The Delaware Supreme Court held that the Court of Chancery erred by failing to give preclusive effect to an earlier with-prejudice dismissal of a parallel derivative suit in another state, and by creating a presumption that all plaintiffs who file derivative suits without first conducting books-and-records inspections are inadequate representatives. Pyott v. La. Mun. Police Emps.’ Ret. Sys., No. 380, 2012 (Del. Apr. 4, 2013). The decision stresses the importance of interstate comity and the need to give full faith and credit to the decisions of other courts.

Allergan is a drug company that incurred losses in resolving civil and criminal investigations of off-label drug marketing. Derivative suits were filed in both federal court in California and the Court of Chancery alleging that Allergan’s directors were liable for the losses because they failed to properly monitor the company’s marketing practices. The Delaware shareholder plaintiff obtained documents through a books-and-records inspection under 8 Del. C. § 220 before filing suit. The California plaintiffs did not, but later amended their complaints when the Delaware plaintiff shared the documents. Defendants moved to dismiss in both jurisdictions. The California federal court ruled first, dismissing with prejudice for failure to establish demand futility. The Court of Chancery refused to give preclusive effect to that ruling, applying Delaware law to the preclusion question. Turning to the merits, Chancery disagreed with the federal court, holding that demand was futile and that the case should proceed.

…continue reading: Delaware Court Limits Non-Delaware Dismissal

The prevalence of settlements in class and derivative litigation challenging mergers and acquisitions in which the only payment is to plaintiffs’ attorneys suggests potential systemic dysfunction arising from the increased frequency of parallel litigation in multiple state courts. After examining possible explanations for that dysfunction, and the historical development of doctrines limiting parallel state court litigation — the doctrine of forum non conveniens and the “first-filed” doctrine — this paper suggests that those doctrines should be revised to better address shareholder class and derivative litigation. Revisions to the doctrine of forum non conveniens should continue the historical trend, deemphasizing fortuitous and increasingly irrelevant geographic considerations, and should place greater emphasis on voluntary choice of law and the development of precedential guidance by the courts of the state responsible for supplying the chosen law. The “first-filed” rule should be replaced in shareholder representative litigation by meaningful consideration of affected parties’ interests and judicial efficiency.

Putting Stockholders First responds to the observation that in 2011, only 5% of settlements of shareholder litigation challenging mergers and acquisitions involved an additional payout to stockholders, 84% of such settlements were based on additional disclosure only, but all of such settlements involved payment of fees for plaintiffs’ attorneys. These figures reflect a significant change from 1999 to 2000, when 52% of suits filed on behalf of shareholders produced a financial benefit for the class, and only 10% of settlements were “disclosure-only.”

…continue reading: Putting Stockholders First, Not the First-Filed Complaint

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.

…continue reading: Delaware Court of Chancery Dismisses Hastily Filed Caremark Action

A number of derivative suits have been filed in recent months alleging that the senior executive compensation plans at public companies do not comply with Section 162(m) of the Internal Revenue Code. Section 162(m) provides that any compensation paid to the CEO and next three highest compensated proxy officers (other than the CFO) in excess of $1 million per year is not tax deductible unless, among other things, the compensation is subject to objective performance metrics that have been disclosed to and approved by shareholders. The complaints generally allege that the performance goals established by the plans are not sufficiently objective to comply with Section 162(m) and that the purported failure of the plans to comply with Section 162(m) renders the required proxy disclosure false and misleading in violation of Section 14(a) of the Securities Exchange Act. In addition, the complaints allege that the provision of non-deductible compensation to senior executives constitutes waste, unjust enrichment of the executives and a breach of the directors’ duty of loyalty.

…continue reading: Avoiding Shareholder Suits Challenging Executive Compensation

On January 28, 2011, the Delaware Supreme Court clarified in King v. VeriFone Holdings, Inc., Del. Supr., No. 330, 2010, that plaintiffs may in some circumstances inspect a corporation’s books and records to bolster a derivative action complaint even after they have filed a lawsuit.

