In re Yahoo! Inc. Shareholder Derivative Litigation
Docket: CASE NO. 11-cv-3269-CRB
Court: District Court, N.D. California; December 22, 2016; Federal District Court
An order has been issued by U.S. District Judge Charles R. Breyer, granting a motion to dismiss with prejudice in a case brought by the Iron Works Mid-South Pension Fund and Irving Lassoff, who are plaintiffs suing derivatively on behalf of Yahoo! Inc. The plaintiffs accuse Yahoo and ten named defendants, primarily members of the audit committee and Yahoo's Board, of four breaches of fiduciary duty: (1) disseminating false and misleading information; (2) consciously disregarding their oversight responsibilities; (3) failing to maintain internal controls; and (4) wasting corporate assets. Defendants moved to dismiss the complaint for two reasons: the plaintiffs did not adequately plead demand futility as required by Federal Rules of Civil Procedure 12(b)(6) and 23.1, and they failed to state valid claims for breach of fiduciary duty and corporate waste.
The factual background notes that Yahoo, a Delaware-incorporated digital media company, invested $1 billion in Alibaba Group in 2006 for a 40% share. This investment became Yahoo's most valuable asset, with analysts estimating its worth significantly exceeded Yahoo's market value by 2011. The plaintiffs assert that Yahoo's value depended on its Alibaba holdings, and the Board regularly reported on this investment in SEC filings. They allege that CEO Carol Bartz assured shareholders of ongoing evaluations of this investment, assisted by co-founder Jerry Yang and financial experts. The Stock Purchase and Contribution Agreement (SPCA) stipulated that Yahoo’s officers would be informed of material developments regarding Alibaba, including the appointment of directors to Alibaba's board.
Yahoo secured commitments from Alibaba and its Chairman, Jack Ma, to maintain Alibaba’s business structure, preserve tangible assets, and refrain from asset sales exceeding $500,000, with exceptions for ordinary inventory. Yahoo also obtained the right to veto any sale of Alibaba's Core Businesses, which included Alipay, an e-commerce payment processing system.
Alibaba operated under a Variable Interest Entity (VIE) arrangement, allowing non-Chinese investors to benefit from revenues while complying with Chinese regulations requiring local ownership for internet businesses. Following regulatory changes proposed by the People’s Bank of China (PBOC) in 2005 and subsequent revisions in 2010, Alibaba transferred technical ownership of Alipay to Zhejiang Alibaba E-Commerce Company Ltd., a Chinese entity majority-owned by Ma, while retaining de facto control through the VIE structure until early 2011.
On March 31, 2011, Alibaba notified Yahoo that it had terminated the VIE and fully transferred Alipay's ownership to Zhejiang, which led to deconsolidation of Alipay's financial results. Plaintiffs allege that Ma misappropriated Alipay without board approval and failed to secure necessary consents from Yahoo or Softbank, as required by the governing agreement. Yahoo later disclosed the restructuring of Alipay on May 10, 2011, after an investigation triggered by the March notification.
On May 10, 2011, Yahoo disclosed in a quarterly SEC filing that the ownership structure of Alibaba's online payment business, Alipay, was altered to facilitate regulatory licensing, with 100% of shares held by a majority-owned Chinese company controlled by Ma. Two days later, Yahoo announced it had been informed by Alibaba of the stock transfer, which occurred without the board's or shareholders’ knowledge. Following discussions with Alibaba, Yahoo stated that negotiations regarding the restructuring were ongoing.
On July 29, 2011, Yahoo entered into a Framework Agreement with Alibaba and other parties to address issues related to Alipay. This complex multi-party contract established the commercial relationship terms between Alibaba and Alipay, including preferential payment terms for Taobao lasting at least 50 years and a commitment to pay Alibaba between $2 billion and $6 billion during future liquidity events like an IPO. Plaintiffs claimed the agreement granted Ma control over the conditions for any triggering liquidity event and the services and fees owed to Alibaba before Alipay's ownership transfer.
The Framework Agreement mandated that Alibaba’s board ratify actions related to Alipay's ownership restructuring and exempted Ma and Yang from claims concerning it. In June 2011, a Class Action was filed by Yahoo stock purchasers, which was dismissed by the court on the grounds that Yahoo’s statements did not misleadingly represent Alipay’s value and that there was no obligation for further disclosure about the restructuring, given its ongoing nature. The Ninth Circuit upheld the dismissal.
Additionally, the complaint summarized allegations that Alipay, valued between $5 billion and $16 billion, was a critical asset for Yahoo. Following proposed regulations from the PBOC, Ma indicated his intent to divest Alipay without waiting for finalized regulations, while Yahoo's directors allegedly failed to act on their rights or to oppose Ma’s actions until 2011.
