholders bore the heavy burden of establishing wrongful refusal. Because, under well-established Delaware law, the board's rejection of a litigation demand was entitled to the deferential business judgment rule (by default). Accordingly, the stockholders could only avoid dismissal if they pled "particularized facts which, taken as true, raise[d] a reasonable doubt that the refusal was a valid exercise of business judgment." But establishing wrongful refusal is no easy task, especially because the service of a litigation demand constitutes a tacit admission that a majority of the board is capable of disinterestedly and independently evaluating the demand.
The stockholders tried to establish demand refusal by arguing, among other things,that: (i) the working group suffered from "structural flaws" that undermined the board's independence and good faith in responding to the demands; and (ii) the working group's rejection of the demands was based on a grossly negligent and bad faith "flawed process."
As to the so-called "structural flaws," the stockholders argued that the board "should have delegated its decision-making authority over the demands to an independent committee" instead of forming an administrative working group. But, as observed in the opinion, "[t]here is no set path a board must take in assessing and responding to a litigation demand" and, as such, the board "was not required to vest [a] committee with its full decision making authority."
The stockholders also argued that the working group was "hopelessly conflicted" because one of its members (Pope) faced a substantial likelihood of liability for oversight- and disclosure-based fiduciary duty claims alleged in the operative complaint. The Court handedly rejected this argument, summarizing its reasoning as follows:
The stockholders' substantial-likelihood argument failed (as to both claims) because they did little more than allege that Pope was the Chairman of the Audit Committee during the relevant events. This allegation was backstopped by generalized allegations that Pope: (i) attended during board and committee meetings where distressed reporting units, trademarks, and brands suffering from impairment risks were discussed; (ii) "caused" the company to issue "Form 10-Ks in 2017 and 2018 that made disclosures about impairment testing; and (iii) knew about the company's ineffective impairment testing and covered it up and/or allowed it to continue. The Court explained why these allegations fell well short of the particularity required under Rule 23.1:
Pleading that a director ... caused or allowed the [c]ompany to issue certain statements is not sufficient particularized pleading under Rule 23.1. Nor is merely alleging that a director served on a committee tasked with overseeing matters within which a corporate trauma occurred. Even if the allegations suggest that Pope understood [the company] was facing business headwinds or approaching impairment triggers, I cannot reasonably conclude that he knew misconduct was occurring or that [the company's] public statements were untrue. Any such inference is further undercut by the [stockholders'] acknowledgement that Pope contemporaneously relied on reports of officers and outside advisors.
The stockholders' arguments regarding the working group's "flawed process" fared no better. In an attempt to establish gross negligence (and, therefore, bad faith), the stockholders argued that the working group improperly failed to obtain 3G's internal documents, relied on prior investigatory materials, and reached conclusions that were "contradicted by evidence and common sense." As to the adequacy of the investigation, the Court explained that the "critical inquiry is whether the directors neglected to consider material facts that are reasonably available." And the stockholders failed to offer any non-speculative arguments on this issue. The Court also noted the absence of any "well-pleaded facts contradicting [the working group's conclusions]," despite the stockholders' insistence that these conclusions defied "common sense." As explained in the opinion, "mere disagreement with the [working group's] ultimate conclusion, as well as its subsidiary conclusions leading thereto, will be insufficient to raise a reasonable doubt that the [board] acted in good faith and on an informed basis."
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