Delaware Supreme Court Ruling in Zynga: Reasonable Doubt of Director Independence

The following post is based on a ThomsonReuters Practical Law publication, and is part of the Delaware law series; links to other posts in the series are available here.

For the second time in the last 14 months, the Delaware Supreme Court has reversed a decision by the Court of Chancery to dismiss a complaint for failure to plead demand excusal under Court of Chancery Rule 23.1. In Sandys v. Pincus (“Zynga”), the Supreme Court, in a majority opinion, held that the derivative plaintiff had pleaded enough particularized facts to raise a reasonable doubt that a majority of the directors of Zynga, Inc. could impartially consider a pre-suit demand on the board (2016 WL 7094027 (Del. Dec. 5, 2016)). In particular, the Supreme Court held that:

  • A director’s co-ownership of a private airplane with the former CEO and controlling stockholder of the company was enough to raise reasonable doubt as to that director’s independence.
  • A network of business relationships and venture capital investments between two other directors and the controlling stockholder raised a reasonable doubt as to those directors’ impartiality as well.

The decision, particularly when read together with the Supreme Court’s opinion in Sanchez, illustrates the Supreme Court’s more apparent readiness to find grounds for demand futility on the basis of shortcomings in a director’s impartiality than the Chancery Court has found in the past (see Del. Cty. Emps. Ret. Fund v. Sanchez, 124 A.3d 1017 (Del. 2015)).


The plaintiff alleged two derivative claims, each centering on allegations that certain top officers and directors at Zynga—including its former CEO, Chairman, and controlling stockholder Mark Pincus—were given an exemption to the company’s rule forbidding sales by insiders until three days after an earnings announcement. According to the plaintiff, top Zynga insiders sold shares for $236.7 million as part of a secondary offering before Zynga made an earnings announcement on April 26, 2012. The plaintiff alleged that these insiders sold their shares at $12.00 per share and that, immediately after the earnings announcement, the market price dropped to $8.52. Three months later, following the release of additional negative information (which the plaintiff alleged was known by Zynga management and the board when it granted the exemption), Zynga’s market price declined further, to $3.18 per share. More background information is detailed in Practical Law Legal Update, Lee v. Pincus: Loyalty Claim Survives Against Zynga Board for Authorizing Waivers of Post-IPO Lock-Ups.

In the suit at issue, the plaintiff alleged that the insiders who participated in the sale breached their fiduciary duties by misusing confidential information when they sold their shares while in possession of adverse, material non-public information. The plaintiff also asserted a duty of loyalty claim against the directors who approved the sale. In response, the defendants brought a motion to dismiss based on the plaintiff’s failure to make a pre-suit demand on the board. On February 29, 2016, the Court of Chancery granted the motion (Sandys v. Pincus, 2016 WL 769999 (Del. Ch. Feb. 29, 2016)).

In that decision, the Chancery Court analyzed the independence of the nine members of Zynga’s board as of when the complaint was filed. In so doing, the court applied the Rales test, which asks whether the plaintiff has pleaded facts indicating that, at the time the plaintiff filed the complaint, a reasonable doubt existed that a majority of the board (in this case, five out of nine directors) could have exercised its business judgment when responding to the stockholder’s demand (Rales v. Blasband, 634 A.2d 927, 934 (Del. 1993)).

The Chancery Court held that the two directors who participated in the transaction, Mark Pincus and Reid Hoffman, were interested in the transaction and therefore could not impartially consider a demand. The court then examined the independence of five other directors—Jeffrey Katzenberg, Stanley Meresman, William Gordon, John Doerr, and Ellen Siminoff—and held that all five of these directors were independent. Having made that determination, the court did not analyze the independence of the remaining two directors and ruled that demand was not excused.


On appeal, the Supreme Court, in a majority opinion, held that the plaintiff had pleaded particularized facts raising a reasonable doubt as to directors Siminoff, Gordon, and Doerr. Consequently, the Supreme Court reversed the Chancery Court’s dismissal under Rule 23.1 and remanded the matter for further proceedings.

Under Delaware law, establishing a lack of independence at the pleading stage requires sowing doubt as to a director’s ability to act impartially on a matter because the director “may feel either subject to the interested party’s dominion or beholden to that interested party” (Sanchez, 124 A.3d at 1024 n.25). However, a director is presumed to be independent even when appointed by a controlling stockholder or other interested party (Aronson v. Lewis, 473 A.2d 805, 816 (Del. 1984)). Bare allegations that a director is friendly with or has had past business relationships with the controlling stockholder who is a proponent of the transaction are not enough to rebut the presumption of independence. At the same time, the Supreme Court in this decision reemphasized its guidance in Sanchez that while the plaintiff must plead particularized facts to establish demand futility, the court must draw all inferences from those particularized facts in favor of the plaintiff, not the defendant, when dismissal of a derivative complaint is sought (Sanchez, 124 A.3d at 1022).

In its decision, the Supreme Court admonished the plaintiff for not making enough use of the tools available to it to investigate the board’s independence, including both requesting books and records that bear on that issue and using “the tool provided by the company whose name has become a verb.” This, the Supreme Court stressed, made the Chancery Court’s decision unduly difficult. Nevertheless, the Supreme Court held that the plaintiff had pleaded enough facts to satisfy the Rales test.

