Court of Chancery Explains how To Infer Scienter
American International Group Consolidated Derivative Litigation, C.A. 769 (Del. Ch. Feb. 10, 2009)
The Court of Chancery is often faced with the difficult task of deciding when a complaint has enough factual allegations to survive a motion to dismiss, particularly when there is no self dealing by directors and the business judgment rule is raised as a defense. This detailed 102-page decision illustrates the thought process that the Court uses.
The basic question presented was whether the plaintiff, could at the pleading stage, state sufficient facts to show that the case should go forward. As is typical, the defendants argued that all the complaint really alleged is that they made some bad decisions or that others below them in the corporate entity were the parties at fault. The Court denied the motion to dismiss because there was enough in the complaint to warrant an inference that the defendants must have known of the corporate wrongdoing. The keys to this result were: (1) the defendants were in position to know of the wrongs that had been committed; (2) they had practiced tight control over the entity so that they generally were aware of all that was going on; and (3) the bad acts were massive in scale and unusual in nature so as to have been unlikely to have been done without the defendants' knowledge.
This case also illustrates the difficult choices that litigation counsel must sometimes make. There is a tendency to try to get cases dismissed on pleading grounds, if only to save money if you win. However, as a motion to dismiss requires the Court to draw any possible inferences from the facts that favor the plaintiff, the motion is a dangerous way to have the court get its first impression of the parties. This opinion is very critical of the conduct alleged. While this Court will not let itself be prejudiced by its first read of the facts, the opinion can only hurt the defense.