The Court Of Chancery Dismisses Derivative Suit Against TrueCar Officers And Directors, Finding Plaintiffs Failed To Allege Substantial Risk Of Liability By A Majority Of The Board – Corporate/Commercial Law

Under Court of Chancery Rule 23.1, a stockholder who wishes to
bring a derivative claim on behalf of a corporation must
“allege with particularity the efforts, if any, made by the
plaintiff to obtain the action the plaintiff desires from the
directors [of the company] or comparable authority and the reasons
for the plaintiff’s failure to obtain the action or for not
making the effort.” The latter concept is known as
“demand futility.”

In an opinion issued September 30, 2020, the Court of Chancery
dismissed a derivative consolidated complaint alleging that
officers and directors of TrueCar, Inc., anticipated the harmful
effect a partner’s website redesign would have on TrueCar’s
sales, and that certain defendants sold off their personal shares
before a November 2017 earnings report revealed the extent of the
harm, for plaintiffs’ failure to make demand upon the board or
to adequately plead demand futility.

TrueCar claims to offer prospective car buyers the
“true” market price for new and used vehicles. The
company is allegedly dependent on “affinity partner”
organizations that direct internet traffic to TrueCar’s
co-branded sites. One such partner, USAA Insurance, accounts for
almost one-third of TrueCar’s annual revenue. The complaint
alleged that, in January 2017, USAA decided to redesign its website
to de-emphasize car purchasing and access to TrueCar. The complaint
further alleged that TrueCar’s directors and officers were
aware that the redesign would have a negative impact on
TrueCar’s sales, but failed to disclose it while also
completing a secondary public offering of one million shares. The
company’s chief financial officer, chief accounting officer,
chief marketing officer, and chief legal officer sold millions of
their own TrueCar shares, generating significant personal
profits.

Notwithstanding the company’s previously positive public
filings, the company reported a $9.5 million net loss for the third
quarter of 2017 and announced that it would be reducing its sales
and revenue guidance for the year. Upon the announcement, the
company’s stock price had plummeted more than 35%.

In the derivative consolidated complaint, filed November 9,
2019, TrueCar stockholders asserted various derivative claims,
including breach of fiduciary duty, insider trading, unjust
enrichment, and aiding and abetting a breach of fiduciary duty
against current and former TrueCar officers and directors, along
with entities that sold stock in a 2017 secondary public
offering.

According to the court, “The threshold issue in this case
is whether plaintiffs’ failure to make a demand on the TrueCar
board to initiate litigation should be excused.” Dismissing
the suit in its entirety, the court found that plaintiffs
“failed to plead particularized facts sufficient to impugn the
ability of any of the members of the demand board, let alone a
majority, to have considered a demand impartially,” as
contemplated under Court of Chancery Rule 23.1. The court
determined that the allegations did not demonstrate that the
directors on which demand would be made (the “Demand
Directors”) knew about the USAA website redesign that was
implemented in June 2017 or its potential impact on TrueCar’s
financial performance until they were briefed on the issue at a
September 15, 2017, board meeting, or that they failed to
appropriately monitor the situation.

 

The court distinguished the Demand Directors’ knowledge from
company management’s, stating that “[t]he critical
question…is not when TrueCar’s management learned about the
website redesign, but when the members of the Demand Board were
informed about the redesign and understood its significance to
TrueCar’s financial performance.” The court noted that
“vague references” in board materials to underperformance
or a need to “re-energize” the company’s relationship
with USAA were not sufficient to infer that the board had knowledge
of the impending issues sufficient to give rise to a substantial
likelihood of liability for any of the claims. 
   

The court also determined that the plaintiffs failed to
“allege particularized facts to allow a reasonable inference
that TrueCar management provided reports to or otherwise informed
the Board about any expected changes to the USAA website at any
time before the Secondary Offering closed.” Therefore, to the
extent certain Demand Directors had participated in the offering,
the complaint did not support “a reasonable inference”
that any of them possessed material nonpublic information when they
traded, much less that they consciously acted to exploit such
information.”

Finally, the court rejected plaintiffs’ arguments that the
Demand Directors would be unable to impartially consider a demand
due to the existence of a parallel securities class action that
named several of the directors as defendants based on similar
allegations. The court found that “none of the six Demand
Board directors named in that case face a substantial likelihood of
liability in the Securities Class Action because they would be
exculpated for all the claims asserted against them” in that
action due to an exculpatory provision in the company’s charter
and because a settlement agreement executed in that action
“eliminated as a practical matter” any exposure to
personal liability. 

The opinion is significant because it clarifies the court’s
perspective on the level of detail required to sufficiently allege
demand futility and confirms that directors may be found to be
impartial based on lack of knowledge provided that they did not
ignore “red flags” or fail to appropriately discharge
their oversight duties.

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.