Co-Ownership of Private Airplane as Grounds for Reasonable Doubt

In finding a reasonable doubt as to director Siminoff’s independence, the Supreme Court focused on one salient fact: the Siminoff family’s co-ownership of a private plane with Pincus’s family. In the majority’s opinion, this reflected not only a business venture between the two directors, but an “extremely close, personal bond” between them. Owning an airplane is “not a common thing,” in the court’s words, but entails “detailed planning indicative of a continuing, close personal friendship.” Importantly, the court added that a plaintiff does not have to plead a “detailed calendar of social interaction” to demonstrate a substantial personal relationship that could undermine one’s impartiality. A plaintiff is only required to plead facts supporting an inference, or a reasonable doubt, that a director cannot act impartially. In the majority’s opinion, the co-ownership of a private plane is suggestive of the type of relationship that would be expected to “heavily influence a human’s ability” to exercise impartial judgment.

VC Relationships as Grounds for Reasonable Doubt

In arguing that reasonable doubt existed as to the impartiality of directors Gordon and Doerr, the plaintiff highlighted the following facts:

  • Both are partners at Kleiner Perkins Caufield & Byers, which controls approximately 9.2% of Zynga’s equity.
  • Kleiner Perkins is also invested in One Kings Lane, a company that Pincus’s wife co-founded.
  • 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.

The plaintiff added that the Zynga board itself had determined that Gordon and Doerr do not qualify as independent directors under the NASDAQ Listing Rules. Undermining this factor somewhat was that the company had never disclosed why its board made that determination, and the plaintiff had never investigated that issue through a books and records demand.

In spite of the business relationships among the various directors, the Chancery Court found that Gordon and Doerr were independent for pleading-stage purposes. The Chancery Court held that the plaintiff had not alleged why Gordon and Doerr lacked independence under the NASDAQ rules and had not raised any other questions about their independence. In so ruling, the Chancery Court placed a great deal of emphasis on the presumption of independence of directors under Delaware law. However, the Supreme Court warned that to dismiss the suit because of the presumptive independence of directors whose own colleagues would not consider them independent “creates cognitive dissonance that our jurisprudence should not ignore.”

The Supreme Court acknowledged that the NASDAQ’s criteria for independence do not match perfectly with the Delaware standard. However, the bottom line of those criteria is that a director is not independent if he has a relationship that, in the board’s opinion, would interfere with his exercise of independent judgment in carrying out his responsibilities as a director. The court stressed that a finding by the director’s own board that that director cannot be expected to consider an issue independently of the benefits he gets from his relationship with the company ought to bear on the similar question of whether that director can act independently of the company’s controlling stockholder. The court therefore held that while the company had not disclosed why its board had determined that Gordon and Doerr were not independent for NASDAQ Listing Rules purposes, it was likely because of the facts pled by the plaintiff.

The defendants argued that to the contrary, the network of investments among the various directors should prove that Pincus is beholden to Gordon, Doerr, and Kleiner Perkins for financing, not the other way around. To this the court responded that the reality is that firms like Kleiner Perkins compete to finance talented entrepreneurs like Pincus, and networks arise of “repeat players who cut each other into beneficial roles in various situations.” It is therefore reasonable to expect that people will act to protect those relationships, to the point where that instinct will affect their ability to act adversely toward each other.

Dissenting Opinion

Justice Valihura dissented from the majority opinion, holding that the Chancery Court’s opinion should have been affirmed. In the main, Justice Valihura emphasized that:

  • There was no proof that the private plane co-owned by Siminoff and Pincus was anything more than a business venture or that it was material to them.
  • The plaintiff had pleaded no facts establishing the size, profits, or materiality to Gordon and Doerr of the various Kleiner Perkins investments.
  • A board’s determination that certain directors do not qualify as independent under the NASDAQ Listing Rules is relevant but not dispositive. The courts have held that a director was independent for demand-futility purposes even if that director would not qualify as independent under the relevant stock exchange rule (see Teamsters Union 25 Health Serv. & Ins. Plan v. Baiera, 119 A.3d 44, 61 (Del. Ch. 2015)).

Practical Implications

As observed after the Delaware Supreme Court’s reversal in Sanchez, the court’s decision in Zynga signals something of a departure from the approach that the Court of Chancery has frequently taken when considering allegations of director dependence in the context of a motion to dismiss. (For more on the Sanchez decision and its implications, see Practical Law Legal Update, Delaware Supreme Court Reverses Chancery Court in “Sanchez Energy,” Finds Reasonable Doubt of Director Independence.)

The Chancery Court frequently delves into the materiality of a director’s business relationships with the controller before finding a reasonable doubt as to impartiality, much in the way that the dissenting opinion in Zynga advocated doing. Yet the majority opinion took the network of venture capital investments among the directors as enough on its own to raise a reasonable doubt that the two directors would risk harming their ongoing relationship with Pincus for the sake of pursuing the plaintiff’s derivative complaint. This view of human psychology may indeed be more credible or realistic, but it differs from the Chancery Court’s approach all the same.

Even more surprising is the finding of reasonable doubt as to a director’s impartiality on the basis of nothing more than the co-ownership of a private plane. Once again, the majority’s intuition into the meaning of the plane may be clearer than the Chancery Court’s was, but the decision still stands out from the many others that have preceded it.

Ultimately, the decision signals that each case can only be determined on the specific facts, and that a plaintiff is best served by using the tools available to it to investigate the grounds it may have for demand futility.

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