On August 14, 2024, Judge Michael T. Liburdi of the United States District Court for the District of Arizona granted with leave to amend a motion to dismiss a shareholder derivative suit brought in the name of the company, a buyer and seller of residential properties (the "Company"), against numerous current and former directors and officers of the Company as well as directors of the special purpose acquisition company—or SPAC—through which the Company went public (the "Individual Defendants"). Gera v. Palihapitiya, et al., CV-23-02164-PHX-MTL (D. Ariz. Aug. 14, 2024). Plaintiff asserted a claim under Section 14(a) of the Securities Exchange Act of 1934 (the "Exchange Act") and SEC Rule 14a-9 thereunder.
The Company went public via a de-SPAC merger in late 2020 pursuant to a merger proxy statement filed on November 30, 2020. The proxy statement allegedly included a post-merger compensation plan for the Company's officers and directors—including some of the Individual Defendants—that made them eligible for stock awards but did not affirmatively grant stock awards. Shareholders approved the merger proxy statement. Subsequently, the Company filed post-merger proxy statements in 2021 and 2022 that allegedly contained various proposals related to executive compensation, among other things, and shareholders approved those proxy statements as well. Plaintiff alleged that the merger proxy statement as well as post-merger annual proxy statements contained misleading statements and omissions, which caused shareholders to approve the merger and the post-merger proposals, and that the Company suffered and will continue to suffer harm as a result. Namely, plaintiff alleged that the merger proxy statement (1) misrepresented the ability of the Company's pricing algorithms to accurately predict home values and failed to disclose other alleged technological issues, (2) misrepresented the pre-merger due diligence efforts, (3) misrepresented the value of the SPAC company's shares, and (4) failed to disclose certain financial ties of the SPAC company's board of directors to founder shares. Plaintiff made similar allegations regarding the post-merger proxy statements, while adding allegations of (5) misconduct in bringing about the merger, (6) certain fraudulent business practices, (7) the Company's failure to follow its own code of conduct, and (8) the Individual Defendants' disregard of their role in risk oversight. Plaintiff did not make a demand on the Company's board of directors before filing the derivative suit.
The Court granted defendants' motion to dismiss on the grounds of plaintiff's failure to allege demand futility and plaintiff's use of puzzle pleading.
As to demand futility, the Court observed that, having failed to make a demand of the Company's board of directors, plaintiff's suit "may proceed only if she has alleged with particularity that demand would have been futile as to a majority—in this case, five—of [the Company's] board of directors at the time that the suit was filed." The Court held that plaintiff could not meet this burden because she did not adequately allege that five of the directors (i) received a material benefit from the alleged misconduct; (ii) faced a substantial likelihood of liability on the claims; or (iii) lacked independence from someone who received a material benefit or faced a substantial likelihood of liability.
First, the Court held that the post-merger compensation plan for the Company's officers and directors—which made them eligible for stock awards but did not affirmatively grant stock awards—could not qualify as a material benefit. The Court noted that under the applicable state law (Delaware) "an incentive-based compensation plan must do more than merely enable future stock awards to constitute a material personal benefit" and that "eligibility for future awards does not guarantee an award, and thus provides no certain benefit."
Second, the Court held that plaintiff failed to allege any non-exculpated conduct that could give rise to individual liability for the claims at issue. The Company's certificate of incorporation includes an exculpatory provision that eliminates director liability for any breach of fiduciary duties as a director, except to the extent not permitted under the Delaware General Corporation Law. The Court found that all of the alleged conduct of the directors fell within the exculpatory clause, and thus the director defendants did not face a substantial likelihood of liability.
Third, the Court held that plaintiff failed to adequately allege a lack of independence of any director from someone who received a material benefit or faced a substantial likelihood of liability. To the extent plaintiff alleged that certain of the Individual Defendants were beholden to directors as to whom the Court had already held that plaintiff had failed to allege a material benefit or substantial likelihood of liability, the lack of independence allegation also necessarily failed. The Court also held that, as to one director whom plaintiff alleged lacked independence from non-director defendants, plaintiff failed to allege particular facts to create reasonable doubt that his "discretion has been sterilized by his dependence upon those Defendants" (even assuming arguendo that this prong of the demand futility test could be met by alleging lack of independence from non-directors).
Finally, the Court held that plaintiff employed impermissible puzzle pleading and thereby failed to state a claim under Section 14(a) and Rule 14a-9. Specifically, the Court found that plaintiff copied large blocks of text from the proxy statements without specifying the allegedly false or misleading statements and thus impermissibly placed "the burden on the reader to sort out the statements and match them with the corresponding adverse facts to solve the 'puzzle' of interpreting plaintiff's claims." Such pleading, the Court held, violates the PSLRA and Rule 8(a).
Links & Downloads
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.