Saturday, July 29, 2017
I’ve previously posted about the problem of multiforum litigation, and how it’s very much in Delaware’s interest to figure out a way to keep cases flowing to its courts. In particular, Delaware’s recommendation that derivative plaintiffs seek books and records before proceeding with their claims simply invites faster filers to sue in other jurisdictions – and invites defendants to seek dismissals against the weakest plaintiffs, which will then act as res judicata against the stronger/more careful ones. As VC Laster put it during a hearing in Avi Wagner v. Third Avenue Management, LLC, “The defendants want to get out of litigation, and the best way to do it is to fight the weak plaintiff . . . [T]hey have the plaintiff they want and the allegations they want…. This whole system of multi-forum litigation … creates a lot of systemic dysfunction. It's certainly true that things should be resolved in one forum and at one time, but it doesn't follow from that … that they should necessarily be followed under a system that incentivizes the filing of a fast complaint by a weak plaintiff so that defendants have the high ground.” (May 20, 2016).
Delaware’s latest proposal to deal with the problem came in the form of a suggestion from its Supreme Court: perhaps when derivative actions are dismissed for failure to allege demand futility, it would violate the constitutional due process rights of subsequent plaintiffs to bind them to that decision. The theory is that until the demand requirement is satisfied, a plaintiff represents only him or herself, and not the corporate entity; therefore, any dismissal only extends to that plaintiff. In January, the Supreme Court remanded to Chancery to make a determination of the constitutional law issues. See Cal. State Teachers Ret. Sys. v. Alvarez, 2017 WL 239364 (Del. 2017).
Well, a few days ago, Chancellor Bouchard came back with an answer. He concluded that an Arkansas court’s dismissal of a derivative case on the grounds that those plaintiffs failed to show demand futility should not bar similar claims by Delaware plaintiffs.
The reason I find this fascinating is because it once again highlights Delaware’s uneasy relationship with the substantive versus the procedural aspects of its law.
We begin with the principle that state courts must give full faith and credit to decisions in other jurisdictions, which means that they must give the same preclusive effect to a judgment that the rendering court would have given. In this case, that meant determining what kind of preclusive effect Arkansas would have given to the original judgment.
Chancellor Bouchard concluded that – like most jurisdictions – Arkansas would have found the original judgment was res judicata against subsequent plaintiffs. The obvious way out of that – suggested by the Delaware Supreme Court – was to find that preclusion would violate federal due process.
And that’s sort of what Bouchard held. But he was clearly uncomfortable resting entirely on federal constitutional standards, especially given the near-universal agreement that preclusion is permissible in these circumstances. So, rather than phrase his holding purely in terms of a constitutional holding (as the Delaware Supreme Court had asked him to do), he phrased it in terms of a recommendation to the Delaware Supreme Court of the rule they should adopt. And his recommendation rested not only on federal constitutional standards, but also public policy– Delaware’s policy, and by extension Delaware’s control over its corporations. He concluded by recommending that Delaware adopt Laster’s reasoning from In re EZCORP, Inc. Consulting Agreement Derivative Litigation – which itself was based both on Delaware law and federal law. (It is significant to note at this point that when the Delaware Supreme Court remanded the case to him, it specifically held “Delaware law does not apply here, as the parties agree.” Cal. State Teachers Ret. Sys. v. Alvarez, 2017 WL 239364 (Del. 2017)).
Which raises the same question that Trulia raises: Is this a substantive issue, or a procedural one? More specifically, do we treat the preclusive effect of derivative litigation as a matter of civil procedure, or as a matter of corporate internal affairs? Bouchard kinda straddled the line; it will be interesting to see what the Delaware Supreme Court (and other jurisdictions) choose to do.