Delaware Business Litigation Report

Court of Chancery Grants In Part Motion To Dismiss Class and Derivative Complaint

Khanna v. McMinn, C.A. No. 20545-NC, 2006 WL 1388749 (Del. Ch. May 9, 2006). Defendants moved to dismiss class and derivative complaint under Court of Chancery Rules 23.1 and 12(b)(6). Defendants also moved to disqualify the plaintiffs, to strike portions of the complaint and for continued sealing of the complaint. Plaintiff David Khanna for a co-founder. shareholder and former general counsel of Covad Communications Group, Inc. ("Covad"). After Khanna was removed from his position as a result of sexual harassment charges, he sent a letter to the board outlining alleged breaches of fiduciary duty and demanding certain benefits for himself. The board formed a special committee that investigated the claims and concluded litigation was not warranted. Khanna and two other Covad shareholders instituted the litigation, asserting direct and derivative claims against current and former directors of Covad arising from various transactions. First, the Court rejected the defendants' argument that Khanna had conceded the disinterestedness and independence of the board by making demand on the board in the form of his letter. The Court concluded that the actions sought by Khanna in the letter related to his employment status at Covad and were personal to Khanna. Second, the Court addressed whether the plaintiffs had established futility of demand under Court of Chancery Rule 23.1. The Court held that the plaintiffs failed to plead particularized allegations creating a reasonable doubt as to the reasonableness and disinterestedness of at least half the Covad board under the first prong of Aronson or Rales. However, the Court held that the plaintiffs established demand futility under the second prong of Aronson for some of the challenged transactions by creating a reasonable doubt that those transactions were otherwise the product of a valid exercise of business judgment. The Court also refused to dismiss aiding and abetting claims arising from one of the challenged transactions where plaintiffs had established demand futility, but dismissed respondeat superior claims. Third, the Court dismissed some of the plaintiffs' disclosure claims under the doctrine of laches and the remaining disclosure claims for failure to state a claim. Fourth, the Court denied the defendants' motion to strike privileged portions of the complaint and for continued sealing of the complaint. Although the complaint contained some privileged information, the Court concluded that the defendants had waived the attorney-client privilege with respect to these portions of the complaint during a prior Section 220 trial. The Court denied the defendants' motion for continued sealing of the complaint because it did not contain sufficiently sensitive information to counteract strong policy reasons in favor of a public record. Fifth, the Court granted the defendants' motion to disqualify Khanna as a representative plaintiff, but refused to disqualify the other plaintiffs. The Court held that Khanna was an inadequate representative plaintiff because he had previously represented Covad on matters substantially related to the challenged transactions and there was a substantial likelihood that Khanna was bringing the action as a result of Covad's termination of him. With respect to the other plaintiffs, the Court found that the defendants had not established a sufficient conflict to support their disqualification. Share