On April 4, 2013, the Supreme Court of the State of Delaware in Pyott v. La. Municipal Police Employees' Retirement System1 reversed the trial court's opinion and held that a final judgment in a California federal court required the dismissal of "essentially the same [derivative] complaint" in the Delaware Court of Chancery. The case had drawn considerable controversy and substantial public attention because it raised further concerns about the risks of multi-forum litigation.
The case concerned Allergan, Inc., which creates and markets pharmaceutical products, including BOTOX. In September 2010, Allergan entered into a settlement with the Department of Justice (DOJ) in which it pled guilty to the criminal misdemeanor of misbranding and paid $600 million in civil and criminal fines.
Multiple derivative suits were filed in the wake of the settlement with the DOJ in both the U.S. District Court for the Central District of California (the "California action") and the Delaware Court of Chancery (the "Delaware action"). Separately, a stockholder sought to inspect certain books and records of Allergan, pursuant to 8 Del. C. § 220 (the "Section 220 demand").
The defendants in the California and Delaware actions filed motions to dismiss the complaints in those actions in part for failure to make a demand or adequately allege demand futility. The California action proceeded through briefing, but the Delaware Court of Chancery postponed a hearing on the motion to dismiss in the Delaware action to allow the Section 220 demand to proceed first. Meanwhile, the California federal court granted the defendants' motion to dismiss with prejudice. Thereafter, the plaintiffs in the Delaware action, which now included the stockholders that originally sought documents under Section 220, filed a joint complaint. The defendants moved to dismiss this complaint, arguing in part that the California dismissal had preclusive effect and required the dismissal of the Delaware action.
The Delaware Court of Chancery's Decision
The Delaware Court of Chancery determined that the dismissal of the California action did not require the dismissal of the Delaware action.2 Specifically, the Court of Chancery held that the doctrine of collateral estoppel applies only if the parties are in privity. The Court held that the determination of whether a derivative plaintiff was in privity with the corporation or another purported derivative plaintiff is governed by the internal affairs doctrine and, since Allergan was a Delaware corporation, the issue was governed by Delaware law. Applying Delaware law, the Court of Chancery determined that the plaintiffs in the California and Delaware actions were not in privity with each other merely because they all filed derivative suits on behalf of a corporation: plaintiffs do not obtain standing to bring a suit until it is determined that the plaintiffs have made a demand that was wrongfully refused or establish that demand was futile.
As an alternative basis for refusing to give the California ruling preclusive effect, the Court of Chancery found that Allergan's interests were not adequately represented by the plaintiffs in California. In so holding, the Court of Chancery adopted a "fast filer presumption" under which the Delaware Court of Chancery has the discretion to determine that derivative plaintiffs are not adequate representatives of the corporation because they have rushed to be the first to file their case.
The Delaware Supreme Court's Decision
California Law on Collateral Estoppel Required Dismissal of the Delaware Action
At the outset, the Delaware Supreme Court acknowledged that a state court must "give a federal judgment the same force and effect as it would be given under the preclusion rules of the state in which the federal court is sitting."3 Thus, "[o]nce a court of competent jurisdiction has issued a final judgment . . ., a successive case is governed by the principles of collateral estoppel, under the full faith and credit doctrine, and not by demand futility law, under the internal affairs doctrine."4 This is because "the undisputed interests that Delaware has in governing the internal affairs of its corporations must yield to the stronger national interests that all state and federal courts have in respecting each other's judgments."5 Therefore, according to the Supreme Court of Delaware, the Delaware Court of Chancery should have applied the preclusion rules of California.
Applying California preclusion law required dismissal, according to the Delaware Supreme Court, because (1) the California action addressed the same question now pending before the Delaware court (i.e., whether Rule 23.1 required dismissal), and (2) the question was litigated to final judgment with prejudice on the merits in California. Further, the Delaware Supreme Court held that the plaintiffs in the California and Delaware actions were in privity to each other because under the California federal court's interpretation of Delaware corporate law, "the real plaintiff in the derivative suit is the corporation[.]"6
There Is No "Fast Filer" Presumption of Inadequacy
The Delaware Supreme Court also held that there is no "fast filer" presumption of inadequacy. The court rejected the notion that a court can find that a plaintiff is automatically inadequate because the plaintiff initiated a lawsuit without first filing a books and records demand under 8 Del. C. § 220.7 Absent that presumption, the court found no basis to hold that the California plaintiffs were "grossly deficient" given the substantial similarities between the California and Delaware complaints.
This case reinforces the recognition that when a court enters a final judgment with prejudice, Delaware courts will apply the preclusion laws of the state in which the court sits to determine whether preclusion requires dismissal. This ruling may calm the concerns of those facing multi-forum shareholder litigation that a resolution on the merits in one forum will be given preclusive effect in Delaware (and presumably other jurisdictions). The court's opinion further clarifies that a plaintiff that files a derivative complaint first is not presumptively inadequate merely because of the swift filing or the failure to obtain documents under 8 Del C. § 220, and that the court should continue to evaluate the adequacy of the plaintiff in representative litigation on a case-by-case basis.
For more information about the Delaware Supreme Court's decision or any related matter, please contact a member of Wilson Sonsini Goodrich & Rosati's securities litigation practice.