If a “fast filer” plaintiff races to the courthouse in one jurisdiction to file a derivative suit without prior due diligence, should a dismissal of the lawsuit for failure to plead demand futility preclude a separate derivative lawsuit brought be a different , more diligent plaintiff who files in a second forum? On the one hand, considerations of judicial efficiency and conservation of public resources argues in favor of precluding the second claim. On the other hand, policies in favor of greater pre-suit care prior to filing a lawsuit would militate in allowing the more diligent plaintiff’s claim to go forward.
In an interesting July 25, 2017 opinion (here) in which he reviewed these questions of the prior derivate suit dismissal’s claim preclusive effects on subsequent non-party claimant derivative claims, Chancellor Andre Bouchard concluded, in a break with the Court’s prior practices, the prior derivative suit dismissal on grounds of failure to plead demand futility does not preclude the claims of a subsequent claimant. This new approach to the issue of non-party preclusion in derivative litigation has important practical implications, as discussed below.
In April 2012, the Mexican subsidiary of Wal-Mart stores was the subject of a New York Times article alleging a bribery scheme. Shortly after the lawsuit appeared, several Wal-Mart shareholders filed derivative lawsuits in Delaware and Arkansas. The Delaware plaintiff sent a books and records demand to the company. While the books and records proceedings went forward in Delaware, the defendants filed a motion to dismiss in the Arkansas action. In March 2015, the federal district court judge in the Arkansas granted the defendants’ motion to dismiss the Arkansas complaint for failure to adequately allege demand futility. The Eighth Circuit subsequently affirmed.
The defendants then sought to dismiss the Delaware actions, arguing that the Arkansas decision collaterally estopped the Delaware plaintiffs from alleging demand futility. In May 2016, Chancellor Bouchard granted the defendants motion to dismiss, holding that the Arkansas decision precluded the Delaware plaintiffs from re-litigating the issue. The defendants appealed to the Delaware Supreme Court, which in turn remanded the case back to the Chancery Court, to consider the following question:
In a situation where dismissal by a federal court in Arkansas of a stockholder plaintiff’s derivative action for failure to plead demand futility is held by the Delaware Court of Chancery to plead demand futility is held by the Delaware Court of Chancery to preclude subsequent stockholders from pursuing derivative litigation , have the subsequent stockholders’ Due Process right been violated? See Smith v. Bayer Corp., 564 U.S. 299.
The July 25, 2017 Opinion
In a 35-page July 25, 2017 opinion, Chancellor Bouchard decided the question posed by the Supreme Court in the affirmative; that is, he concluded that the preclusion of the second claimant’s claim under the stated circumstances to violate due process s.
In his prior consideration of these issues, Bouchard had concluded that due process is satisfied if the plaintiff in the first action adequately represented the other stockholders of the corporation who were not parties to the first action.
Subsequent to Bouchard’s ruling in the Wal-Mart case, Vice Chancellor Travis Laster established in the EZCORP case a bright line test on the preclusion question between pre- and post-demand futility phases of derivative litigation. Laster analogized the question in the context of derivative actions to the class action context, in which the decisions against one class action claimant cannot bind another non-party claimant prior to class certification.
In his latest opinion in consideration of the Delaware Supreme Court’s remanded question, Chancellor Bouchard recommended that the Supreme Court adopt the rule proposed in EZCORP, that the ruling of prior court is not binding at the pre-demand futility stage.
In reaching this decision, Bouchard acknowledged that competing public policy interests exist on both sides. The prior standard, and the one on which he previously ruled in the Wal-Mart case, “better serves judicial efficiency and conserve public resources” by preventing duplicative litigation. The EZCORP rule, which he proposed to be adopted, “will better safeguard the due process rights of stockholder plaintiffs and should go a long way to addressing fast-filer problems currently inherent in multi-forum derivative litigation.”
Bouchard also acknowledge that under the rule was adopting “different stockholders theoretically would be able to file seriatim lawsuits litigating demand futility.” However, he said, “principals of stare decisis and comity are likely sufficient to allow courts to swiftly dispose of truly repetitive actions. “ He added that “rarely does another stockholder file a substantially similar complaint simply to try again.” What can and does happen, he said, is that a second plaintiff “will file a more refined complaint with more particularized allegations or more tailored legal theories after doing additional homework, such as obtaining books and records through a Section 220 proceeding.”
As Bouchard noted, the case will now go back to the Delaware Supreme Court, to consider his analysis on the remand question. If the Supreme Court agrees with his analysis, it will then remand the back to Bouchard again for him to take up the demand futility issue. If the Court disagrees with this analysis, it will then reinstate his prior dismissal of the Delaware plaintiffs’ case.
Thus, it remains to be seen whether or not the rule Bouchard described in his opinion will in fact be adopted as the standard in Delaware’s courts.
However, assuming for the sake of discussion, the rule would seem to set up the opportunity for plaintiffs to seek a second bite of the apple. Bouchard is skeptical that subsequent claimants will simply try a second time based on the same essential allegations, but there would be nothing to prevent a subsequent plaintiff from trying again based on a warmed over and dressed up version of the claims that previously were rejected. Bouchard himself acknowledged the risk of seriatim lawsuits.
Bouchard clearly hopes that the ruling will encourage prospective claimants to exercise greater diligence, for example by taking advantage of books and records requests, by ensuring that a more deliberate approach is not punished when less diligent fast-filer claimants prior complaints are dismissed. Indeed, it could be argued that the Delaware judicial predisposition in favor of encouraging greater pre-lawsuit preparation determined here the outcome of the due process issue.
It remains to be seen which of these two scenarios prevails in the event that the Delaware Supreme Court takes up the rule Bouchard has proposed.
In any event, there would seem to be the possibility that the demand futility stage could involve multiple rounds as subsequent claimants seek a second bite at the apple. As Jason Cronic wrote on the Wiley Rein law firm’s Executive Summary Blog (here), if the Supreme Court adopts Bouchard’s approach, “D&O insurers should expect a significant uptick in derivative actions and related defense costs, as a significant hurdle to subsequent derivative actions where an earlier action has failed due to demand futility will have been removed.”
We may be along way yet from the realization of the worst of these fears for defendants and their insurers. As Alison Frankel details in her characteristically excellently written post on her On the Case blog about Chancellor Bouchard’s opinion, defense-side allies are gearing up for a fight at the Delaware Supreme Court on these issues. If Bouchard’s view prevails at the Delaware Supreme Court, the defendants apparently are prepared to take the case to the U.S. Supreme Court on the theory that, were the U.S. Supreme Court to side with Bouchard, the Court would be at odds with two U.S. Circuit court decisions ruling against re-litigating decided issues in this context.
In any event, it is going to be very interesting to see what happens at the Delaware Supreme Court. Stay tuned.