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In re China Agritech Inc. Shareholder Derivative Litigation | 2013 WL 2181514 (2013.)
In the 2006 case In re Caremark International Incorporated Derivative Litigation, Delaware first recognized a breach of fiduciary duty claim against corporate directors who fail to properly oversee the corporation.1 Seven years later, in In re China Agritech, Incorporated Shareholder Derivate Litigation, the Delaware Court of Chancery considered whether directors could breach this duty of oversight for failing to establish proper financial disclosure controls and procedures.
China Agritech is a Delaware corporation that develops, manufacturers, and markets environmentally friendly fertilizer products in China. The company was cofounded by Yu Chang and Xiao Teng, both of whom were directors. In 2005, Agritech accessed the securities markets through a reverse merger, thereby acquiring an inactive corporation with a NASDAQ listing.
In 2007, Agritech filed its annual financial report with the United States Securities and Exchanges Commission in which the company disclosed that it didn’t have financial controls and procedures in place required by United States law. One year later, Agritech hired three new executives in an effort to correct its control problems. The five-member board established an audit committee comprised of the new executives, but the committee never met to discuss corporate compliance.
In 2009 and 2010, Agritech engaged in a series of major transactions, including acquiring an interest in a company that Chang and Teng owned. Further, in 2010, Agritech disclosed in its financial report that material weaknesses had undermined its disclosure controls and procedures. As a result, the company hired Ernst and Young as an outside auditor. Ernst and Young then met with the audit committee to discuss various violations but was fired just four months later.
In 2011, the NASDAQ delisted Agritech from its stock exchange after Agritech failed to file a timely financial report. In 2012, Agritech shareholders filed a derivative suit against Agritech’s directors in the Delaware Court of Chancery for breach of fiduciary duties. Specifically, the shareholders argued that the directors breached their duty of good faith by engaging in a sustained or systematic lack of oversight of Agritech. In response, the directors moved to dismiss for failure to make a pre-suit demand and for failure to state a claim upon which relief could be granted.
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