Section 220 of Delaware’s General Corporation Law provides shareholders with a limited right to inspect the books and records of Delaware companies in which they own stock. That right is subject to several conditions, including the condition that shareholders have a “proper purpose” for seeking inspection. [1] Investigating corporate mismanagement, for example, is a proper purpose. [2] Indeed, Delaware courts have repeatedly urged shareholders to use Section 220 to conduct such investigations before filing a derivative action. By using the “tools at hand,” those courts have explained, shareholders can become better equipped to plead allegations that are sufficient to meet the stringent pleading requirements that apply to derivative complaints, particularly in cases in which the plaintiffs did not serve a pre-suit demand and thus must plead “demand futility” (i.e., that serving a demand would be useless because the board of directors is biased against the claims or dominated by others who are). [3] Litigants have frequently clashed over whether the purpose of obtaining information to fortify a derivative complaint is “proper” when the complaint has already been filed.

…continue reading: Delaware Supreme Court Allows Books and Records Action After Derivative Lawsuit

In a recent decision, the Delaware Court of Chancery for the first time held that preferred stockholders have standing to bring derivative suits on behalf of a corporation. MCG Capital Corp. v. Maginn, C.A. No. 4521-CC (Del. Ch. May 5, 2010).

The plaintiff was the sole holder of Jenzabar, Inc.’s preferred stock but held no common stock of the corporation. Plaintiff brought suit alleging that the board’s decision to pay certain compensation to executive management breached fiduciary duties owed to the corporation and violated both the corporation’s charter and contractual consent rights. Resolving an issue of first impression under Delaware law, the Court held that “preferred shareholders have standing to bring derivative claims unless the ability to bring a derivative claim has been expressly limited in the articles, preferred stock designations, or some other appropriate document.” Delaware corporations are thus now on notice that preferred stockholders presumptively have the same rights as common stockholders to attack corporate action through derivative litigation. At the same time, the Court indicated that express limitations on preferred holder derivative standing will be enforced.

Coming in the wake of the Supreme Court’s 2007 Gheewalla decision, which explained that the creditors of a corporation may bring derivative suits once the corporation is insolvent, MCG Capital Corp. expands the universe of potential derivative plaintiffs, and, accordingly, potential derivative liability. Nevertheless, and in accordance with Delaware’s longstanding policy favoring private ordering, the Chancellor took pains to reassure Delaware companies that limitations on such standing will be respected if clearly set forth in the charter or the preferred stock’s designations.

The Delaware Chancery Court recently issued a resounding affirmation of the business judgment rule in the case In re the Dow Chemical Company Derivative Litigation. [1] Directors can take comfort in this timely reminder that, despite challenging economic circumstances and an environment of heightened scrutiny of boards and individual directors, the protections of the business judgment rule remain robust in Delaware.

The Dow Chemical Case

Dow was a shareholder derivative suit filed nearly a year ago amid turmoil over Dow’s planned acquisition of another chemical company, Rohm & Haas, for aggregate consideration of approximately $18.8 billion. The Dow stockholders alleged that the directors and officers of Dow had breached their fiduciary duties in at least three different respects: first, in approving the Rohm & Haas transaction without a financing contingency; second, in misrepresenting the connection between the Rohm & Haas transaction and another pending transaction, a joint venture with a Kuwaiti company for which a memorandum of understanding had been entered into six months previously; and third, in failing to detect and prevent various corporate misdeeds during the course of both transactions, including bribery, misrepresentation, insider trading and wasteful compensation.

