Opinion
H048613
07-18-2023
In re ALPHABET SHAREHOLDER DERIVATIVE CASES
NOT TO BE PUBLISHED
Santa Clara County Super. Ct. No. CV300731) (JCCP No. 4877)
Greenwood, P. J.
I. Introduction
This shareholder derivative action arises from shareholders' claims that nominal defendant Alphabet engaged in anticompetitive acts in violation of European Union law while conducting its business in the European Union, which resulted in the European Commission imposing fines on Alphabet that totaled approximately $9.4 billion. Defendants Alphabet and the individual defendants (Alphabet directors and officers) demurred to the complaint on the ground that plaintiff shareholders had failed to allege demand futility in accordance with Delaware corporations law. (See United Food &Commercial Workers Union v. Zuckerberg (Del. 2021) 262 A.3d 1034, 1047 (Zuckerberg).)
The trial court sustained the demurrers without leave to amend and entered judgment in Alphabet's favor, finding that plaintiffs had failed to allege demand futility based on the theory that the individual director defendants knowingly directed Alphabet to violate European Union law or on the theory that the officer defendants had a substantial likelihood of liability due to their gross negligence. For the reasons stated below, we conclude that the trial court did not err and we will affirm the judgment.
Portions of the record on appeal have been sealed pursuant to the court's orders granting the parties' applications for sealing. We notified the parties of the court's proposal to order certain records unsealed. (Cal. Rules of Court, rules 8.45, 8.46) and received opposition from respondents. We have determined to limit our discussion of the facts rather than unseal any records in this matter. However, we will discuss some facts as necessary to provide an opinion "in writing with reasons stated" as required by the California Constitution. (Cal. Const., art. VI, § 14; see Sager v. County of Yuba (2007) 156 Cal.App.4th 1049, 1051.) Because the dissenting opinion requires redaction to protect confidential information, we are filing a public version of the majority opinion with the redacted dissenting opinion. We will also file under seal the majority opinion with the unredacted dissenting opinion.
II. Overview Of Demand Futility Under Delaware Law
The Delaware Supreme Court has stated: "Under Delaware law, the board of directors manages the business and affairs of the corporation, which includes deciding whether the corporation should pursue litigation against others." (McElrath v. Kalanick (Del. 2020) 224 A.3d 982, 990 (McElrath), fns. omitted.)" 'In order for a stockholder to divest the directors of their authority to control the litigation asset and bring a derivative action on behalf of the corporation, the stockholder must' (1) make a demand on the company's board of directors or (2) show that demand would be futile. The demand requirement is a substantive requirement that '" '[e]nsure[s] that a stockholder exhausts his [or her] intracorporate remedies,' 'provide[s] a safeguard against strike suits,' and 'assure[s] that the stockholder affords the corporation the opportunity to address an alleged wrong without litigation and to control any litigation which does occur." '" (Zuckerberg, supra, 262 A.3d at p. 1047.)
In Zuckerberg, supra, 262 A.3d at page 1058, the Delaware Supreme Court adopted a "three-part test as the universal test for assessing whether demand should be excused as futile." "[C]ourts should ask the following three questions on a director-by- director basis when evaluating allegations of demand futility: [¶] (i) whether the director received a material personal benefit from the alleged misconduct that is the subject of the litigation demand; [¶] (ii) whether the director faces a substantial likelihood of liability on any of the claims that would be the subject of the litigation demand; and [¶] (iii) whether the director lacks independence from someone who received a material personal benefit from the alleged misconduct that would be the subject of the litigation demand or who would face a substantial likelihood of liability on any of the claims that are the subject of the litigation demand. [¶] If the answer to any of the questions is 'yes' for at least half of the members of the demand board, then demand is excused as futile." (Id. at p. 1059.)
The Delaware Supreme Court also described the fiduciary duties of a director, which if breached may result in a substantial likelihood of liability: "The directors and officers of a Delaware corporation owe two overarching fiduciary duties-the duty of care and the duty of loyalty. '[P]redicated upon concepts of gross negligence,' the duty of care requires that fiduciaries inform themselves of material information before making a business decision and act prudently in carrying out their duties. The duty of loyalty' "requires an undivided and unselfish loyalty to the corporation" and "demands that there shall be no conflict between duty and self-interest." '" (Zuckerberg, supra, 262 A.3d at pp. 1049-1050.)
However, a Delaware corporation may limit its directors' liability for breach of fiduciary duty as follows: "Section 102(b)(7) [Del. Code. Ann. tit. 8, § 102(b)(7)]authorizes corporations to adopt a charter provision insulating directors from liability for breaching their duty of care: [¶] '[T]he certificate of incorporation may . . . contain any or all of the following matters: [¶] (7) A provision eliminating or limiting the personal liability of a director to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, provided that such provision shall not eliminate or limit the liability of a director: (i) For any breach of the director's duty of loyalty to the corporation or its stockholders; (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law; . . . or (iv) for any transaction from which the director derived an improper personal benefit." (Zuckerberg, supra, 262 A.3d at p. 1050.)
Hereafter, all references to section 102(b)(7) are to section 102(b)(7) of the Delaware Code Annotated, title 8, section 102(b)(7).
Where a Delaware corporation has adopted a charter provision insulating directors from liability for breaching their duty of care, an allegation of demand futility cannot be based upon "exculpated care violations." (Zuckerberg, supra, 262 A.3d at pp. 10501051.) "Given this protection from due care violations, the plaintiff must plead with particularity that the directors 'acted with scienter, meaning "they had actual or constructive knowledge that their conduct was legally improper."' In other words, directors are liable for 'subjective bad faith' when their conduct is motivated 'by an actual intent to do harm,' or when there is an 'intentional dereliction of duty, a conscious disregard for one's responsibilities.' Pleading bad faith is a difficult task and requires 'that a director acted inconsistent with his [or her] fiduciary duties and, most importantly, that the director knew he [or she] was so acting.' Gross negligence, without more, is insufficient to get out from under an exculpated breach of the duty of care." (McElrath, supra, 224 A.3d at pp. 991-992, fns. omitted.)
Under Delaware law, gross negligence in the corporate context is defined as a "reckless indifference to or a deliberate disregard of the whole body of stockholders or actions which are without the bounds of reason." (In re McDonald's Corp. Shareholder Derivative Litigation (Del. Ch. 2023) 289 A.3d 343, 372, fn. 17.) A corporation's officers are not insulated by section 102(b)(7) from duty of care violations, and may be subject to a substantial likelihood of liability based upon gross negligence. (In re McDonald's Corp. Shareholder Derivative Litigation, supra, at p. 365; Gantler v. Stephens (2009) 965 A.2d 695, 709, fn. 37.)
In the present case, it is undisputed that Alphabet's certificate of incorporation includes a provision insulating its directors from liability for breaching their duty of care under section 102(b)(7).
III. Factual And Procedural Background
A. Complaint
This shareholder derivative action was brought by Alphabet shareholders Robert Jessup, Mary Mullaney, Aviva Pifko, Irving Firemen's Relief and Retirement Fund, Police Retirement System of St. Louis, and Louisiana Sheriffs' Pension &Relief Fund (collectively, plaintiffs). The operative complaint is the corrected second amended consolidated complaint (complaint).
These coordinated actions were filed in San Mateo and Santa Clara counties in 2016. On September 6, 2016, the Santa Clara County Superior Court granted defendants' petition for coordination and designated Santa Clara County as the venue for the coordinated actions.
The defendants include nominal defendant Alphabet, a Delaware corporation, that is the holding company for Google. The individual defendants include present and former officers and directors of Alphabet, as follows: Larry Page, chief executive officer and director; Sergey Brin, president and director; and Eric E. Schmidt, former chief executive officer and former chairman of the board of directors. Plaintiffs allege that Page, Brin, and Schmidt together own more than 50 percent of Alphabet's voting stock and control the company's business practices and long-term strategies. Additional individual defendants include directors L. John Doerr, Diane B. Greene, John L. Hennessy, Ann Mather, Alan R. Mulally, Sundar Pichai (also chief executive officer), K. Ram Shriram, and Shirley M. Tilghman.
