In Shabbouei v. Potdevin, the Delaware Court of Chancery granted a motion to dismiss a stockholder derivative complaint alleging that the board of directors of lululemon athletica inc. breached its fiduciary duties and committed corporate waste by paying $5 million in severance to its CEO who was engaged in pervasive misconduct, rather than terminating the CEO’s employment for cause.  In essence, the shareholder complained that the board of directors acted too slowly in uncovering and addressing the CEO’s misconduct, and subsequently acted too quickly in deciding to negotiate a settlement rather than firing the CEO outright. The Delaware Court of Chancery dismissed the plaintiff’s claims for failure to meet the Rule 23.1 demand futility standards.

Full Analysis

In Shabbouei v. Potdevin, the Delaware Court of Chancery granted a motion to dismiss the shareholder derivative complaint alleging the board of directors (the “Board”) of lululemon athletica inc. (“lululemon”) breached its fiduciary duties and committed corporate waste by paying $5 million in severance to its CEO, Laurent Potdevin, who was engaged in pervasive misconduct, rather than terminating the CEO’s employment for cause.  In essence, the Plaintiff shareholder (the “Plaintiff”) complained that the Board acted too slowly in uncovering and addressing the CEO’s misconduct and subsequently acted too quickly in deciding to negotiate a settlement rather than firing the CEO outright.

While lululemon’s press release vaguely states Potdevin resigned for behavior that “fell short of the company’s standards,” Plaintiff’s complaint set forth allegations that Potdevin “created a toxic culture at lululemon and engaged in a pattern and practice of harassment and sexual favoritism.” In addition, Potdevin allegedly expressed “patriarchal beliefs of male superiority,” filled lululemon’s executive positions with men and turned the executive team “into a boy’s club.”  Plaintiff alleges that this boy’s club would gather and drink alcohol and engage in illicit drug abuse.

Plaintiff’s complaint attempts to characterize the Board’s decision to enter into the separation agreement with Potdevin as either (i) not a product of a valid business judgment, (ii) an interested transaction, or (iii) corporate waste.

Addressing Plaintiff’s first argument, the Delaware Court of Chancery found the Plaintiff’s complaint failed to allege facts to support a reasonable inference that the Board’s decision to pursue a quiet separation with Potdevin with a $5 million severance agreement was not the product of valid business judgment.  Under the business judgment rule, if a director makes a decision (i) in good faith, (ii) with the care that a reasonably prudent person would use and (iii) with the reasonable belief that the director is acting in the best interests of the corporation, then courts will uphold the director’s decision and not impose liability on the director for the claim that the director violated the director’s duty of care.  Because lululemon’s charter contained exculpatory language, the court determined if the Board’s decision was “so egregious on its face that Board approval cannot meet the test of business judgment.”  The exculpatory language in lululemon’s states that its directors “shall not be personally liable to [lululemon] or its stockholders for monetary damages for breach of fiduciary duty as a director except for liability (a) for any breach of the director’s duty of loyalty to [lululemon] or its stockholders, (b) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law (c) under Section 174 of the DGCL, or (d) for any transaction from which the director derived an improper personal benefit.” The business judgment rule prevents Delaware courts from evaluating whether decision-makers made “right” or “wrong” decisions.  Instead, courts focus on the process employed to make the decision.  As such, the Plaintiff needed to plead facts that were “predicated upon concepts of gross negligence” in order to avoid the business judgement rule and find the Board liable for breaching its duty of care.  The court found the Board acted reasonably by deciding to negotiate with Potdevin and the Board did not have a duty to terminate Potdevin’s employment for cause.  Addressing the Plaintiff’s argument that the Board was too slow in addressing Potdevin’s misconduct, the court found it was the Board’s “prerogative to decide when it had enough information to decide how to separate Potdevin from the company.”

The second argument that the Plaintiff asserted was that the Board was “self-interested” in the CEO’s severance agreement because the “agreement was an artifice designed to shield the Board from oversight liability.”  In order to prove this, the court stated that the Plaintiff needed to meet the standard set forth in Aronson v. Lewis, 473 A.2d 805 (Del. 1984) by pleading particularized facts to support a reasonable inference that at least 5 of the 10 Board members (a) appeared on both sides of the severance agreement, (b) derived a personal financial benefit from it in the sense of self-dealing or (c) were beholden to an interested person.  To demonstrate this, the court stated that there needed to be facts supporting an inference that the severance agreement extinguished a substantial likelihood of Board liability.  To the court, only then would there be a significant personal impact on the Board members, making it unlikely that the Board could perform its fiduciary duties to shareholders without being overridden by personal interests.  The court noted that lululemon (i) established an ethics code, (ii) made available a whistleblower hotline, (iii) launched an internal investigation, (iv) hired outside counsel to conduct an outside investigation and (v) formed a subcommittee of the Board to handle the investigations, and then used those systems to detect Potdevin’s misconduct.  The court concluded that since it was not conceivable that the Board failed to establish oversight, the Board was not likely to be acting in self-interest to shield itself from oversight liability.  The court further noted that it is well-settled in Delaware law that the company obtaining a general release in a settlement agreement with the CEO would not result in the agreement being treated as an interested party transaction.

The third argument that the Plaintiff asserted was that the severance agreement constituted corporate waste.  Plaintiff argued Potdevin would not have been able to mount a legal challenge against a “for cause” termination and as such, the decision to pay him $5 million was unwarranted.  The court stated that the Plaintiff needed to plead facts to allow a reasonable inference that the severance amounted to a “transfer of corporate assets that served no corporate purpose, or for which no consideration at all was received.”  The court first pointed out that just because Potdevin likely did not have a good argument against being terminated for cause, it does not mean that Potdevin could not have mounted a very public challenge of the dismissal.  The court then pointed out that the severance agreement required Potdevin to release all claims against the company and secured an extended non-solicitation covenant, both of which are undeniably corporate benefits.  As a result, the court found that Plaintiff’s argument failed to present a claim of corporate waste.

This case shows an unwillingness of Delaware courts to overturn board decisions and recognizes that there is “no single blueprint a board must follow to satisfy its fiduciary duties.” In this case, the court found that lululemon’s response to misconduct by (a) launching an internal investigation, (b) hiring outside counsel to conduct an outside investigation, (c) forming a Board subcommittee regarding the investigation, and (d) considering of the impact on the company’s brand to be laudable.  In the wake of the #MeToo movement, prudent companies will take note of these judicially approved processes for dealing with misconduct and harassment.

Full case text is available here.