…continue reading: Dow Reaffirms Delaware’s Business Judgment Rule

Does a Director Qua Director Have Standing to Sue Derivatively? No, so said the Delaware Supreme Court yesterday in Schoon v. Smith. The Supreme Court affirmed the Court of Chancery’s little-noticed ruling last year that dismissed a derivative claim brought by a director against the company’s other directors, including its controlling stockholder. The plaintiff-director, who was not a stockholder of the company, charged his fellow directors with, among other things, breach of fiduciary duty and unjust enrichment. The court held that, notwithstanding the equitable origins of derivative suits, the issue of director standing today is best left to the legislature. “Although the Delaware General Assembly has the prerogative to confer standing upon directors by statute,” the court wrote, “it has not chosen to do so.” Rejecting the American Law Institute Principles that give individual directors standing to sue on behalf of their corporations, the court continued that, “[b]ecause a stockholder derivative action is available to redress any breach of fiduciary duty, we decline to extend the doctrine of equitable standing to allow a director to bring a similar action.” The court concluded, however, by leaving itself a little room to permit directors to bring derivative suits, but only where the failure to do so would result in a “complete failure of justice”—a seemingly high standard.

As a practical matter, the decision is unlikely to have much significance because most directors are also stockholders. But the decision is still significant and may draw criticism with respect to its implications for corporate governance and director duties. In particular, the court noted that the concept of being an “independent director” does not mandate “a duty to sue on behalf of the corporation.”

The opinion is available here.

The Delaware Court of Chancery issued a decision last week of both practical and theoretical importance for corporate lawyers. The opinion is Melzer v. CNET Networks, Inc., and there are at least three reasons why this case is noteworthy.

First, the court held that Section 220 of the Delaware General Corporation Law, which is the statutory basis on which stockholders can demand books and records of a company, enables plaintiffs under certain circumstances to receive documents for a period prior to their stock ownership. In order to allow a pleading to be prepared with details of alleged “systemic and sustained” lack of oversight by the board (the well-known Caremark standard), the Court allowed the plaintiffs to access materials prepared before they became stockholders.

Second, the case is interesting because it began as a derivative action filed in federal court in California. The California case was dismissed by the federal judge, however, who instructed the plaintiff to avail himself of the provisions of DGCL Section 220. The parties now appear to be headed back to California, where the plaintiff will be able to amend the complaint in light of the discovery authorized in this opinion.

Finally, the case is striking because the defendant admitted that it engaged in the backdating of stock options, which is the factual basis of the underlying claims. In a separate blog post that can be found here, I offer more analysis of those facts and the court’s application of Delaware law to this fascinating case.

Robert K. Payson and Bradley W. Voss of Potter, Anderson & Corroon have released this Memorandum summarizing Vice Chancellor Strine‘s recent decision in In re: The Topps Company Shareholders Litigation.  In Topps, the Court builds on the narrative Chancellor Chandler offered in Ryan v. Gifford, explaining why the Delaware courts will not stay a later-filed Delaware action in a shareholder derivative suit in favor of a first-filed action in another state if the Delaware courts are persuaded that the issues are important and novel under Delaware law.  Although the general rule favors deference to the speedier plaintiff in the first-filed action, since plaintiffs in derivative suits (in theory, at least) are not suing on their own behalf, Delaware courts have not hesitated to proceed with a later-filed Delaware action notwithstanding ongoing proceedings elsewhere.

The Ryan and Topps decisions represent an interesting nuance in the debate over competition among states with respect to corporate law.  Although that scholarship emphasizes where firms will choose to incorporate, there may be competition among courts over shareholder derivative suits as some plaintiffs file in Delaware and others in different jurisdictions (such as the venue where the company’s headquarters is located).  If some plaintiffs file suit outside of Delaware courts–believing, perhaps, that a foreign state’s court will apply Delaware law in a manner more favorable to shareholders–which court takes control of the case will be particularly important.  And, of course, the fact that dueling suits are proceeding side by side raises a host of interesting issues, including whether the courts or the parties will “race” to an outcome to gain collateral estoppel effect and whether having two costly suits proceeding simultaneously is an efficient use of judicial resources.