Plaintiffs allege that under the "direction, management, and oversight" of Page, Brin, and Schmidt, "Alphabet systematically engaged in anticompetitive acts, including: (i) leveraging the Company's dominant position in online search to unfairly advantage other products that were not able to compete on the merits; (ii) forcing anticompetitive tying agreements on manufacturers and service providers for mobile devices; and (iii) requiring its customers to submit to exclusivity agreements that closed off important internet search and online advertising markets to [Alphabet's] competitors." Plaintiffs additionally allege that "[t]hese acts have resulted in Alphabet being found liable in three enforcement actions brought against the Company by the European Commission ('EC') for violation of EU competition laws. Further, the EC imposed massive fines on Alphabet, totaling approximately $9.4 billion."
Allegations of Anticompetitive Acts
Regarding the three types of anticompetitive acts, the fines imposed by the European Commission for those acts, and the Board's responses, plaintiffs allege more specifically as follows:
1. Universal Search and Google Shopping
Plaintiffs assert that Alphabet's Universal Search product abused Alphabet's dominance by automatically placing Google Shopping at the top of search results. Alphabet receives revenue when a shopper clicks on an advertisement displayed by Google Shopping.
In 2010 the European Commission announced that it would" 'investigate whether Google has abused a dominant market position in online search by allegedly lowering the ranking of unpaid search results of competing services . . . and by according preferential treatment to the results of its own vertical search services in order to shut out competing services.'" The Board members were aware that the European Commission had fined Microsoft for similar anticompetitive conduct, consisting of tying its Windows operating system to Microsoft's products, including Windows Media Player, to shield itself from competition.
According to plaintiffs, the Board received information from counsel that did not say that Alphabet's conduct with respect to Universal Search and Google Shopping complied with the European Union's competition laws, that the European Commission's investigation was without merit, or that Alphabet had a good or strong defense. Further, Board members were advised during Board presentations that Alphabet was more likely to succeed in defending antitrust litigation by the United States' Federal Trade Commission than the European Union, due to the differences in market share, substantive law, and procedures.
In 2012 the European Commission announced preliminary findings that Google had four business practices that might be considered abuses of its dominance, including preferential treatment of its own search results compared to those of competitors. A July 2012 presentation to the Board titled" 'Antitrust Board Update'" "did not suggest that the [European Commission] was mistaken on the facts, that the [European Commission's] inquiries were without merit, that Alphabet's actions complied with [European Union] law or even that Google had strong defenses." The July 2012 Board presentation also noted that the European Commission had rejected Alphabet's initial settlement proposal because Alphabet refused an agreement that would bind future products, and warned that the European Commission would serve a Statement of Objections and proceed with further investigations if Alphabet's proposals were not accepted.
In 2013 and 2014 Alphabet submitted second and third proposals that the European Union found insufficient, while at the same time Alphabet was expanding its prominent placement of Google Shopping results to mobile devices and other countries. Documents produced by Alphabet show that in 2014 Alphabet did not receive legal advice that its conduct complied with European Commission law, that the European Commission's investigation was without merit, or that Alphabet had a strong defense. A 2014 Board presentation cited an article stating that Google had been warned by the European Union "to make changes or face fines."
In 2015 the European Commission commenced formal proceedings against Alphabet by issuing a Statement of Objections that alleged that Alphabet had" 'abused its dominant position in the markets for general Internet search services in the European Economic Area by systematically favoring its own comparison shopping product in its general search results pages.'" The European Commission stated that" 'previous commitment proposals from Google were insufficient to address its competition concerns.' "
In 2016 the European Commission sent two Statements of Objection to Alphabet that outlined "a broad range of additional evidence and data that reinforces the Commission's preliminary conclusion that Google has abused its dominant position by systematically favouring its own comparison shopping service in its general search results." In 2017 the European Commission announced that it had reached a decision in its enforcement action and fined Alphabet 2.42 billion for breaching EU antitrust rules by giving its own comparison shopping service prominent placement in search results and demoting rival comparison shopping services. The European Commission also required Alphabet to give equal treatment to rival comparison shopping services.
is the symbol for the Euro, which is the official currency of many member states of the European Union. (SACE S.p.A. v. Republic of Paraguay (D.D.C. 2017) 243 F.Supp.3d 21, 28, fn.7.)
2. Android and Mobile Internet Search
Alphabet began developing two versions of an operating system for mobile devices in 2005, Google Android and Open Source Android. Alphabet published the source code for Open Source Android and allowed third parties to make their own version of Android, known as an "Android Fork." After Android became the dominant licensable operating system for mobile devices, Alphabet exclusively tied its mobile applications, such as Maps, YouTube, and Gmail, to Google Android. Open Source Android and Android Forks could not run those applications. Alphabet also required mobile device manufacturers that licensed Google Android to enter into agreements requiring the manufacturers to install Alphabet's mobile search application and web browser application on their mobile devices.
In 2011 the Board was informed in litigation and regulatory updates that the European Commission was now investigating Alphabet's conduct with respect to Android. These updates, along with a 2012 antitrust update presented to the Board, did not state that Alphabet's conduct was legal, that the European Commission's investigation lacked merit, or that Alphabet had a strong defense. In 2013 the Board was informed by management that the European Commission had given them a complaint with regard to Android. Multiple litigation and regulatory updates in 2013 and 2014 also did not advise the Board that Alphabet's conduct was legal, that the European Commission's investigation lacked merit, or that Alphabet had a strong defense.
In 2015 the European Commission announced a formal investigation into Google Android, and in 2016 the European Commission brought formal charges in a Statement of Objections. The Statement of Objections found that Alphabet was dominant in the markets for "(1) general internet search services; (2) licensable smart mobile operating systems; and (3) app stores for the Android operating system." The European Commission alleged that Alphabet's anticompetitive conduct included requiring mobile device manufacturers to pre-install Google Play Store and Google Search and set Google Search as the default browser, and preventing manufacturers from installing Google applications on competing versions of Android. The Board did not receive any legal advice that its conduct complied with European Union law.
In 2018 the European Commission announced that it was fining Alphabet 4.34 billion for Alphabet's conduct with regard to Google Android. In response, Alphabet implemented new licensing agreements that allowed Google applications to be installed on Android Forks; allowed Google Search to be licensed separately from other Google applications; offered separate licenses for Google Search and Chrome; and offered agreements for non-exclusive pre-installation of Google Search and Chrome. Plaintiffs allege that these remedies were similar to the remedies imposed on Microsoft by the European Commission.
3. Internet Search and Advertising
Alphabet developed a search advertisement intermediation product called AdSense for Search (AdSense). Search advertisement intermediation allows advertisers to display advertisements on the results of a website user's search queries. According to plaintiffs, Alphabet dominated the market in search advertisement intermediation from 2006 to 2016 and abused its domination by requiring third party websites to enter into exclusivity agreements with Alphabet. Alphabet then replaced the exclusivity agreements with a requirement for premium placement of Alphabet's advertisements and also required approval from Alphabet to change the placement of search intermediation advertisements by rival internet search providers, such as Yahoo and Bing.
From 2010 through 2012 the Board received updates advising that the European Commission's investigation into Alphabet's anticompetitive conduct included an investigation of Alphabet's search advertisement intermediation conduct. None of the updates advised the Board that its conduct with respect to AdSense complied with European Union law, that the European Commission's investigation lacked merit, or that Alphabet had strong defenses.
In 2012 the European Commission disclosed its preliminary conclusions from its investigation of AdSense, which identified potentially abusive practices such as requiring exclusivity agreements with third party websites and requiring prominent placement of Alphabet's advertisements. In May 2012 Alphabet made a settlement proposal that the European Commission rejected. A July 2012 update presented to the Board included a quote from an Alphabet executive indicating concern about Alphabet's potentially anticompetitive conduct with regard to advertising. The July 2012 update did not say that Alphabet's conduct complied with European Union law, that the European Commission's investigation lacked merit, or that Alphabet had a strong defense.
