Delaware Supreme Court Holds That Chancery Court Should Have Given Preclusive Effect to California Judgment Dismissing Complaint for Failing to Plead Demand Futility

04/11/2013


Last week the Delaware Supreme Court held in Pyott v. Louisiana Municipal Police Employees’ Retirement System, ___ A.3d ___, 2013 WL 1364695 (Del. 2013), that a Delaware derivative complaint should have been dismissed after a California federal court entered a judgment dismissing essentially the same complaint brought by different stockholders for failure to plead demand futility. The Delaware Supreme Court held that because the California federal court had already issued a final judgment, the successive Delaware action should have been governed by the principles of collateral estoppel, under the full faith and credit doctrine. The Delaware Supreme Court also held that there is no irrebutable presumption that derivative plaintiffs who quickly file suit after the announcement of a “corporate trauma,” without first seeking books and records, are inadequate representatives. While empathizing with the Chancery Court’s attempt to curb the “race to the courthouse” by plaintiffs’ firms, who specialize in stockholder representative litigation, the Delaware Supreme Court’s opinion makes clear that such attempts cannot come at the expense of well-settled principles of federalism, comity, and finality associated with final judgments. This decision should help corporate defendants and Boards minimize the burdens of duplicative derivative litigation in different jurisdictions.

Background Facts and Procedural History

Allergan, Inc. is a Delaware corporation that develops and markets BOTOX, a prescription neurotoxin approved by the FDA for several therapeutic and cosmetic uses. In 2007, the Department of Justice began an investigation into Allergan’s allegedly improper marketing of BOTOX. In September 2010, Allergan announced that it had pled guilty to the criminal misdemeanor of misbranding and agreed to pay $600 million in civil and criminal fines.

News of the settlement immediately spawned shareholder derivative suits in Delaware and California. Allergan and its directors moved to dismiss both complaints for failure to plead demand futility, i.e., that demand on the Board of Allergan to file suit would have been futile.

In Delaware, the plaintiffs had filed suit two days after Allergan announced the settlement and without having first served Allergan with a demand for books and records under Section 220 of the Delaware General Corporation Law. When a second plaintiff, who had served Allergan with a books and records demand, sought to intervene, the Chancery Court postponed any hearing on the motions to dismiss “until after the 220 process [was] over.”

The California litigation advanced more quickly. Before the Delaware Chancery Court ruled on Allergan’s motion to dismiss, the California federal court dismissed the California action with prejudice for failure to plead demand futility. The parties to the Delaware action then filed supplemental briefs addressing the preclusive effect of the California judgment.

The Delaware Chancery Court held that the California judgment did not bar the Delaware action. First, applying Delaware law, the Chancery Court held that the plaintiffs in the California and Delaware actions were not in privity because until a stockholder survives a motion to dismiss based on failure to make a demand, the stockholder is not acting for the corporation; rather, the stockholder is asserting an “individual claim to obtain equitable authority to sue.” Second, the Chancery Court held that, under Delaware law, the plaintiffs in the California litigation had provided inadequate representation for Allergan because they had filed suit quickly and without having first conducted a meaningful investigation.

Delaware Supreme Court: Collateral Estoppel Applies

The Delaware Supreme Court reversed the Chancery Court’s ruling and held that the Chancery Court should have given preclusive effect to the California judgment. The Delaware Supreme Court began by noting that a state court is required “to give a judgment [from another jurisdiction] the same force and effect that it would be given by the rendering court.” The Delaware Supreme Court stated that the “rationale for this determination originates from the United States Constitution’s Full Faith and Credit Clause and the Full Faith and Credit Act.” Thus, federal common law “imposes on the state of Delaware a full-faith-and-credit requirement to give the California Federal Judgment the same force and effect as it would be entitled to in the California federal or state courts under California’s preclusion rules.”

The Delaware Supreme Court held that the Chancery Court erred by applying Delaware law to determine the California judgment’s preclusive effect. Once the California federal court had issued its final judgment, the “successive case is governed by the principles of collateral estoppel, under the full faith and credit doctrine, and not by demand futility law,” under Delaware law. The Delaware Supreme Court reiterated that under its precedents, “the undisputed interest that Delaware has in governing the internal affairs of its corporations must yield to the stronger national interests that all state and federal courts have in respecting each other’s judgments.” The Delaware Supreme Court held that the Chancery Court should therefore have applied California law or federal common law to analyze the elements of collateral estoppel.

According to the Delaware Supreme Court, had the Chancery Court applied federal common law or California law, as it was required to do, it would have been compelled to dismiss the Delaware complaint because: (1) the issue sought to be precluded, whether demand on the Allergan board was excused as futile, was identical to that decided by the California federal court; (2) that issue was actually litigated and necessarily decided on the merits by the California federal court; and (3) the differing groups of shareholders were in privity because the real plaintiff in a derivative suit is the corporation.

The Delaware Supreme Court also faulted the Chancery Court for announcing and applying “an irrebutable presumption that derivative plaintiffs who file their complaints without seeking books and records, very quickly after the announcement of a ‘corporate trauma’, are inadequate representatives.” Although the Delaware Supreme Court empathized with the Chancery Court’s concerns about “fast filers,” the Delaware Supreme Court found no record support “for the trial court’s premise that stockholders who file quickly, without bringing a § 220 books and records actions,” are acting on behalf of their law firms instead of the corporation. According to the Delaware Supreme Court, the “remedies for the problems [fast filers] create should be directed at the lawyers, not the stockholder plaintiffs or their complaints.”

Takeaway

The Chancery Court’s opinion sought to address the issue of “plaintiffs’ firms who specialize in stockholder representative litigation rush[ing] to the courthouse.” The Chancery Court emphasized that a putative stockholder plaintiff should make a Section 220 books and records request before filing a derivative action. The Chancery Court was unwilling to give preclusive effect to the California judgment because it believed that the plaintiffs there had not adequately investigated their claims before filing suit. Giving preclusive effect to the California judgment would have, in effect, punished the Delaware plaintiffs, especially in light of the fact that the Chancery Court had delayed ruling on Allergan’s motion to dismiss pending completion of a Section 220 books and records demand.

The Delaware Supreme Court’s decision makes clear that the principles of federalism, comity, and finality cannot be sacrificed in the name of addressing the vexing problem of multi-forum litigation, no matter how well-intentioned those attempts may be. The Delaware Supreme Court’s decision confirms that when a final judgment is issued in another state, Delaware courts will apply the law of that state to determine the judgment’s preclusive effects. This decision should help corporate defendants and Boards minimize the burdens of duplicative derivative litigation in different jurisdictions.

For more information, please visit the Securities Class Action Defense and Shareholder Litigation page of the Haynes and Boone, LLP website, or contact one of the attorneys below.

Nicholas Even
214.651.5045
nick.even@haynesboone.com

 

 

Thad Behrens
214.651.5668
thad.behrens@haynesboone.com

 

Carrie L. Huff
214.651.5509
carrie.huff@haynesboone.com

Odean Volker
713.547.2036
odean.volker@haynesboone.com

Daniel H. Gold
214.651.5154
daniel.gold@haynesboone.com

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