Plaintiffs argue that a pre-suit demand on the Yahoo Board would have been futile due to the Directors' substantial likelihood of liability for breaching fiduciary duties of loyalty and good faith. Specifically, they allege that the Directors failed to act against known threats to Yahoo’s assets and did not disclose regulatory risks associated with Yahoo’s stake in Alibaba, particularly regarding Alipay and potential divestment by Alibaba's CEO, Ma. Additionally, Plaintiffs contend that the Board's decision to release Yang via the Framework Agreement lacked a rational business purpose, questioning the validity of that business judgment.
In response, Defendants move to dismiss the Complaint, asserting that Plaintiffs have not sufficiently demonstrated demand futility or established claims for breach of fiduciary duty and corporate waste. They argue that Plaintiffs fail to show that a majority of the Directors would face liability for preventing Ma’s alleged misappropriation of Alipay or that any received personal benefits from the Framework Agreement. Defendants further claim that the Complaint lacks details on the involvement of individual Directors in allegedly misleading statements and does not prove any Director acted in bad faith or neglected their fiduciary duties. Lastly, Defendants argue that the approval of the Framework Agreement does not constitute corporate waste.
Defendants also request judicial notice of certain documents to support their motions, asserting these documents are either referenced in the Complaint or qualified for judicial notice under Federal Rule of Evidence 201, which allows courts to recognize facts that are not disputed and readily verifiable. They highlight that eleven of the fourteen exhibits are referenced in the Complaint and are not disputed by Plaintiffs, thus justifying their consideration by the Court. Exhibits not referenced, specifically Exhibits 1, 12, and 14, are also deemed subject to judicial notice.
Exhibit 1, Yahoo's articles of incorporation, is recognized for judicial notice in derivative actions, as established in prior case law, including Brown v. Moll and In re Computer Scis. Corp. Deriv. Litig. Exhibit 12, Alibaba's Prospectus, is also subject to judicial notice as an SEC filing, not for its truth but to demonstrate that a statement was made. Exhibit 14, detailing Yahoo's current directors from its website, is acknowledged due to its incorporation by reference and lack of reasonable dispute. The Court recommends judicial notice of Exhibits 1 through 14.
Plaintiffs admit they did not make a pre-suit demand to Yahoo's Board. Defendants argue for dismissal, asserting Plaintiffs failed to demonstrate that a majority of the Board was incapable of responding to such a demand, which leads to the Court's conclusion in favor of Defendants. The legal standard under Federal Rule of Civil Procedure 23.1 necessitates that a plaintiff detail any efforts made to obtain the desired action from directors and explain any failures. Delaware law governs this case because Yahoo is incorporated in Delaware, and courts assume directors act in good faith unless proven otherwise by the plaintiff. This burden requires specific factual allegations that are more demanding than those needed to survive a motion to dismiss under Rule 12(b)(6).
Delaware law provides two tests for assessing demand futility: the Aronson test and the Rales test.
Delaware courts utilize the Aronson test for derivative actions that challenge specific decisions made by a corporation's board, requiring plaintiffs to present particularized facts that raise reasonable doubts regarding the directors' disinterest or the validity of the business judgment exercised. Conversely, the Rales test applies when the derivative suit addresses breaches of the board's oversight duties. Under Rales, plaintiffs need only establish a reasonable doubt regarding the board's ability to exercise independent judgment at the time the complaint is filed, potentially excusing the need for pre-suit demand.
In the case at hand, plaintiffs argue that demand would be futile because the defendants would likely face substantial personal liability from pursuing the requested litigation and that there are doubts regarding the legitimacy of the board's decision to release a director without compensation. However, the court finds these arguments unpersuasive. The plaintiffs claim that Yahoo Directors' alleged false statements and failure to oversee investments justify excusing demand, needing to meet the Rales standard.
The plaintiffs assert that the Directors could be liable for improper statements regarding Yahoo's investment in Alibaba within a specific timeframe. The defendants counter that the plaintiffs have not demonstrated that a majority of the Directors face such liability. To succeed, plaintiffs must allege facts indicating fraudulent or bad faith conduct and demonstrate that the Directors acted with intent. The court notes that the plaintiffs' allegations mirror those in a prior class action, where the court determined the statements were not materially misleading. Furthermore, the plaintiffs fail to show that each Director acted with the requisite scienter regarding the alleged misleading statements.
Plaintiffs have not presented specific allegations demonstrating that the Yahoo Directors were aware of their failure to fulfill fiduciary responsibilities, thereby failing to prove that the Directors acted in bad faith or that demand would be futile. Their claims echo previous cases where insufficient particularity was shown regarding the Directors' knowledge of conflicting facts, as established in relevant precedents. The Complaint lacks sufficient evidence that the director defendants knew any disclosures were misleading or that they were deeply involved in the preparation of the contested disclosures. Conclusory assertions about their engagement do not meet Delaware law requirements for excusing pre-suit demand.
