Saturday, January 28, 2017
I’ve previously posted about Delaware’s vulnerability – namely, to the extent it tries to police shareholder litigation through procedural rather than substantive legal standards, it is vulnerable to losing disputes to other jurisdictions that have rules deemed more favorable by litigants. Plaintiffs and defendants can reach sweetheart merger settlements in jurisdictions that examine the terms less searchingly; defendants can win a dismissal of all claims filed by weak plaintiffs in one jurisdiction and estop stronger plaintiffs who bring suit in Delaware.
So, for example, Delaware encourages derivative plaintiffs to seek books and records under Section 220 before bringing a lawsuit, but that takes time. A plaintiff in another jurisdiction might simply file a lawsuit right away, and if that suit is dismissed, the dismissal can preclude the Delaware plaintiff– which only gives the Delaware plaintiff less incentive to seek books and records in the first place.
Well, until now. In Cal. State Teachers Ret. Sys. v. Alvarez, 2017 WL 239364 (Del. 2017), that exact scenario occurred in the long-running action against Wal-Mart for violations of the foreign corrupt practices act in Mexico. While the Delaware plaintiffs sought books and records to bolster a derivative claim, federal plaintiffs in Arkansas ploughed ahead using public information, only to see their suit dismissed for failure to plead demand futility. And Delaware Chancery concluded that the Arkansas ruling was res judicata against the Delaware plaintiffs.
Not so fast, said the Delaware Supreme Court last week. Following VC Laster's analysis in In re EZCORP Inc. Consulting Agreement Deriv. Litig., 130 A.3d 934 (Del. Ch. 2016), the Supreme Court expressed concern that, as a matter of constitutional due process, until demand futility is established, any single group of plaintiffs represents only its own interests, and not the interests of the corporation. Therefore, they bind only themselves – not the corporation – in any litigation, and a dismissal of one claim cannot preclude a subsequent claim.
The Court did not so hold definitively, though; it simply remanded to Chancery for further consideration of the issue.
This is certainly a dramatic solution to the problem of multiforum shareholder litigation. Prior proposals have suggested a more searching inquiry into the adequacy of the first plaintiff; this approach, however, would mean that in derivative actions, no plaintiff is ever precluded by another plaintiff’s failure to plead demand futility. Talk about firing off a canon to kill a bug.
It still leaves Delaware in a precarious position, because it rests wholly on federal constitutional law – and there’s no telling how federal judges will rule once they get hold of the problem. They certainly don’t have the same interests in protecting Delaware law that Delaware has.