In 2016 the European Commission issued a Statement of Objections finding that Alphabet dominated the search advertisement intermediation market and had violated European Union law by imposing exclusivity agreements on third parties, requiring premium placement of Google advertisements, and requiring third parties to obtain Alphabet's approval before changing the display of competing search advertisements. Although the Board had been informed of the European Commission's investigation, it failed to stop or remedy this conduct until after the 2016 Statement of Objections. In 2019 the European Commission "fined Google 1.49 billion for breaching EU antitrust rules,'" finding that" 'Google has abused its market dominance by imposing a number of restrictive clauses in contracts with third-party websites which prevented Google's rivals from placing their search adverts on these websites.'" Plaintiffs assert that Alphabet's Board knowingly exposed the company to the fine by not stopping its anticompetitive conduct years earlier. Further, plaintiffs assert that Alphabet has engaged in a pattern and practice of anticompetitive conduct, as shown by regulatory actions and investigations in the United States and in other countries.
Allegations Regarding Demand Futility
Plaintiffs allege that members of the Board were dominated by and beholden to Page, Brin, and Schmidt, the controlling shareholders of Alphabet, who "ignored antitrust laws" and as a result the Board "caused or failed to prevent Alphabet from engaging in illegal, anticompetitive practices." Further, plaintiffs allege that "[t]hroughout the relevant period, the Board continued to allow or failed to prevent Alphabet from violating [European Union] antitrust laws even though they knew that there was no advice from counsel that Alphabet's conduct complied with EU law or even that Alphabet had a strong defense to the allegations, and an adverse judgment from [European Union] regulators could have a material impact on the Company's business, financial condition, and operations."
Plaintiffs assert that they were excused from making a demand on the Board to investigate and prosecute the alleged wrongdoing because the officer defendants, Page, Brin, and Schmidt, were grossly negligent in directing Alphabet to engage in anticompetitive conduct despite knowing that (1) the European Commission was investigating Alphabet and issuing Statements of Objection; (2) Microsoft had faced liability for similar bundling practices; (3) Alphabet's exposure was greater in Europe than the United States; (4) senior executives believed the company was violating antitrust laws; and (5) Alphabet's conduct could result in massive fines and a negative impact on Alphabet's business. Plaintiffs further assert that the officer defendants faced a likelihood of substantial liability for "their involvement in Alphabet's [European Union] antitrust violations," such that demand would be futile. Plaintiffs also alleged that Pichai, as chief executive officer involved in Alphabet's products at issue in the European Union, was incapable of objectively assessing a demand to sue the Alphabet Board or the officer defendants.
Additionally, plaintiffs allege that demand upon the individual director defendants would have been futile because they "each knowingly or recklessly permitted Alphabet to engage in anticompetitive practices," despite knowing that (1) Alphabet had a dominant position in several European Union markets; (2) Alphabet was under scrutiny by European regulators; (3) Microsoft had faced liability for similar bundling practices; (4) Alphabet's exposure was greater in Europe than the United States; (5) senior executives believed the company was violating antitrust laws; (6) the European Commission's Statements of Objection were mounting evidence of antitrust violations; (7) the European Commission gave Alphabet several opportunities to "remedy its concerns"; and (8) Alphabet's conduct could result in massive fines and a negative impact on Alphabet's business.
Plaintiffs further assert that demand would be futile because the director defendants face a likelihood of substantial liability for "their involvement in Alphabet's [European Union] antitrust violations," and also because a majority of the Board was controlled by Page, Brin, and Schmidt such that they would be incapable of assessing a demand.
Causes of Action and Prayer for Relief
Based on these allegations, plaintiffs state causes of action against the director defendants for (1) breach of fiduciary duty; (2) unjust enrichment; and (3) corporate waste. Plaintiffs also state causes of action against Page, Brin, and Schmidt for (1) breach of fiduciary duty (in their capacity as officers); and (2) breach of fiduciary duty (in their capacity as controlling shareholders).
Plaintiffs seek recovery of the amount of damages sustained by Alphabet as result of defendants' breach of fiduciary duty, corporate waste, and unjust enrichment. They also seek restitution and disgorgement of profits, injunctive relief, and costs.
B. Demurrers to the Complaint
Alphabet, as nominal defendant, demurred to the complaint on the grounds that plaintiffs had failed to adequately plead demand futility. Alphabet noted that "Alphabet's charter, . . . contains a provision 'exculpating directors from personal liability for breaches of fiduciary duty . . . other than . . . "[f]or acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law."' "
Alphabet argued that plaintiffs had failed to plead particularized facts that would excuse a demand on the Board, since the allegations did not show that the director defendants had a substantial likelihood of liability absent allegations showing that they failed to exercise oversight of the company's business practices in the European Union, or that the directors acted in bad faith. Further, Alphabet argued that the allegations that the controlling shareholders, officer defendants Page, Brin, and Schmidt, were grossly negligent and dominated the Board, and their dominance resulted in the Board causing or failing to prevent Alphabet's illegal anticompetitive practices, are inadequate because the documents produced by Alphabet do not show that they knew the practices were illegal.
The individual director defendants filed a separate demurrer, arguing that plaintiffs failed to state facts sufficient to constitute a cause of action for breach of fiduciary duty because the allegations in the complaint and the documents produced by Alphabet do not show any wrongdoing or bad faith on the part of either the individual directors or Page, Brin, and Schmidt as officers. Further, the director defendants argued that the causes of action for unjust enrichment and waste necessarily fail because they are derivative of the causes of action for breach of fiduciary duty.
In opposition, plaintiffs argued that demand was excused as to the cause of action for "breach of fiduciary duty against the directors because the majority of the Board faces a substantial likelihood of liability for willfully or recklessly failing to curtail the Company's abusive business practices after learning that they 'contemplated illegality.'" Plaintiffs asserted their factual allegations and the documents produced by Alphabet show that "the top officers and directors knew or should have known that the Company's business practices were likely illegal under EU law and breached their fiduciary duties by allowing the Company's illegal practices to continue for years."
Further, plaintiffs argued that demand is excused because Page, Brin, and Schmidt, as officers and controlling shareholders, knowingly or recklessly allowed the company to engage in a business plan that was potentially illegal in light of the European Commission's warnings and investigations and failed to reform the company's business practices. In addition, plaintiffs contended that at least three members lacked independence from the controlling shareholders and were therefore incapable of considering a demand.
C. Orders Sustaining Demurrers and Judgments
In the June 20, 2020 order, the trial court sustained Alphabet's demurrer without leave to amend and ruled that the individual director defendants' demurrer was consequently moot. Having reviewed the complaint and the documents that Alphabet attached to the complaint, including the Board presentations, the trial court concluded plaintiffs had failed to alleged demand futility based on the theory that the individual director defendants knowingly directed Alphabet to violate European Union law.
In so ruling, the trial court found that the documents did not support an inference that the directors had knowingly directed Alphabet to violate European Union law, since the documents showed that "the board monitored potential antitrust actions by the [European Commission] and other regulators and received advice from counsel, including outside European counsel, regarding how to respond. While the board clearly understood that risk was associated with the challenged practices-a risk that was higher in Europe than in other jurisdictions where Alphabet ultimately prevailed-the documents reflect a justifiable belief that a settlement with the EC would be achieved...."
The trial court also ruled that plaintiffs had failed to allege demand futility with respect to their oversight theory under In re Caremark International Inc. Derivative Litigation (Del. Ch. 1996) 698 A.2d 959 (Caremark) since Alphabet's documents showed that "the board had an oversight system in place and engaged with it regularly in a manner that does not suggest bad faith."
The trial court also ruled that plaintiffs had failed to sufficiently allege demand futility with respect to the controlling shareholders, Page, Brin, and Schmidt, since there were no new factual allegations that would compel the court to change its ruling in the prior January 14, 2019 order sustaining the demurrers with leave to amend. In the January 14, 2019 order, the trial court ruled that plaintiffs had failed to allege facts that would show Page, Brin, and Schmidt had a substantial likelihood of liability due to their gross negligence in the absence of allegations showing a" 'wide disparity' between management's approach to the business practices at issue in Europe and a process that would have been rational."
Finally, the trial court ruled that the causes of action for unjust enrichment and waste were wholly derivative of the claims for breach of fiduciary duty, and therefore plaintiffs had failed to allege demand futility with respect to those causes of action.