Additionally, Plaintiffs argue that demand would have been futile due to the Directors' alleged inaction regarding the misappropriation of Alipay, claiming the Directors ignored significant risks related to their stake in Alibaba. They identify five specific failures of oversight by the Directors, including not preventing Ma’s alleged misappropriation and ignoring red flags about this issue. The legal framework for these claims is rooted in the Caremark standard, which is challenging for plaintiffs to meet. To establish a Caremark claim, Plaintiffs must plead with particularity that red flags indicating problems were consciously ignored by the Directors. However, Delaware courts recognize that a director's duty to be informed does not necessitate detailed knowledge of all operational aspects. The core of the Caremark claim is based on a systematic failure of the board to exercise oversight in bad faith, which Plaintiffs assert occurred when Ma terminated Alibaba’s VIE arrangement with Alipay.
Plaintiffs have not sufficiently pleaded facts indicating that the Yahoo Directors consciously disregarded clear signs pointing to the potential misappropriation of Alipay. Their allegations mistakenly conflate a negative outcome with bad faith, relying on hindsight rather than providing specific facts that demonstrate a failure by the Board to implement or monitor Yahoo's internal controls, which resulted in company losses. The Court finds that this hindsight reasoning does not justify the demand for action.
Plaintiffs argue that proposed PBOC regulations regarding foreign ownership of payment processing companies constituted a warning that warranted action from the Yahoo Directors. They assert that after a September 2010 announcement regarding future rules, the Board should have acted to mitigate the risks posed by these regulations. However, by March 2012, it was still uncertain whether the total transfer of Alipay was necessary, as the regulations had not yet been finalized and the potential for a variable interest entity (VIE) structure remained.
Moreover, Plaintiffs claim that members of Yahoo's Audit Committee ignored warning signs related to Alipay's misappropriation. However, the Complaint lacks factual details about what the Audit Committee knew regarding these red flags. Delaware law does not support inferring a culpable state of mind based solely on board membership in an audit committee.
Finally, while Plaintiffs argue that the Board could have prevented the misappropriation by exercising its veto rights under the SPCA regarding Alibaba's core assets, it is noted that Ma unilaterally terminated the VIE without the necessary consent from Alibaba's board or stakeholders, thus undermining this argument.
A shareholder decision was made to divest from the Variable Interest Entity (VIE) and initiate compensation discussions with other shareholders. Plaintiffs claim that Yahoo Directors acted in bad faith by not stopping this unilateral action by Ma, but fail to present evidence of such bad faith. They argue that demand is excused because Yang, a Yahoo Director on Alibaba's board, was aware of Ma's intent to divest Alipay. However, the allegations lack factual support that Ma communicated any intention to terminate the VIE unilaterally. Ma’s prediction regarding government control of Alipay did not materialize, and he did not warn of unilateral action. Even if Yang had knowledge of Ma's intent, Delaware law does not allow the imputation of one director's knowledge to others for demand excusal. Therefore, the plaintiffs' claims do not excuse demand concerning any Yahoo Director.
Additionally, plaintiffs assert that the approval of the Framework Agreement constitutes waste, thereby excusing pre-suit demand. Under the Aronson test, plaintiffs must demonstrate reasonable doubt regarding the disinterest and independence of directors or the validity of the business judgment exercised. The business judgment rule presumes decisions are made in good faith for the company's benefit. Plaintiffs must provide specific facts to challenge this presumption, but they argue that the Framework Agreement's terms were significantly unfavorable compared to what Yahoo could have negotiated.
The Delaware Court of Chancery has rejected the Plaintiff's argument that the Board members should have leveraged the Company's position to obtain a more advantageous agreement. This type of hindsight critique is dismissed as insufficient to demonstrate demand futility without specific allegations of director interest, self-dealing, inadequate information, or bad faith. Business decisions made by the board are not subject to challenge merely because alternative choices could have been made. Courts are generally not equipped to evaluate the adequacy of consideration or to assess business risks retrospectively.
The Court noted that the Plaintiffs failed to present evidence that the Framework Agreement could have been obtained without the release, which provided benefits such as resolving uncertainties related to Alipay’s restructuring and potential financial gains for Yahoo. The Court emphasized that waste cannot be claimed if the corporation received any substantial consideration. The Plaintiffs’ disagreement with the Yahoo Directors’ decisions does not constitute waste, which is defined as irrationally squandering corporate assets.
