## Facts

- A China Agritech, Inc. stockholder filed a consolidated derivative action on the corporation’s behalf against certain directors and officers, alleging the company was operated to benefit its co-founders.
- The complaint challenged an interested transaction in which the company acquired the remaining interest in a subsidiary from an entity owned by the co-founders (the “Yinlong Transaction”).
- The complaint alleged misuse of proceeds from a secondary public offering represented as funding distribution centers; later allegations and investigation suggested no such centers existed.
- The company disclosed material weaknesses in internal controls, replaced outside auditors, and its replacement auditor identified additional material weaknesses and deficiencies.
- Over roughly two years, two outside auditors were terminated and multiple outside directors and senior officers resigned.
- The company stopped making federal securities filings after November 2010 and was delisted by NASDAQ.
- An external report alleged, among other things, no manufacturing activity, missing licenses, no distribution centers, and discrepancies between Chinese and U.S. filings; the company issued rebuttals but formed a special committee to investigate.
- The special committee overlapped substantially with the audit committee whose conduct was implicated; before the investigation concluded the company terminated its auditor and further resignations followed.
- Before suing, the plaintiff pursued a DGCL § 220 books-and-records demand and pled based on produced materials and alleged missing documents the company should have maintained.

## Issues

1. Whether demand was excused under Court of Chancery Rule 23.1 because a majority of the board could not exercise disinterested and independent business judgment under *Aronson* and *Rales*.
2. Whether the complaint stated claims under Rule 12(b)(6), including fiduciary duty claims based on self-dealing and bad-faith oversight failures.
3. Whether the action should be stayed.

## Decision

- The court denied the Rule 23.1 motion, holding demand was excused as futile under *Aronson* and *Rales*.
- The court denied the Rule 12(b)(6) motion, finding the complaint pled non-conclusory facts supporting fiduciary duty claims, including loyalty-based oversight and self-dealing theories.
- The court denied the requested stay and allowed the derivative action to proceed.

## Legal Principles

- Demand is excused when well-pled, particularized facts support a reasonable inference that a majority of directors face a substantial likelihood of liability or otherwise lack independence, preventing valid business judgment on a demand.
- Under *Aronson* and *Rales*, the demand-futility framework depends on whether the challenged conduct is tied to board decisions by the demand board and whether directors can act disinterestedly and independently.
- Director oversight liability may proceed at the pleading stage where facts support an inference of bad faith, including conscious disregard of duties in the face of significant warning signs affecting reporting, controls, or corporate compliance.
- Allegations of controller or founder self-interest in corporate transactions, coupled with weak procedural protections (e.g., non-independent review), can support loyalty-breach claims.
- A DGCL § 220 inspection can support pleading particularity; alleged absence of expected corporate records may contribute to an inference supporting claims and demand futility.

## Conclusion

The Court of Chancery permitted the derivative case to go forward because the complaint, strengthened by § 220 materials and alleged missing records, pled substantial red flags and interested conduct supporting an inference that a majority of the board could not consider a demand and that the directors and officers plausibly breached fiduciary duties through self-dealing and bad-faith oversight failures.


In re China Agritech, Inc. S'holder Deriv. Litig., C.A. No. 7163-VCL (Del. Ch. May 21, 2013)