A judgment of dismissal with prejudice was filed on July 17, 2020.
III. Discussion
A. Standard of Review
On appeal from a judgment of dismissal upon an order sustaining a demurrer without leave to amend our review is de novo. (Committee for Green Foothills v. Santa Clara County Bd. of Supervisors (2010) 48 Cal.4th 32, 42.) In performing our independent review of the complaint, we assume the truth of all facts properly pleaded by the plaintiff. (Evans v. City of Berkeley (2006) 38 Cal.4th 1, 6 (Evans).)
Further, "we give the complaint a reasonable interpretation, and read it in context." (Schifando v. City of Los Angeles (2003) 31 Cal.4th 1074, 1081 (Schifando).) But we do not assume the truth of"' "contentions, deductions or conclusions of fact or law." '" (Evans, supra, 38 Cal.4th at p. 6.) We also consider matters that may be judicially noticed and facts appearing in any exhibits attached to the complaint. (Code Civ. Proc, § 430.30, subd. (a); Schifando, at p. 1081.)
In this shareholder derivative action, Alphabet has demurred on the grounds of the affirmative defense of failure to plead demand futility. We will apply Delaware law to determine whether plaintiffs' pleading of demand futility in the operative complaint is adequate, since Alphabet is a Delaware corporation. "The law of the place of incorporation governs the liability of directors to the corporation and its shareholders." (Charter Township of Clinton Police &Fire Retirement System v. Martin (2013) 219 Cal.App.4th 924, 934 (Charter Township); Corp. Code, § 2116.)
In Delaware, Court of Chancery Rule 23.1 provides the standard for pleading demand futility: The complaint shall "allege with particularity the efforts, if any, made by the plaintiff to obtain the action the plaintiff desires from the directors or comparable authority and the reasons for the plaintiff's failure to obtain the action or for not making the effort." "To comply with Rule 23.1, the plaintiff must meet 'stringent requirements of factual particularity that differ substantially from . . . permissive notice pleadings.'" (Zuckerberg, supra, 262 A.3d at p. 1047.)
Under Delaware law, the court "may rely on the allegations of the complaint and documents referred to or incorporated by reference. [Citations.]" (City of Birmingham Retirement &Relief System v. Good (Del. 2017) 177 A.3d 47, 51 (City of Birmingham).) The documents referred to or incorporated by reference may include documents produced by the corporation in response to a demand by shareholders as authorized by the Delaware Corporations Code. (8 Del. Code tit. 8, § 220; Lebanon County Employees' Retirement Fund v. Collis (Del. Ch. 2022) 287 A.3d 1160, 1181.) However, "[t]he incorporation-by-reference doctrine does not enable a court to weigh evidence on a motion to dismiss. It permits a court to review the actual documents to ensure that the plaintiff has not misrepresented their contents and that any inference the plaintiff seeks to have drawn is a reasonable one." (Ibid.)
"The adequacy of the pleading of presuit demand futility may be resolved at the pleading stage of litigation, a ruling we review de novo." (Charter Township, supra, 219 Cal.App.4th at p. 934; see also Leyte-Vidal v. Semel (2013) 220 Cal.App.4th 1001, 1007.)
B. The Parties' Contentions
On appeal, the plaintiffs argue that the trial court erred in sustaining Alphabet's demurrer without leave to amend because a detailed review of the documents produced by Alphabet pursuant to 8 Delaware Corporations Code, title 8, section 220 show that Page, Brin, and Schmidt "and Board knew or should have known that [Alphabet's] anticompetitive business practices were, at a minimum, likely illegal under [European Union] law, and breached their fiduciary duties by allowing the Company's illegal practices to continue for years." Further, plaintiffs contend that "[n]otably absent from the July 2012 presentation, or any other document Alphabet produced, was any suggestion that the [European Commission's] investigation and conclusions lacked merit, or even that Alphabet had strong defenses to the EC's claims."
According to plaintiffs, the Board presentations showed that Page, Brin, and Schmidt as officers and the directors knew or should have known that the company's "myriad anticompetitive" business practices with respect to Universal Search/Google Shopping, Android, and AdSense, were "likely illegal" under European Union law, and therefore they faced a substantial likelihood of personal liability such that demand should be excused as futile. Plaintiffs do not expressly challenge the trial court's ruling that they failed to show that demand was excused with respect to their Caremark oversight claim and have not addressed the ruling sustaining the demurrers to the causes of action for unjust enrichment and waste.
Alphabet and the individual defendants respond that the allegations in the complaint do not "identify any Board decision in which the directors knowingly directed Alphabet to violate the law." They contend that the Delaware standard for demand futility does not excuse demand where, as here, the plaintiffs merely allege that the officers and directors knew that the company's business practices where "likely illegal." Further, they contend that plaintiffs' arguments improperly depend on hindsight, maintaining that "[w]hether the Board's 'approach, in hindsight, was right or wrong is not the point; the point is that the approach was not conceivably a product of bad faith.' "
Plaintiffs reply that the allegations in the complaint were sufficient to support a reasonable inference that Page, Brin, and Schmidt, in their capacities as officers, faced a substantial likelihood of liability because they were "recklessly indifferent" to the illegality of the company's practices with respect to Google Shopping, Android, and AdSense. Plaintiffs point to Board presentations that they contend informed the officers and directors that Alphabet was abusing its market dominance with respect to these products.
C. Analysis
In conducting our independent review, we are mindful that the Delaware Supreme Court has instructed that "the directors are entitled to a presumption that they were faithful to their fiduciary duties. In the context of presuit demand, the burden is upon the plaintiff in a derivative action to overcome that presumption." (Beam ex rel. Martha Stewart Living Omnimedia, Inc. v. Stewart (Del. 2004) 845 A.2d 1040, 1048-1049.)
We also bear in mind that "a showing of bad faith in the context of demand excusal is a high hurdle, and essentially requires the plaintiff to demonstrate intentional wrongdoing by the board." (McElrath, supra, 224 A.3d at p. 993.)" '[T]here is a vast difference between an inadequate or flawed effort to carry out fiduciary duties and a conscious disregard for those duties.'" (Ibid., fn. omitted.) "In other words, directors are liable for 'subjective bad faith' when their conduct is motivated 'by an actual intent to do harm,' or when there is an 'intentional dereliction of duty, a conscious disregard for one's responsibilities.' Pleading bad faith is a difficult task and requires 'that a director acted inconsistent with his [or her] fiduciary duties and, most importantly, that the director knew he [or she] was so acting.'" (McElrath, at pp. 991-992, fns. omitted.)
Accordingly, as the Delaware Supreme Court stated in Zuckerberg, where, as here, the certificate of incorporation exculpates directors from duty of care violations under section 102(b)(7) of the Delaware General Corporation Law, presuit demand is excused where the directors are subject to a substantial likelihood of liability "for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law; . . ." (Zuckerberg, supra, 262 A.3d at p. 1050.)
The Delaware Supreme Court's decision in City of Birmingham, supra, 177 A.3d 47 is also instructive. The shareholder derivative action in City of Birmingham arose from a toxic spill from a Duke Energy Corporation (Duke Energy) power station into a river. (Id. at p. 50.) After federal and state investigations showed that Duke Energy had failed to discover the corroded pipe that resulted in the spill, Duke Energy pleaded guilty to criminal charges and paid millions of dollars in fines, clean up costs, and other expenses. (Id. at pp. 53-54.)
The plaintiffs alleged in City of Birmingham that Duke Energy's directors breached their fiduciary duties because they knew of and disregarded Duke Energy's Clean Water Act violations and allowed Duke Energy to collude with North Carolina's Department of Environmental Quality to evade compliance with environmental regulations. (City of Birmingham, supra, 177 A.3d at p. 54.) They argued that demand on Duke Energy's board of directors was futile because the directors' mismanagement of Duke Energy's environmental issues rose to the level of a violation of their fiduciary duty of oversight under Caremark, supra, 698 A.2d 959. (City of Birmingham, at p. 51.)