Ultimately, the Court concluded that the Plaintiffs did not raise doubts regarding the validity of the Yahoo Directors’ business judgment in approving the Framework Agreement, thus not excusing demand on that basis or any other. The motion to dismiss the claims for breach of fiduciary duty and corporate waste was granted, as the Plaintiffs failed to state viable claims under the applicable legal standards. The Court reiterated that a complaint must present sufficient factual allegations to support a plausible claim for relief.
Courts must evaluate the entirety of the complaint and relevant documents when addressing Rule 12(b)(6) motions to dismiss, incorporating judicially noticeable matters (Tellabs v. Makor Issues, 551 U.S. 308, 322). Plaintiffs claim that Defendants breached their fiduciary duty through the dissemination of false information and neglecting oversight of Yahoo’s interests in Alipay. This claim mirrors an earlier demand futility claim, and the Court finds that Plaintiffs have not sufficiently demonstrated that the Directors’ alleged breaches justified excusal of demand or constituted a breach of fiduciary duty.
For a claim of corporate waste, Plaintiffs must show that a board's decision was egregiously irrational and not based on a valid assessment of the company's best interests (White, 783 A.2d at 554). Claims of waste require proof of an affirmative decision rather than mere inaction (Brehm, 746 A.2d at 263). Plaintiffs argue that the Directors wasted corporate assets by failing to secure adequate consideration for Yahoo's interest in Alipay, but this claim is flawed for three reasons: it is founded on inaction rather than a definitive decision, it incorrectly assumes a $46 million value for Alipay, and the Framework Agreement contradicts this by entitling Alibaba to significantly higher amounts in a liquidity event.
Ma denied the accuracy of the $46 million figure related to Alipay, questioning the logic of selling it at such a low price. Plaintiffs did not demonstrate that any Yahoo Director was aware of this figure. Their claim that the Yahoo Directors "irrationally squandered" potential claims against Ma lacked sufficient evidence to show that the Framework Agreement was excessively one-sided. The agreement provided Yahoo with consideration, allowing it to obtain a pro rata share of $2 billion to $6 billion from Alibaba's liquidity event for Alipay. The decision not to pursue claims against involved parties is considered a business judgment within the board's discretion. Consequently, the Court found that Plaintiffs failed to adequately plead facts indicating that the Framework Agreement constituted corporate waste. The Court granted the Defendants' Motions to Dismiss, ruling that the Plaintiffs did not establish demand futility or claims for breach of fiduciary duty and corporate waste, leading to the dismissal of the case with prejudice. The named Yahoo Directors, collectively referred to as the "Audit Committee Defendants," were listed, and it was noted that Plaintiffs had not served Jack Ma or attempted to do so despite asserting claims against him. The excerpt also highlighted that the adequacy of pleadings is assessed under federal law, while state law determines the sufficiency of reasons for not making a demand, emphasizing that the court only considers well-pleaded allegations and judicially-noticed facts at this stage.
Directors of Yahoo allegedly failed to either implement a robust reporting or information system, or, if such a system existed, consciously neglected to oversee its operations, leading to a lack of awareness regarding significant risks. Plaintiffs acknowledge that Yahoo had internal controls but argue that the Directors deliberately overlooked their responsibilities. The Plaintiffs contend that the Directors should have anticipated Jack Ma's unilateral misappropriation of Alipay, especially given Ma's persistent inquiries about repurchasing Yahoo's stake in Alibaba. However, the argument that Ma's attempts to buy shares indicated his intent to misappropriate Alipay is countered by the absence of conclusive evidence. The Plaintiffs also claim that Ma warned Yahoo's CEO, Yang, about the misappropriation, but this assertion is undermined by evidence from a magazine article that shows Ma was actually recounting a conversation with Softbank's CEO, not Yang. The Plaintiffs have acknowledged this inaccuracy yet continue to rely on it. Furthermore, the Plaintiffs introduce the "core operations inference" to suggest that Yang's knowledge of the misappropriation should be attributed to other board members due to its significance to Alibaba. However, this inference is not applicable in derivative litigation, as it only pertains to knowledge of one’s own company’s operations, not those of a subsidiary. The Plaintiffs have also abandoned any claims regarding the Directors’ disinterestedness and independence, which results in the waiver of those arguments.
Plaintiffs allege that the Yáhoo Directors were uninformed when they approved the Framework Agreement; however, this claim lacks specific factual support in the Complaint. Citing case law, the court notes that there are no allegations indicating the board was not adequately informed to make a decision. The plaintiffs have not established a reasonable doubt regarding the Board's informed decision-making. The court also references an article available online, which it judicially noticed in a related class action. For any amended complaint to succeed, the plaintiffs must demonstrate demand futility against Yahoo’s current board of directors, but this demand cannot be excused, as all but one director joined after the relevant events. The court concludes that plaintiffs have not presented any facts that would allow for amendment to address the identified deficiencies in the Complaint, leading to the dismissal of the derivative action without leave to amend.
