How Collateral Estoppel Can Be Your Best Friend in Stockholder Litigation
Two recent decisions from the Delaware Court of Chancery have dusted off the venerable doctrine of collateral estoppel to dismiss stockholder claims. Of course, this issue is not new in Delaware. In 2013, the Delaware Supreme Court held the dismissal of a derivative action in a federal court in California for failure to plead demand futility was entitled to collateral estoppel effect in Delaware, in Pyott v. Louisiana Municipal Police Employees' Retirement System, 74 A.3d 612 (Del. 2013). These recent decisions show the power that the theory can have for corporations facing multiple lawsuits arising out of the same alleged wrongdoing.
The first case, Brevan Howard Credit Catalyst Master Fund Ltd. v. Spanish Broadcasting System, C.A. No. 9209 (Del. Ch. May 19, 2015), is the second iteration of a case brought by holders of 10.75 percent Series B cumulative exchangeable, redeemable preferred stock of Spanish Broadcasting System, alleging that Spanish Broadcasting System incurred debt in violation of the terms of the Series B stock. In the first action, Lehman Brothers Holdings v. Spanish Broadcasting System, 105 A.2d 989 (Del. 2014), the Delaware Supreme Court affirmed the Court of Chancery's decision that the holders of the Series B stock acquiesced in the incurrence of debt by Spanish Broadcasting allegedly in breach of the terms of the Series B stock. In this action, the plaintiffs, holders of Series B stock, alleged, among other things, that Spanish Broadcasting incurred debt in violation of the terms of the Series B stock.
Spanish Broadcasting moved to dismiss the claims related to the alleged breach of the terms of the Series B stock on several grounds, but the court addressed only one: whether the plaintiffs were barred by collateral estoppel from relitigating those issues because of the holding in Lehman Brothers. The court held that there was no dispute that the question of whether the stockholders acquiesced to the incurrence of debt was ably and vigorously litigated by people in Lehman Brothers with identical interests to the plaintiffs here. The only issue, therefore, was whether the plaintiffs in Brevan were in privity with those in Lehman Brothers.
Relying on the Court of Chancery's decision in Kohls v. Kenetech, 791 A.2d 763 (Del. Ch. 2000) aff'd, 794 A.2d 1160 (Del. 2002), the plaintiffs argued that privity does not apply to all people within the same class of stockholders. The court, however, read Kohls to require the plaintiffs to demonstrate why they are situated differently from the plaintiffs in the prior case. Here, the plaintiffs argued that they were differently situated because their state of mind in deciding not to pursue rights because of the breach of the terms of the Series B stock was different than the plaintiffs' state of mind in Lehman Brothers. The court rejected this argument because in an acquiescence analysis, the relevant inquiry was Spanish Broadcasting's state of mind, not the plaintiffs' state of mind. For the same reasons, the court also rejected the plaintiffs' argument that they acquired certain of their shares after the debt was incurred, and therefore they should have the opportunity to obtain discovery from their predecessors in title. The court held that this argument ignored that Spanish Broadcasting's state of mind is the key to an acquiescence analysis, so the state of mind of predecessors in title was irrelevant.
After rejecting these arguments, the court dismissed the plaintiffs' claims that were identical to those claims asserted in Lehman Brothers.
In the second case, Asbestos Workers Local 42 Pension Fund v. Bammann, C.A. No. 9772 (Del. Ch. May 21, 2015), the court again applied collateral estoppel to dismiss claims. In Bammann, the plaintiffs were stockholders of JPMorgan Chase & Co., who were attempting to assert derivative claims arising out of the losses suffered by JPMorgan due to the "London Whale." The plaintiffs in this action asserted Caremark claims against the members of the board and certain officers for failing to monitor the company's risks in its investments.
But this action was not the first putative derivative claim brought against the directors and officers of JPMorgan. In 2012, a consolidated derivative action was brought in the U.S. District Court for the Southern District of New York against the officers and directors of JPMorgan for, among other things, failing to manage the company's risks in its investments. The court in that case granted a motion to dismiss for failure to plead demand futility as required by Federal Rule of Civil Procedure 23.1. Also in 2012, a consolidated derivative action was commenced in the New York Supreme Court against the directors and officers of JPMorgan alleging that they ignored red flags and concealed the increased risk in the company's investments. The judge in that case also dismissed the case for failure to plead demand futility, but this time without prejudice to the plaintiff's right to make demand on the board and proceed with a wrongful refusal action.
Following the directive of the Supreme Court in Pyott, the court held that it must address exclusively whether the plaintiff in the Delaware action was estopped from relitigating the demand excusal holdings in the New York cases. Under New York law, collateral estoppel may be applied in the shareholder derivative context, so the court did not need to conduct a privity analysis. Instead, the court focused on whether the elements of collateral estoppel were met.
First, the court rejected the plaintiff's argument that the "controlling facts" of the case were different because the complaint in the Delaware action contained additional facts supporting the demand excusal arguments. The court held that "the underlying conduct is what is at issue, not whether the complaint raises additional facts, or a more compelling characterization of those facts, regarding the same conduct previously at issue." Nonetheless, the court analyzed the "additional" facts and found them to be either cumulative of those pleaded in the New York cases or not truly additional. Because the exact same demand futility question had been decided by the New York courts and the plaintiff had not demonstrated that different issues were present, the court found collateral estoppel applied and the demand futility issue could not be relitigated.
What value these holdings have for other defendants in stockholder litigation is a little unclear. First, the acquiescence holding in Lehman/Brevan was tied to the defendants' state of mind, a defense that does not always arise. It may be difficult to apply that holding generally across all cases. Second, the broader holding of Bammann may have more utility, assuming the forum state has the same approach to privity as in New York. The scope of privity under Delaware law, however, was expressly not addressed in Pyott and could be the next area of the law to develop.