The Delaware Supreme Court upheld the lower court's dismissal of the action on the ground that the plaintiffs had failed to adequately plead demand futility. (City of Birmingham, supra, 177 A.3d at p. 51.) Noting that the Duke Energy board of directors was protected from due care violations under section 102(b)(7), the court rejected the plaintiffs' contention that the board presentations and minutes showed Duke Energy was violating environmental laws and avoiding remediation. (City of Birmingham, at p. 56.) After reviewing the board presentations in detail, the court determined that "the board was not only informed of environmental problems, but also the steps being taken to address them. It does not support plaintiffs' central theory that a majority of the board consciously ignored or intentionally violated positive law," and therefore it could not be inferred that "the board consciously disregarded its oversight responsibility by ignoring environmental concerns" in violation of its duties under Caremark, supra, 698 A.2d 959. (City of Birmingham, at pp. 57, 59.)
Also instructive is the Delaware Court of Chancery's decision in Louisiana Municipal Police Employees' Retirement System v. Pyott (Del. Ch. 2012) 46 A.3d 313 (Pyott), reversed on another ground in Pyott v. Louisiana Municipal Police Employees' Retirement System (Del. 2013) 74 A.3d 612, 614.) The shareholder derivative action in Pyott, supra, 46 A.3d 313 was filed against nominal defendant Allergan, Inc. (Allergan) after Allergan entered into a settlement with the United States Department of Justice that included pleading guilty to criminal misdemeanor misbranding and a total of $600 million in civil and criminal fines for illegal marketing of off-label uses of Botox. (Id. at p. 316.) Federal law expressly prohibited drug manufacturers from marketing or promoting drugs for uses not approved by the Food and Drug Administration (FDA). (Id. at p. 318.)
The defendants in Pyott sought dismissal on the ground that the plaintiffs had failed to adequately plead demand futility. (Pyott, supra, 46 A.3d at p. 316.) The Court of Chancery found that the complaint alleged that the Allergan board of directors had been informed of FDA warning letters and several investigations by federal authorities regarding the illegal off-label marketing of Botox, and nevertheless approved a strategic plan that included sale of Botox for off-label uses. (Id. at pp. 319-321.) The court ruled that "[r]ead as a whole, the particularized allegations support a reasonable inference that the Board consciously approved a business plan predicated on violating the federal statutory prohibition against off-label marketing. '[O]ne cannot act loyally as a corporate director by causing the corporation to violate the positive laws it is obliged to obey.' [Citation.] '[I]t is generally accepted that a derivative suit may be asserted by an innocent stockholder on behalf of a corporation against corporate fiduciaries who knowingly caused the corporation to commit illegal acts and, as a result, caused the corporation to suffer harm.' [Citation.] The Complaint therefore pleads a nonexculpated breach of the duty of loyalty, exposes the defendants to a substantial threat of liability, and renders demand futile." (Id. at p. 323.)
In contrast, in the present case the complaint does not include an allegation that Alphabet's directors knowingly caused the corporation to violate positive law in the European Union. In Delaware, "positive law' is defined as including "the United States Constitution, federal statutes, federal regulations, the state constitution, state statutes, state regulations, and common law." (Matter of Scottish Re (U.S.), Inc. (Del.Ch. 2022) 273 A.3d 277, 295-296.) We assume for purposes of discussion that positive law also includes the laws of the European Union. Plaintiffs emphasize that the Board presentations show that Page, Brin, and Schmidt "and Board knew or should have known that [Alphabet's] anticompetitive business practices were, at a minimum, likely illegal under [European Union] law, and breached their fiduciary duties by allowing the Company's illegal practices to continue for years." However, we agree with Alphabet that the Delaware standard for demand futility does not excuse demand where the company's directors know that its business practices are "likely illegal"; to the contrary, demand is excused only for "a knowing violation of law." (See Zuckerberg, supra, 262 A.3d at p. 1050.)
Further, our review of the Board presentation excerpts included in the complaint shows that the excerpts do not support a reasonable inference that Page, Brin, and Schmidt and the directors consciously approved a business plan with respect to Google Shopping, Android, or AdSense that was predicated on violating European Union law. Plaintiffs argue repeatedly that the various Board presentations and legal advice did not say that Alphabet's conduct complied with European Union law, that the European Commission's investigation lacked merit, or that Alphabet had a strong defense. However, even accepting these allegations, we cannot reasonably infer the opposite-that the Board presentations and legal advice directly informed Alphabet's officers and directors that its business practices violated European Union antitrust law.
We reach a similar conclusion with regard to plaintiffs' contentions that the officer defendants, Page, Brin, and Schmidt, faced a substantial likelihood of liability because they were "recklessly indifferent" to the illegality of the company's practices with respect to Google Shopping, Android, and AdSense, and therefore demand was futile. As we have noted, a corporation's officers are not insulated by section 102(b)(7) from duty of care violations, and may be subject to a substantial likelihood of liability based upon gross negligence. (In re McDonald's Corp. Shareholder Derivative Litigation, supra, 289 A.3d at p. 365; Gantler v. Stephens (2009) 965 A.2d 695, 709, fn. 37.) Gross negligence in the corporate context is defined as a" 'reckless indifference to or a deliberate disregard of the whole body of stockholders or actions which are without the bounds of reason.'" (In re McDonald's Corp. Shareholder Derivative Litigation, at p. 372, fn. 17.) Here, the complaint and the documents produced by Alphabet do not support an inference of reckless indifference or actions outside the bounds of reason, in light of the numerous Board presentations concerning the European Commission's concerns about Alphabet's business practices and Alphabet's proposals in response to those concerns, which all arose in the context of evolving technology, new products, and new markets.
For these reasons, we conclude that plaintiffs have not met their burden to allege with sufficient particularity acts or omissions by the director defendants that were not in good faith or which involved intentional misconduct or a knowing violation of law or that the officer defendants, Page, Brin, and Schmidt, were grossly negligent, such that demand was excused under Delaware law. (See Zuckerberg, supra, 262 A.3d at p. 1050.) We therefore further conclude that the trial court did not err in sustaining the demurrers without leave to amend, and we will affirm the judgment.
IV. Disposition
The July 17, 2020 judgment is affirmed.
I CONCUR: Danner, J.
Lie, J., Dissenting:
Plaintiffs allege that the individual defendants breached their duty of loyalty as corporate fiduciaries by approving Alphabet's violation of the European Union's prohibition on a company's abuse of its market dominance "[d]espite their knowledge of [Redacted] fines that the EC [(European Commission)] imposed thereunder, the EC's investigation of Alphabet, and [Redacted] By "steadfastly continuing] plans to leverage [Alphabet's] dominance in internet search, mobile operating systems and online advertising to unfairly trample competitors, protect its core business and artificially gain market share in new business areas," the individual defendants breached their fiduciary duty of loyalty and caused Alphabet to "receive[] massive fines and reputational harm."
"The European Commission, which is part of the executive branch of the European Union, handles the public enforcement of antitrust laws from start to finish: it determines what European competition policy is, how it is implemented on the ground, identifies breaches of the rules, investigates the breach, decides whether to take a formal decision, decides whether to fine the errant party, and at what level." (In re Air Cargo Shipping Services Antitrust Litigation (E.D.N.Y. Sept. 26, 2008) 2008 U.S. Dist. LEXIS 107882, at p. *164; 2008 WL 5958061, at p. *31, report and recommendation adopted in part, In re Air Cargo Shipping Services Antitrust Litigation (E.D.N.Y. Aug. 21, 2009) 2009 U.S. Dist. LEXIS 107882; 2008 WL 5958061, aff'd, In re Air Cargo Shipping Services Antitrust Litigation (2d Cir. 2012) 697 F.3d 154.)
To support these allegations, plaintiffs plead particularized facts as to the nature of the internal communications about the practices alleged to be anticompetitive, the numerous successive updates by counsel as to the European Commission investigation, the advice of counsel as to (1) the requirements of European law, (2) the extent of Google's dominance of the relevant European markets, and (3) the uniform internal assessment of the practices at issue, their purpose, and their effect. To document the particularized facts so pleaded, plaintiffs incorporate by reference and attach documents Alphabet produced under section 220 of the Delaware General Corporations Law and Garner v. Wolfinbarger (5th Cir. 1970) 430 F.2d 1093.
