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Summaries and analysis of recent Delaware court decisions concerning business-related litigation.
Morris James Blogs
After a spin–off of a subsidiary, there is a question as to whether the subsidiary’s stockholders have standing to bring a derivative suit on behalf of the subsidiary for past wrongs against the subsidiary committed by the parent’s directors. More ›
Court Of Chancery Explains That The Existence Of A Controlling Stockholder Does Not Determine Demand Is Excused
A transaction with a controlling stockholder that is the subject of a derivative complaint still requires that a majority of the directors be interested before demand is excused. More ›
This decision involves the currently hot topic of the extent of a board of directors’ duty to properly assess corporate risks and act to prevent loss. More ›
This is an interesting decision because it explains what direct claims are available to investors in an LLC. More ›
When investors bargain for the right to have their stock sold in a secondary offering after the company goes public, fiduciary duties normally do not operate to restrict that right. More ›
This decision will be remembered for the very large fee it awarded to some very entrepreneurial lawyers who risked their all to win a big case. More ›
This comprehensive decision is particularly interesting because it considers whether a disclosure claim is subject to the normal Rule 23.1 demand rules. Normally, disclosure claims are thought of as direct claims based on the violation of the stockholder's right to cast an informed vote. But when, as here, the plaintiff chooses to assert a derivative claim for an alleged disclosure claim, he must also meet the normal demand rules. The plaintiff argued that there was no business judgment involved in making the disclosures at issue and, hence, the demand rules should not apply. The federal court rejected that argument, relying largely on non-Delaware cases.
This decision clearly explains when a derivative suit should be stayed in favor of securities litigation elsewhere. The general rule is that when the derivative suit depends on the outcome of the securities litigation because it seeks recovery of the damages to be paid for a securities law violation, the derivative suit should be stayed. Of course, when the derivative suit is not dependent on the securities litigation outcome, the stay should be lifted.
In these 2 decisions, the U.S. Magistrate shows a sound understanding of Delaware corporate law. She recommends the dismissal of these 2 derivative suits under Rule 23.1 because the complaints do not show the directors were disqualified from considering a demand they sue. The directors' interest in a compensation plan that was only currently applicable to employees did not make them interested under Delaware law.
Under Delaware law, a so-called Brophy claim seeks to recover the profits made by trading on insider information. Showing that material insider information was available is not too hard. What is harder is showing the intent to use that information, the scienter requirement. After all, an insider may trade for a variety of reasons, such as a favorable public announcement of good future prospects. Here the Court explains, in the context of a motion to dismiss, how to interpret the circumstances surrounding insider trades to find that they were done with the intent to benefit from the insider information. Among the key facts are the timing of the trades in reference to obtaining the information, the failure to disclose the insider information until after the trades are completed, and the size of the trades in comparison to any prior trading.
When does a derivative suit survive a merger? This decision says "not very often." There seems to be two rules at play here. First, when the merger's sole purpose is to eliminate the standing of the derivative plaintiff, then the derivative suit may continue. Second, the merger may be attacked when it is an "inseparable" part of a fraud alleged as part of a direct pre-merger suit. Note the word "direct." A direct claim is not a derivative claim, but instead alleges wrongs for which the plaintiff may recover for herself. Hence, even if the merger is cast as part of some fraud inseparable from pre-merger acts, a derivative suit will not survive the merger just for that reason.
The rules for determining when demand on the directors is excused apply even to Chinese-based companies despite their bad press. This decision in a direct and clear way spells out when demand is not excused. For example, merely being on the audit committee does not mean a director faces a serious risk of personal liability for auditing mistakes. More "red flags" are required.
This federal decision follows the recent Chancery explanation of the Gentile doctrine that permits a direct claim for equity dilution. In short, the dilution can be by paying too little cash for the additional shares and the so-called "controlling" stockholder requirement for the buyer can be satisfied by a group of buyers operating though their elected directors that are a majority of the board.
This federal decision illustrates when a complaint does state a proper derivative claim because it alleges that a majority of the Board violated a clear restriction on its right to award stock options. Such violations of an option plan are akin to violations of the law that are almost always beyond the business judgment of the directors to do.
When stock options are awarded may be important to their actual value. Get an option when the market price is in the toilet and you will do better when the market turns than with an option granted at the top of the market. But is option grant timing itself actionable? This decision says that it is and that a complaint that alleges such timing may withstand a motion to dismiss.