Federal Court’s Dismissal of Shareholder Derivative Action Entitled to Preclusive Effect in Courts of Delaware
A troubling trend over the past few years in the shareholder derivative context has been the significant rise in multi-jurisdictional litigation requiring defendants to defend substantially similar claims in several courts simultaneously. Regardless of the cause or origin of this development, defendants faced with these duplicative claims are not only burdened by significantly increased costs and expenses, but also exposed to a substantial risk of inconsistent judgments.
On April 4, 2013, the Supreme Court of Delaware issued its opinion in Pyott v. La. Municipal Police Employees’ Retirement System, No. 380, 2013 Del. LEXIS 179 (Del. Apr. 4, 2013), holding that a California federal court’s dismissal of a shareholder derivative complaint for failure to plead demand futility had preclusive effect over a nearly identical action filed in the Delaware Court of Chancery. This decision will help minimize the burden, expense and risk of inconsistent judgments when defendants are faced with duplicative, multi-jurisdictional shareholder derivative litigation.
In Pyott, Allergan, Inc. publicly announced that it had entered into a settlement with the United States Department of Justice, pleading guilty to criminal misdemeanor misbranding and paying a total of $600 million in civil and criminal fines. An Allergan shareholder then brought an action in Delaware pursuant to Delaware General Corporation Law, 8 Del. C. § 220, for the inspection of books and records of the company. Multiple shareholder derivative actions were then filed in both the Delaware Court of Chancery and the United States District Court for the Central District of California. Defendants in both actions filed motions to dismiss, and the California action was first dismissed without prejudice. After the California plaintiffs obtained copies of the documents that had been produced in the Section 220 action, the California plaintiffs filed an amended complaint, which the defendants again moved to dismiss. Briefing before the California court outpaced that of the Court of Chancery, and prior to a ruling in Delaware, the California court dismissed the amended complaint with prejudice.
Subsequently, in the Court of Chancery, Vice Chancellor Laster denied the defendants’ motions to dismiss and refused to give preclusive effect to the California judgment. Under Delaware’s internal affairs doctrine, the Court of Chancery found two independent bases for declining to give collateral estoppel effect to the California judgment. First, the privity requirement was not satisfied where, pursuant to Federal Rule of Civil Procedure 23.1, the California plaintiffs did not have standing to bring suit until they made a demand that was wrongfully refused or established that a pre-suit demand was futile. Additionally, the adequate representation requirement was not satisfied where the California plaintiffs did not adequately represent Allergan, as demonstrated by their rush to the courthouse to file suit without first seeking to inspect the Company’s books and records pursuant to Section 220.
Vice Chancellor Laster’s analysis of inadequate representation provided valuable insight into the Court of Chancery’s current outlook on multi-jurisdictional shareholder derivative litigation. Namely, Vice Chancellor Laster adopted and applied the fast-filer presumption, based upon Chancellor Strine’s suggestion that Delaware law presumes “that a fast-filing stockholder with a nominal stake, who sues derivatively after the public announcement of a corporate trauma in an effort to shift the still-developing losses to the corporation’s fiduciaries, but without first conducting a meaningful investigation, has not provided adequate representation. 1” The Court of Chancery utilized this presumption against the adequacy of a “fast-filing” derivative plaintiff as a basis for refusing to give preclusive effect to the federal court’s dismissal of the complaint in the California action.
Defendants sought interlocutory review of the Court of Chancery’s denial of their motion to dismiss the shareholder derivative action, and the Delaware Supreme Court reversed, holding that the California judgment was entitled to preclusive effect. The Supreme Court stated that “[o]nce a court of competent jurisdiction has issued a final judgment . . . a successive case is governed by the principles of collateral estoppel, under the full faith and credit doctrine, and not by demand futility law, under the internal affairs doctrine. 2” Accordingly, the Supreme Court held that the Court of Chancery should have applied California preclusion law which required dismissal where the action addressed the same question and was litigated to final judgment on the merits, that the plaintiffs were in privity with the Delaware plaintiffs, and that there is no “fast-filer presumption” of inadequacy.
While the Supreme Court of Delaware empathized with the Court of Chancery’s frustration with the “fast-filing problem” and recognized that the desire to curb plaintiffs’ race to the courthouse raised important interests in Delaware, it held that “the undisputed interests that Delaware has in governing the internal affairs of its corporation must yield to the stronger national interests that all state and federal courts have in respecting each other’s judgments. 3” While the Court of Chancery will have to continue addressing the problem of “fast-filers” who do not conduct adequate pre-suit investigation on a case-by-case basis, the Delaware Supreme Court’s decision will reduce the risk of inconsistent decisions and the burden and expense to defendants in duplicative, multi-jurisdictional shareholder derivative litigation when one jurisdiction has already dismissed a case on the merits.
1 46 A.3d 313, 335 (Del. Ch. 2012) (citing King v. VeriFone Holdings, Inc., 994 A.2d 354, 364 n.34 (Del. Ch. 2010), rev’d on other grounds, 12 A.3d 1140 (Del. 2011)).
2 2013 Del. LEXIS 179, at *7-8.
3 Id. at *8.
© TROUTMAN SANDERS LLP. ADVERTISING MATERIAL. These materials are to inform you of developments that may affect your business and are not to be considered legal advice, nor do they create a lawyer-client relationship. Information on previous case results does not guarantee a similar future result.