Delaware Court of Chancery Dismisses Hastily Filed Caremark Action

Posted by Eduardo Gallardo, Gibson, Dunn & Crutcher LLP, on Tuesday October 30, 2012 at 9:07 am
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Editor’s Note: Eduardo Gallardo is a partner focusing on mergers and acquisitions at Gibson, Dunn & Crutcher LLP. This post is based on a Gibson Dunn client alert by Mr. Gallardo, Brian Lutz, James Hallowell, and Jefferson Bell. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

On September 25, 2012, Vice Chancellor Travis Laster of the Court of Chancery of the State of Delaware dismissed the derivative complaint in South v. Baker, C.A. No. 7294-VCL, with prejudice. This decision reaffirms the Chancery Court’s low tolerance for hastily filed shareholder derivative lawsuits brought under the In re Caremark International Inc. Derivative Litigation, 698 A.2d 959 (Del. Ch. 1996), line of cases where the plaintiff makes little effort to plead any connection between a “corporate trauma” and the conduct of a board of directors. At the same time, the South decision also finds that shareholders are entitled to, and should seek, books and records from Delaware corporations before bringing derivative lawsuits in Delaware. Accordingly, Delaware corporations should anticipate an increase in shareholder demands for books and records under Section 220 of the Delaware General Corporation Law in the wake of any “corporate trauma.” In addition, the South decision found that dismissal of the South complaint did not preclude other Hecla shareholders from filing future derivative suits because the South plaintiffs did not use Section 220 and, therefore, did not adequately represent Hecla’s interests.

In 2011, Hecla Mining Company had three unfortunate, but apparently unrelated, safety incidents occur at one of its mining operations in Idaho. The incidents left several miners injured and two dead, and resulted in several negative safety reports from the U.S. Mine Safety and Health Administration (“MSHA”). In January 2012, Hecla announced that, on orders from the MSHA, it was closing the primary access shaft to the mine to remove debris. The closure was apparently unrelated to the safety incidents of 2011, but in connection with the closure, Hecla lowered its estimated silver production for 2012.

The Hecla announcement and a press release from MSHA regarding safety citations issued to Hecla led to a race to the courthouse. Two federal securities fraud class actions were filed, and thereafter, several derivative actions were filed in Idaho state and federal court. The South plaintiffs filed in the Delaware Court of Chancery two months after the Hecla announcement, and, as they later admitted at oral argument before Vice Chancellor Laster, they rushed to court in an attempt to prevent plaintiffs in other jurisdictions from asserting control of the litigation. The gravamen of the South complaint was that the directors of Hecla were liable for any damages that Hecla suffered as a result of the mining incidents because the directors had breached their fiduciary duties by permitting the underlying legal violations to occur. Critically, before filing suit, the South plaintiffs and their counsel did not use Section 220 of the Delaware General Corporation Law, which permits a stockholder to obtain access to books and records of a corporation for a “proper purpose,” to investigate what personal involvement, if any, the Hecla directors had with the circumstances that led to the mine incidents. Instead, the South plaintiffs premised their claims of director liability only upon Hecla’s public announcement and MSHA press releases, which stated that “management” had failed to ensure appropriate safety at the mine.

Vice Chancellor Laster found that the South plaintiffs did not adequately allege that the directors of Hecla had been involved in conscious wrongdoing, and thus the plaintiffs failed to satisfy the requirements for bringing a derivative action under Caremark, which provides that directors of a corporation may be held liable for knowingly causing or consciously permitting the corporation to violate the law, or for failing to attempt to establish an oversight system to monitor the corporation’s legal compliance. The court specifically faulted the plaintiffs for failing to take advantage of the investigative opportunities presented by Section 220 which, unlike public sources alone, may have enabled the plaintiffs to plead a connection between the mining accidents and the Board. Accordingly, the court dismissed the South complaint with prejudice.

The court, however, left the door open for other Hecla stockholders to file future derivate complaints, should those complaints prove to be the product of adequate investigation. In doing so, Vice Chancellor Laster articulated an evidentiary presumption that “a plaintiff who files a Caremark claim hastily and without using Section 220 or otherwise conducting a meaningful investigation has acted disloyally to the corporation and served instead the interests of the law firm filing suit.” Vice Chancellor Laster held further that, in the circumstances of this case, the South plaintiffs and their counsel had not presented evidence sufficient to rebut this presumption, particularly since they could establish no adequate reason for failing to use Section 220 before filing suit. As a result, the court held that Hecla’s interests had thus not been adequately represented in the South suit, and future derivative suits on behalf of Hecla were not precluded.

The South decision raises several important issues for Delaware corporations to consider when litigating shareholder derivative claims under Caremark in Delaware. The South decision suggests that use of Section 220 is essentially required before a derivative plaintiff may bring suit under Delaware law. Delaware corporations should accordingly expect an uptick in Section 220 demands, which require careful assessment of whether the requesting shareholder has a “proper purpose” for making such a demand, and the appropriate scope of any production under Section 220. These decisions require careful consideration with counsel experienced in Delaware law issues.

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