In re Kraft Heinz Company Derivative Litigation: Plaintiffs fail to plead demand futility

Quarterly Corporate / M&A Decisions update series

In re Kraft Heinz Company Derivative Litigation addresses demand futility in a case involving an insider stock sale. 3G Capital, Inc., a 24.2 percent shareholder in Kraft Heinz, sold 7 percent of its stake in August 2018 after the company removed certain stock restrictions. Kraft Heinz reported poor results in the third and fourth quarters of 2018, causing the stock to drop. Shareholders filed derivative suits, alleging that 3G knew of the poor financial results when it traded and that the board of Kraft Heinz breached its fiduciary duties in allowing the trade. The Delaware Court of Chancery dismissed the complaint on demand futility grounds, finding a majority of the board to be disinterested and independent after a director-by-director analysis. This case provides a practical application of the new Zuckerberg demand futility test and insight into how Delaware courts may view potentially biasing factors, such as personal relationships and voting agreements between large shareholders.

The Kraft Heinz Company (Kraft Heinz) was formed in 2015 when Kraft Food Groups (Kraft) merged with The H.J. Heinz Company (Heinz). Prior to the merger, 3G Capital, Inc. (3G) purchased 50 percent of Heinz. After the closing of the merger to form Kraft Heinz, 3G owned approximately 24.2 percent of the combined company and three of its designees sat on the 11-member board of directors.

On August 2, 2018, the board learned that Kraft Heinz likely would miss its EBITDA target for the first half and full year 2018. On August 7, 2018, 3G sold 7 percent of its stake in Kraft Heinz for over US$1.2 billion after Kraft Heinz agreed to remove certain restrictions on the stock. As anticipated, Kraft Heinz reported poor financial results in November 2018 for its third quarter and February 2019 for its fourth quarter and full year 2018. Kraft Heinz’s stock dropped 10 percent in November 2018 and 27.5 percent in February 2019.

Several shareholders filed derivative actions, alleging that the board of directors breached its fiduciary duties in connection with 3G’s sale of 7 percent of its stake in August 2018. Specifically, the plaintiffs alleged: (1) breach of fiduciary duty for approving or allowing the 3G sale; (2) contribution and indemnification for causing Kraft Heinz to issue false and misleading statements in violation of the securities laws; and (3) aiding and abetting against 3G-related entities for facilitating the allegedly unlawful sale. The defendants moved to dismiss, arguing that the plaintiffs had not pleaded demand futility. The Delaware Court of Chancery agreed and dismissed the complaint in its entirety.

The court’s analysis followed the recently established three-part test from United Food & Commercial Works Union v. Zuckerberg, which requires a plaintiff to show, on a director-by-director basis, that a majority of the directors (1) “received a material personal benefit from the alleged misconduct that is the subject of the litigation demand”; (2) “faces a substantial likelihood of liability on any of the claims that would be the subject of the litigation demand”; and (3) “lacks independence from” a director who is not disinterested under prong (1) or (2).

In this case, the court found that the independence of only six directors was at issue because the plaintiffs conceded that two of the 11 board members were independent and disinterested while the defendants conceded that three 3G-affiliated directors were not independent.

Of the six remining directors, the court found that only prong (3) of the Zuckerberg test was relevant because the six directors were non-parties, and thus did not face a substantial likelihood of liability, and were not alleged to have sold stock during the relevant period or otherwise benefitted from 3G’s sale. As a result, the analysis “hinge[d] entirely on whether the directors had disabling connections to 3G.” The court rejected each of the plaintiffs’ arguments.

First, the plaintiffs argued that 3G should be considered to be a “control group” with Berkshire Hathaway, another large shareholder in Heinz and subsequently Kraft Heinz. The court found that even if 3G did control Kraft Heinz with Berkshire, such an allegation, without more, did not overcome the presumption of the directors’ independence from a controlling shareholder.

Second, the plaintiffs argued that each of the six directors was not independent from 3G for specific reasons, ranging from a director’s private foundation placing 12 percent of its investment portfolio in 3G to close personal relationships between directors to potential opportunities for promotion. The court found all of these allegations insufficient to overcome the presumption of independence. In particular, the court noted that it would not credit a “transitive theory of independence,” whereby plaintiffs alleged that two of the directors were beholden to Berkshire Hathaway and Warren Buffett, its CEO, who in turn allegedly were not independent of 3G. The court also found that a shareholders’ agreement, which required 3G and Berkshire to vote for one another’s director nominees, was not relevant because the two directors the agreement allegedly rendered interested were neither signatories to the agreement nor “Affiliates” under certain provisions.

After conducting a director-by-director analysis for four of the six directors, the court noted that, combined with the two directors the plaintiffs admitted were independent, six of eleven members, and thus a majority, of the board were independent directors. As a result, the court did not reach a conclusion regarding the independence of the final two directors, who the court indicated were most likely to be found not independent under the applicable case law.

 

Authored by Ryan M. Philp and Allison M. Wuertz.

 

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