As the majority correctly observes, plaintiffs must overcome a" 'high hurdle'" to show "intentional wrongdoing by the board" that would make futile a demand that the board elect to sue a majority of its current members. (See McElrath v. Kalanick (Del. 2020) 224 A.3d 982, 993).) But at the pleading stage, we assume the truth of all facts plaintiffs have properly pleaded (Evans v. City of Berkeley (2006) 38 Cal.4th 1, 6), and we draw "objectively reasonable" inferences in their favor (City of Birmingham Retirement and Relief System v. Good (Del. 2017) 177 A.3d 47, 55-56 (City of Birmingham)). Because I read plaintiffs' well-pleaded facts as raising a reasonable inference that at least half of the directors on the demand board faced a substantial likelihood of liability as to at least two of plaintiffs' claims (see United Food &Commercial Workers Union v. Zuckerberg (Del. 2021) 262 A.3d 1034, 1048, 1058-1059 (Zuckerberg)), I respectfully dissent.
I. The Duty of Loyalty
"Delaware law does not charter law breakers. Delaware law allows corporations to pursue diverse means to make a profit, subject to a critical statutory floor, which is the requirement that Delaware corporations only pursue 'lawful business' by 'lawful acts.' As a result, a fiduciary of a Delaware corporation cannot be loyal to a Delaware corporation by knowingly causing it to seek profit by violating the law." (City of Detroit Police and Fire Retirement System v. Hamrock (Del. Ch. Jun, 30, 2022, No. 2021-0370-KSJM) 2022 Del. Ch. LEXIS 159, at p. *43; 2022 WL 2387653, at p. *18, fn. omitted, quoting In re Massey Energy Co. (Del. Ch. May 31, 2011, No. 5430-VCS) 2011 Del. Ch. LEXIS 83, at pp. *73-*74; 2011 WL 2176479, at p. *20 (Massey); see also Louisiana Municipal Police Employees' Retirement System v. Pyott (Del. Ch. 2012) 46 A.3d 313, 352 (Pyott), revd. on other grounds, Pyott v. Louisiana Municipal Police Employees' Retirement System (Del. 2013) 74 A.3d 612; Retirement Lebanon County Employees' Fund v. Collis (Del. Ch. Dec. 22, 2022, No. 2021-1118-JTL) 2022 Del. Ch. LEXIS 358, at p. *54; 2022 WL 17841215, at pp. *2, *16.)
Further, "[w]here directors fail to act in the face of a known duty to act, thereby demonstrating a conscious disregard for their responsibilities, they breach their duty of loyalty by failing to discharge that fiduciary obligation in good faith." (Stone ex rel. AmSouth Bancorporation v. Ritter (Del. 2006) 911 A.2d 362, 370, fns. omitted; see also City of Birmingham, supra, 177 A.3d at p. 55 [listing" 'conscious disregard for one's responsibilities'" and actions" 'with the intent to violate applicable positive law'" as "specific example[s] of bad faith"]; Gatz Props., LLC v. Auriga Capital Corp. (Del. 2012) 59 A.3d 1206, 1216-1217; Ontario Provincial Council of Carpenters' Pension Trust Fund v. Walton (Del. Ch. 2023) 294 A.3d 65, 90-91 (Walton).)
Here, plaintiffs do not merely plead "that a board incorrectly exercised its business judgment and made a 'wrong' decision in response to red flags" (Melbourne Mun. Firefighters' Pension Trust Fund v. Jacobs (Del. Ch. Aug. 1, 2016, No. 10872-VCMR) 2016 Del. Ch. LEXIS 114, at p. *26; 2016 WL 4076369, at p. *9, fn. omitted (Melbourne)) or that the board adopted "a rationally compliant, if ultimately unavailing, position" (Kandell on behalf of FXCM, Inc. v. Niv (Del. Ch., Sept. 29, 2017, No. CV 11812-VCG) 2017 Del. Ch. LEXIS 640, at p. *52; 2017 WL 4334149, at p. *17 (FXCM)). Rather, plaintiffs have pleaded particularized facts from which I believe it is reasonable to infer that a majority of the demand directors breached their fiduciary duty of loyalty in connection with Alphabet's AdSense- and Android-related practices. (See Zuckerberg, supra, 262 A.3d at pp. 1059-1060 [requiring facts establishing demand futility to be pled with particularity].)
I agree with the majority that plaintiffs cannot establish a violation of the duty of loyalty by showing that the company's directors knew that the business practices were" 'likely illegal.'" But plaintiffs have not abandoned their contention that it was "reasonably inferable that [the individual defendants] knew [Alphabet's] business plan contemplated illegality" and that the directors learned of "illegal conduct" and "permitted it to continue." (Italics added).
II. Knowing Violation of European Union Antitrust Law
Article 102 of the Treaty on the Functioning of the European Union (Article 102) (<https://eur-lex.europa.eu/legal-content/EN/TXT/HTML/?uri=CELEX:12016E102> [as of Jul. 17, 2023] archived at <https://perma.cc/ZML9-97NN>) prohibits the abuse of a dominant market position by, among other practices, conditioning the conclusion of contracts as to one subject on the other party's acceptance of unrelated "supplementary obligations." Court decisions have provided a body of common law implementing this prohibition.
Properly cabined, plaintiffs' duty of loyalty theory has two central components: (1) the actual illegality of Alphabet's business practices under European Union law; and (2) the directors' endorsement of Alphabet's business practices and with knowledge of their illegality. Plaintiffs pled sufficient facts to establish those components for demand futility purposes with respect to their AdSense and Android theories of liability.
The parties in their briefing have not addressed the adequacy of plaintiffs' pleading as to Alphabet's dominance in the relevant markets and the actual illegality of Alphabet's business practices. Defendants argue only that it is "danger[ous]" to "rul[e] on demand futility" "when primary liability has not been established" by a final adjudication in the European system from which no further appeal may be taken. But courts regularly assess whether a plaintiff has pled facts that, if true, are sufficient to establish that a defendant has violated the law. Defendants moreover do not suggest that consideration of their demurrers should have awaited finality of the European proceedings.
A. AdSense Exclusivity
There is no dispute that the imposition of exclusivity agreements by a company in a dominant market position constitutes abuse under Article 102 if the agreements foreclose competition without objective justification. (See, generally, Microsoft Corp. v. Commission of the European Communities (Gen. Ct. Sept. 17, 2007) Case No. T-201/04, at ¶¶ 6, 10-12, 43-45, 854-859 (Microsoft) <https://eur-lex.europa.eu/legal-content/EN/TXT/HTML/?uri=CELEX:62004TJ0201> [as of Jul. 17, 2023] archived at <https://perma.cc/LD3A-R85F>).
First, plaintiffs plead the following facts to raise a reasonable inference that Alphabet's AdSense exclusivity arrangements violated European Union antitrust law from 2006 to 2016.
AdSense for Search is Alphabet's search advertising intermediation product. Third parties contract with Alphabet to enable Google search functionality on their websites; Alphabet displays targeted advertising along with the results of the user's search query; the third parties and Alphabet share the advertising revenue.
From 2006 to 2016 Alphabet had a dominant market position in the European Union online search advertising intermediation market, with a market share above 70 percent, and generally maintained stronger positions, with shares consistently over 90 percent, in the related general internet search and online search advertising markets.
In 2006, Alphabet began requiring third parties to enter exclusivity agreements expressly prohibiting them from using competing search advertising intermediation products. In 2009, Alphabet began replacing the express exclusivity provisions with "premium placement" requirements by which third parties had to give the most profitable placement to Alphabet's ads, display a minimum number of Alphabet's ads, and obtain Alphabet's approval for any changes to the display of ads from rival search advertising intermediaries. As a practical matter, these requirements prevented Alphabet's search competitors from contracting with third-party websites to provide intermediation services.
