Litigation » Carvana Derivative Claim Dismissal Upheld by Court

Carvana Derivative Claim Dismissal Upheld by Court

May 14, 2024

Carvana Derivative Claim Dismissal Upheld by Court

Following the 2020 sale of shares totaling over $1 billion by Carvana owners, Carvana filed a legal claim alleging that owners Ernest Garcia II and Ernest Garcia III had breached their fiduciary duties by profiting unfairly from the direct offering. According to an article by Sidley, the Delaware Court of Chancery rejected the defendants’ attempt to dismiss the case in August 2022.

Carvana then established a Special Litigation Committee (SLC) consisting of two directors, which engaged legal counsel to investigate the matter. After conducting interviews and reviewing documents, the SLC produced a 170-page report affirming the fairness of the direct offering and finding no wrongdoing by the Garcias. Based on this report, the SLC sought to have the derivative claim dismissed.

In March 2024, the Court granted the motion to dismiss, determining that the SLC had met the required two-step analysis outlined in Zapata Corp. v. Maldonado. Chancellor McCormick’s detailed 41-page decision, as discussed by Sidley, highlighted several key points:

McCormick found that the SLC members were independent and had conducted a thorough investigation in good faith, providing a reasonable basis for their conclusions. He then used his own judgment to assess whether dismissing the derivative action was in Carvana’s best interests.

In particular, he evaluated whether there were any substantial reasons to doubt the SLC members’ ability to act solely in the company’s best interests. He concluded that the plaintiffs’ arguments did not raise significant concerns about the thoroughness or reasonableness of the SLC’s investigation, nor did they challenge the validity of its conclusions.

McCormick also noted a flaw in the plaintiffs’ case, pointing out that their allegations regarding one SLC member’s business connections with the Garcias lacked detail regarding the extent or impact of those connections. As a result, he deemed these allegations insignificant.

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