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Summaries and analysis of recent Delaware court decisions concerning business-related litigation.
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This decision explains when a Caremark claim exists based on illegal corporate conduct. The “substantial likelihood” of liability that justifies excusing a pre-suit demand on the board must involve a knowing violation of the duty to follow the law. That occurred in the well-known Massey and Pyott cases. Here, however, the best the plaintiff could allege is that the board should have known its company was violating the antitrust laws and the Court held that was not good enough to excuse demand. The key is that the record showed the board was advised that the conduct involved was legal. This highlights that the “should have known better” argument is not going to work in almost all cases when the board has advice it has not crossed the line into illegal conduct.
What happens when a derivative claim is filed outside of Delaware and then is dismissed by that other court? Well even if the other complaint might have stood up in Delaware, the subsequently filed Delaware case will also be dismissed when the law of the state where the case was dismissed gives preclusive affect to such a dismissal. This result again shows that Delaware is respectful of other jurisdictions and that Delaware litigation may be threatened by bad filings elsewhere.
Normally it is the board in place at the time the derivative suit is filed that is evaluated to determine if demand is excused. However, when a plaintiff rushes to file knowing that the board is about to change so that its composition will not permit demand to be excused, the new board will be the board whose independence is considered. This prevents gun jumping.
Delaware does hold that the dismissal of a derivative suit in another jurisdiction may preclude the prosecution of a similar derivative suit in Delaware. However, the Pyott decision left open the question of whether the failure of the plaintiff in the dismissed suit to have first sought production of the company’s records to strengthen the complaint might be deemed so “grossly deficient” as to warrant denying preclusion of the second suit that did seek those records. This decision answers that question by holding that the failure to seek corporate records alone is not so bad that preclusion should be denied. An appeal is sure to follow.
This decision illustrates the importance of putting your best foot forward in derivative litigation. Here, a different plaintiff had his complaint dismissed for failure to satisfy the demand excused rules. When this plaintiff tried to overcome that precedent with some additional allegations, he found the going too tough even if the Court did not apply stare decisis. The Court of Chancery is usually very consistent in its analysis even where different judges are involved in different but related matters. Hence, when multiple suits are filed over the same alleged grievance, attacking the weakest complaint may bear extra dividends.
This is an interesting decision because it illustrates what many do not understand - a complaint has to have some actual facts to support its claims, not just inferences. Thus, when a plaintiff fails to use his rights to inspect an entity’s records to get out the facts, his general allegations of wrongdoing will not be enough to sustain a complaint.
This initial formal decision by the recently-appointed Vice Chancellor shows her firm commitment to the tradition of the Court of Chancery to produce well-written, scholarly opinions. Here the decision explains that after making a demand on a board to file suit and having that demand refused, a plaintiff must do more than plead the Board was wrong to deny the demand. Instead, the complaint must plead a factual basis for the Court to find the Board’s investigation was unreasonable or the Board acted in bad faith. While there are several ways to do just that, just arguing the board’s decision was bad is not one of those ways.
In general, an amended derivative complaint does not need to show that demand is excused if it was excused for the filing of the initial complaint. However, as this decision points out, when the amended complaint alleges an independent, new derivative claim that fails to meet the “claims already in litigation” standard (which refers broadly to the acts and transactions in the original complaint), then the right to assert that new claim must be established by showing that demand was excused.
This is an interesting decision because it applies the demand rules in a derivative case to an odd situation — when some but not all of the board members have changed between when the challenged conduct occurred and when the complaint was filed. The Court held that the demand rules need to be applied to the board in place when the complaint was filed. The changes in the board’s composition made it necessary for the analysis to consider the relationships of new to old board members, particularly as to the independence of the new members. The decision also is a good source for the facts that determine independence. Such facts as common board memberships or how the stock exchange rules apply do not show a lack of independence in themselves.
This is an important and useful decision for at least two reasons. First, the Court carefully analyzes past Delaware precedent to conclude that the entire fairness test applies not just to squeeze-out mergers, but also to other transactions where a controller obtains non-ratable benefits, such as contracts with an entity owned by a controller of the company. This is important because prior case law was inconsistent on the test it applied to such contracts.
Second, the opinion has an exhaustive review of Delaware law on how to determine if a director is interested for purposes of the demand futility standard to bring a derivative suit.
When, after full briefing, the plaintiff decides that he cannot meet the heightened pleading rules of the recent Cornerstone case, may he just walk away without prejudice to his right to sue again later or must the suit be dismissed with prejudice not just to him but to all stockholders? More ›
Court Of Chancery Explores The Effect Of Federal Settlements On A Delaware Action And Applies Unocal To Bylaw Amendments
This is an interesting decision for two reasons. More ›
This decision points out the hazard in providing a separate benefit to the named plaintiff in connection with the settlement of a derivative suit. In short, that is a bad idea and, as in this case, may cause the Court to reject even an otherwise good settlement because of concerns over the conflict of interest when the plaintiff may have agreed to a deal for his own benefit.
To meet the pleading requirements to state a Caremark claim it is necessary that you show either the board ignored signs of wrongdoing or at least took no steps to prevent such wrongdoing. This decision contains an excellent review of when a court will attribute knowledge of wrongdoing to a board of directors in the absence of direct proof the board was aware of those bad acts.
Whether a claim is direct or derivative often determines if it will survive a motion to dismiss. Who would get the benefit of a recovery is one test applied to make that decision. But in the context of a partnership, that test has some weaknesses considering the wrongdoer will benefit from the recovery as a partner if the claim is cast as derivative. More ›