Alphabet's exclusive dealing arrangements harmed competition in both the intermediation markets and the general search markets. Absent the exclusivity provisions, third parties would have contracted with multiple intermediaries. But because third parties wishing to use Alphabet's service had to accept exclusivity provisions, potential competitors were denied the customer base necessary to compete effectively, either in search advertising intermediation or in harvesting the user data essential to compete in internet search and search advertising.
The only documented justification [Redacted] It is therefore reasonable to infer from plaintiff's particularized facts that Alphabet was violating Article 102 by abusing its market dominance to prevent third parties from entering intermediation contracts with Alphabet's rivals in search, search advertising, and search advertising intermediation.
Second, plaintiffs' allegations support a reasonable inference that as of July 2012 the directors who were then members of the board knew that Alphabet was imposing AdSense exclusivity conditions that violated European Union antitrust law and consciously chose to continue imposing those conditions.
A majority of the demand board held seats on the board since November 2005 or earlier. It is reasonable to infer that they were aware of board actions and presentations occurring between that date and the filing of the operative complaint.
It is undisputed that the board was aware of and monitoring European Union investigations into its alleged abuse of market dominance. I agree with the majority that this alone would not warrant an inference of guilty knowledge as the board acquiesced in Alphabet's continuation in its challenged practices. But once corporate fiduciaries are unequivocally informed that [Redacted] I consider it reasonable to infer that the fiduciaries by then knew that the corporation's practices violated European Union law.
Here, for example, the board learned from counsel in a July 2012 presentation that [Redacted] [Redacted] It further learned in the same presentation of the [Redacted]
[Redacted]
What was absent from the July 2012 slides [Redacted]
[Redacted] (See, e.g., Walton, supra, 294 A.3d at p. 75 [ where two reasonable inferences may be drawn, plaintiffs are entitled to the favorable inference at the pleading stage].) The administration of justice being imperfect, a company may simultaneously know that its business practices are unlawful and hold out hope that it will be able to win in enforcement proceedings. Moreover, the broader potential for dissuading regulatory intervention or securing a favorable settlement does not render lawful-or loyal-a decision to cause a company to engage in illegal conduct. (See Ontario Provincial Council of Carpenters' Pension Trust Fund v. Walton (Del. Ch. Apr. 26, 2023, No. 2021-0827-JTL) 2023 Del. Ch. LEXIS 83, at p. *95; 2023; WL 3093500, at p. *34 (Walton II).)
[Redacted] Nevertheless, the board permitted the company to continue imposing AdSense exclusivities until 2016. When the Commission ultimately imposed a fine, the amount took "account of the duration and gravity of the infringement."
On these facts, one can reasonably infer that the board deliberately engaged in just the sort of efficient breach that the duty of loyalty forbids. [Redacted] undercuts defendants' contention that the "complex and nuanced" state of antitrust law effectively insulated them from knowledge of illegality. Defendants rely on In re Intel Corp. Deriv. Litig. (D. Del. 2009) 621 F.Supp.2d 165, 177, where the district court dismissed a shareholder derivative lawsuit premised on antitrust violations, reasoning that the complaint "include[d] no allegations of any internal conclusion by Intel that it had repeatedly violated antitrust laws"; here, however, plaintiffs' allegations are replete with [Redacted] The matter was not so complex or nuanced as to warrant [Redacted] (Cf. Melbourne, supra, 2016 Del. Ch. LEXIS 114, at *38; 2016 WL 4076369, at p. 12 [dismissing derivative lawsuit where directors were "under the impression that [company's] conduct did not violate applicable antitrust laws"].)
I respect but do not share the majority's reticence about drawing inferences at the pleading stage from what strike me as the [Redacted] (See, e.g., Walton, supra, 294 A.3d at pp. 74-75 [where substantive portions of status update concerning compliance with settlement requirements were redacted for attorney-client privilege, plaintiffs, in context, were entitled to favorable inference that the report indicated that compliance efforts remained behind schedule rather than the unfavorable inference that the report indicated that compliance efforts were on track].) As the Delaware Court of Chancery explained in Pyott, it would be "astounding" if internal strategic plans or board presentations directly labeled a corporation's conduct as illegal. (Pyott, supra, 46 A.3d at p. 357.) "If in-house counsel hoped to keep their jobs, those words only could make it into a board presentation in the context of a statement against the practice. But sadly, sophisticated corporate actors at times engage in illegal behavior and attempt to hide their misconduct with the appearance of legal compliance." (Ibid.) As defendants remind us in their briefing, "[t]he Board comprises some of the most experienced business leaders in the world, assisted by sophisticated advisors." In short, it is reasonable to infer that the individual defendants reached the logical conclusion of illegality from the categorical premises presented to them.
" '[I]t is utterly inconsistent with one's duty of fidelity to the corporation to consciously cause the corporation to act unlawfully. The knowing use of illegal means to pursue profit for the corporation is director misconduct.' (Desimone v. Barrows (Del. Ch. 2007) 924 A.2d 908, 934-935) '[A] fiduciary may not choose to manage an entity in an illegal fashion, even if the fiduciary believes that the illegal activity will result in profits for the entity.' (Metro Commc'n Corp. BVI v. Advanced Mobilecomm Techs. Inc. (Del. Ch. 2004) 854 A.2d 121, 131.)" (Walton II, supra, 2023 Del. Ch. LEXIS 92 at pp. *94-*95; 2023 WL 3093500 at p. *34.) Plaintiffs alleged particularized facts supporting a reasonable inference that a sufficient number of the members of the demand board ran afoul of that precept by consciously permitting the company to continue using anti-competitive premium placement agreements in its third-party intermediation business from July 2012 until 2016.
B. Android Tying
At all relevant times, it was well established that European Union law made it unlawful for a company to leverage its dominance in the operating system market to bolster its position in the market for a software application by tying its operating system to a software application.
For example, Microsoft had a dominant position in the PC operating system market, with Microsoft Windows enjoying durable market shares of over 90 percent and significant barriers to entry for potential rivals. (Microsoft, supra, Case No. T-201/04 at ¶ 31; see also id. at ¶ 33 [noting Microsoft's dominant position in the work group server operating systems market, with market share of 60 percent].) As is pertinent here, Microsoft tied two separate products-its PC operating system and its media player-in a manner that leveraged its dominant position in the PC operating system market to shut out competition in the media player market without objective justification. (Id. at ¶¶ 4345, 854-859.) In so doing, Microsoft abused its dominance. (Id. at ¶¶ 1329-1330.) Nor was the Microsoft ruling unprecedented in its day. Microsoft sought to avoid penalties by contending that it "ought [not] have been aware that its refusal might infringe the competition rules" because the Commission's application of European law to Microsoft's tying conduct was novel. (See Microsoft, supra, Case No. T-201/04 at ¶¶ 1335, 1338.) In rejecting Microsoft's contention, the court held that the Commission's "examination of the tying at issue and its conclusion that Microsoft's conduct was abuse were based on a practice that was well established" in European law. (Id. at ¶¶ 859, 863-868, 1338-1339.)
The continued precedential value of the Microsoft decision is confirmed by the General Court's ruling in Google LLC v. European Commission (Gen. Ct. Sept. 14, 2022) Case No. T-604/18 (Google) <https://eur-lex.europa.eu/legal-content/EN/TXT/HTML/?uri=CELEX:62018TJ0604> [as of Jul. 17, 2023] archived at <https://perma.cc/UT8V-DKP8>. Rejecting the contention that "the fine imposed is disproportional" given "the alleged novelty of the practices in question," the General Court held that "the various instances of the conduct at issue were already covered" 15 years earlier in Microsoft. (See id. at ¶ 1106; see also id. at ¶¶ 275-299.)
Formal decisions of the European Commission may be appealed to the General Court, a "constituent court" of the European Union's highest court, the Court of Justice of the European Union. (Micula v. Gov't .of Rom. (D.D.C. 2019) 404 F.Supp.3d 265, 271.)
With Microsoft's clear analog as a backdrop, plaintiffs alleged particularized facts to support a reasonable inference that a critical mass of the demand board knowingly permitted Alphabet to violate European Union antitrust law-thereby facing a substantial likelihood of liability-through tying practices associated with its Android mobile operating system.
First, plaintiffs adequately alleged that Alphabet abused its dominant market position by engaging in anticompetitive tying. Plaintiffs alleged that Alphabet tied its operating system to its "must-have" software applications-Gmail, YouTube, Google Maps-to foreclose competition in the market for licensable mobile operating systems.Further, plaintiffs alleged that Alphabet abused its dominance by tying its dominant mobile operating system and must-have applications with its mobile search application and web browser application to foreclose competition in the mobile general search market.
Plaintiffs alleged that Alphabet had a dominant position in the market for licensable smart phone operating systems during the relevant time period. In 2010, Android, Alphabet's operating system, became the market leader with 30 percent of the market. From there, it "skyrocket[ed]" to over 95 percent of the market. Further, plaintiffs explained how network effects serve as a barrier to competition.
Second, plaintiffs alleged sufficient facts to establish, for pleading purposes, that at least half of the directors knew that Alphabet was engaged in tying practices that violated European Union antitrust law but chose to permit the company to continue with the practices to secure their anticompetitive benefits.
As pleaded by plaintiffs, defendants were acutely aware of the Microsoft decision and were sufficiently secure in their understanding of the law to exploit this aspect of Article 102 to Alphabet's advantage. Specifically, defendants took an active, selfinterested role in the Commission's pursuit of a prohibition decision against Microsoft: in 2008 and 2009, defendants allegedly stoked Commission enforcement of the judgment terms against Microsoft's later bundling of its Internet Explorer web browser with its Windows PC operating system, just as defendants sought to advance their competing web browser. At the pleading stage, it is reasonable to infer from defendants' close tracking of the European Commission's enforcement of Article 102 against Microsoft that defendants knew European law's prohibition on anticompetitive tying extended to a tie between a dominant mobile operating system and a web browser and search application.
In October 2010, a board presentation from a senior executive sought to answer "strategy questions" posed by the Board regarding "the longer[-]term vision for how we make money on Android." Among the strategies described there, which the company actually implemented, was the adoption of contractual provisions requiring third party manufacturers and service providers to install Alphabet's mobile search application and web browser application on mobile devices as a condition for the use of the mobile operating system and the Play Store, housing must-have software applications. Put simply, plaintiffs alleged that Alphabet tied its licensable smart phone operating system to its mobile search application and its web browser to ensure that its search product retained dominance on mobile devices.
Plaintiffs described the presentation as a "smoking[ ]gun" and attached a copy as an exhibit to their operative complaint. The October 2010 and July 2012 slide decks are far from the only internal communications plaintiffs have detailed and liberally quoted in the operative complaint, but I limit my focus to these presentations to the board as a whole.
The October 2010 presentation underscored the company's power in the market for licensable mobile operating systems and explained the relevant practices and their purposes. Among the concerns posed in the presentation was that a competing search product-Microsoft's Bing-would be available on Android devices. The presentation explained that Alphabet could use "stick[s]," including the relevant contractual provisions, described in general terms, to stop "partners and competitors" from developing competing versions of the Android operating system. Further, the presentation described the size of the Android ecosystem and the network effects that "protect [Alphabet] from losing control," and promised to "HARVEST."
In the July 2012 presentation, which came after the board received advisements that the Commission was investigating Alphabet's Android conduct in 2011, the slide deck acknowledged a South Korean regulatory investigation into the tying practices described here. The slide summarized the regulatory theory of liability as presenting "shades of Microsoft." This supports a reasonable inference that the board was aware of the straightforward parallel between Microsoft's unlawful tying of its dominant operating system and a software application it wished to promote and Alphabet's unlawful tying of its must-have apps and dominant operating system with a software application it wished to promote.
Underscoring the inference that the board understood the significance of the Microsoft precedent are plaintiffs' further allegations that the board was "aware of what Microsoft's anticompetitive conduct was, and why it violated EU competition law" because "they received regular updates regarding Microsoft's legal standing in the EU" and Alphabet's own efforts in 2009 to prompt the Commission to take action against Microsoft for tying its dominant operating system to its web browser application. Indeed, in October 2009, "the Board received confirmation that the European Commission had determined that Microsoft's conduct" in tying its operating system to its browser application "constituted illegal tying" such that "Microsoft would be forced to change its practices." (Italics omitted.) Microsoft settled the action in December 2009, agreeing to offer users a choice of browsers and to allow manufacturers to install competing browsers. Alphabet monitored Microsoft's compliance with the settlement, with a July 2012 board presentation flagging Alphabet's allegation to the Commission that Microsoft was not living up to its promise.
Here, a critical mass of the same board members who oversaw Alphabet's successful advocacy regarding a competitor's tying of a dominant computer operating system with a web browser, based on a precedential decision concerning the tying of a dominant computer operating system with a media player application, oversaw Alphabet's decision to tie its dominant mobile operating system with its web browser and search application for the purpose of insulating Alphabet from competition in the mobile search market. It is reasonable to infer, on the facts particularly pled in the complaint, that by no later than July 2012 a critical mass of the demand board knew what the company was doing, knew that in so doing the company was violating European antitrust law, and consciously decided to permit the unlawful conduct to persist. (See Walton II, supra, 2023 Del. Ch. LEXIS 92 at p. *98; 2023 WL 3093500 at p. *35 [where the "pleading-stage record supports an inference that the directors knew about . . . noncompliance and allowed it to happen," it supports an inference that "they consciously condoned illegality"].) Again, one can reasonably infer that the board made precisely the sort of efficient breach calculation that the duty of loyalty under Delaware law forecloses.
Apparently drawing from the October 2010 presentation, the General Court ruled that the Commission was correct to conclude that Alphabet intentionally violated European Union law by abusing the "dominant position or significant power on the markets for Android stores and for general search services" by "consciously pursuing a 'carrot-and-stick' strategy" "to prevent the use of non-approved alternative versions of Android to promote the use of Google's services alone, with the clear aim of protecting and strengthening Google's position in the markets for general search services." (Google, supra, Case No. T-604/18 at ¶¶ 19, 1006, 1044-1046, 1051, 1113.) Whether or not Google survives Alphabet's further appeal to the Court of Justice of the European Union, I do not think it insignificant, in assessing what reasonable inferences can be drawn at the pleading stage from a record including the October 2010 presentation, that the General Court inferred that this board-level communication detailed the unlawful business strategy that the company consciously pursued.
At the pleading stage, courts do not need to "determine what actually happened." (Pyott, supra, 46 A.3d at p. 356.) Plaintiffs need only plead particularized facts sufficient to support the necessary favorable inferences. (See id. at pp. 355-356.)
The "high burden" on plaintiffs pleading demand futility is not an insurmountable one. (See, e.g., Walton II, supra, 2023 Del. Ch. LEXIS 92 at pp. *98-*122; 2023 WL 3093500 at pp. *35-*43; Massey, supra, 2011 Del. Ch. LEXIS 83 at pp. *73-*77; 2011 WL 2176479 at pp. *20; FXCM, supra, 2017 Del. Ch. LEXIS 640 at pp. *5-*6, *54-*55; 2017 WL 4334149 at pp. *2, *17-*18.) "If the complaint contains well-pled allegations that could support different interpretations, then the court must credit the plaintiffs' interpretation. If the record could support different inferences, and if the plaintiff seeks a reasonable inference, then the court must grant the plaintiff the inference." (Walton II, supra, 2023 Del. Ch. LEXIS 92 at p. *6; 2023 WL 3093500 at p. *3, citing Savor, Inc. v. FMR Corp. (Del. 2002) 812 A.2d 894, 896-897.) Here, at the pleading stage, plaintiffs need only raise a reasonable inference that a majority of the demand board knew that Alphabet's conduct was unlawful and yet consciously permitted it.
The information shared with a majority of the demand board in my view plainly establishes the reasonableness of such an inference, even as it remains reasonable to infer the contrary. Although defendants would have the courts treat as dispositive the absence of an express confession of scienter or an overt statement by counsel that the challenged conduct was unlawful, a defendant's confession of wrongdoing even in a criminal trial is not essential to overcoming reasonable doubt as to liability. I would not hold plaintiffs to a higher standard in civil pleading than a criminal prosecutor must meet for proof at trial.