On April 4, 2013, in the Allergan decision, the Delaware Supreme Court reversed the Court of Chancery’s ruling last year that the dismissal of a shareholder derivative action in California did not preclude other stockholders from bringing the same corporate claim in Delaware. The Delaware Supreme Court’s decision was based on a Constitutional Full Faith and Credit analysis.
The Court of Chancery, in contrast, had looked to Delaware’s internal affairs doctrine and demand futility requirement, which the Supreme Court said was error. Central to the Court of Chancery’s analysis was a presumption that the California plaintiffs provided inadequate representation because they did not conduct a Section 220 books and records inspection before filing. However, the Supreme Court rejected this “‘fast filer’ irrebuttable presumption of inadequacy,” holding that plaintiffs who fail to do a Section 220 action are not necessarily inadequate.
The commentary about the Delaware Supreme Court’s decision understandably has focused on the Full Faith and Credit analysis and the Supreme Court’s apparent rejection of a Delaware-centric attitude toward shareholder litigation involving Delaware corporations. Defense lawyers have lauded the decision as a step towards solving the problem of multi-jurisdictional shareholder litigation.
In my opinion, however, the more important and enduring feature of the decision is the Delaware Supreme Court’s rejection of the “fast filer” presumption of inadequacy. For a further discussion of the fast-filer issue, please see my prior post on the Allergan and Hecla Mining Court of Chancery decisions. For a helpful discussion of the Allergan Delaware Supreme Court decision, please see Kevin LaCroix’s blog, The D&O Diary.
Upholding the Court of Chancery’s presumption against fast-filers would have strongly encouraged, if not effectively required, shareholders to make a Section 220 demand before filing a derivative action. Such a rule inevitably would have reduced the number of shareholder cases filed, because plaintiffs’ counsel would have had to be more selective about the cases in which it invested the time and money to investigate. Thus, the Delaware Supreme Court passed up an opportunity to actually reduce the number of shareholder derivative actions – especially those without merit. On the other hand, as I wrote in my prior post, a 220 requirement would make cases that are filed more virulent, because they would be more difficult to dispose of on a motion to dismiss.
Leaving the system as is, however, means that stockholders will continue to file a lot of bad cases – in Delaware and elsewhere, and sometimes in multiple places. And the root cause of the multi-jurisdictional shareholder litigation problem is more this reflexive, thoughtless filing of meritless cases than the fact that they are filed in multiple jurisdictions. The Delaware Supreme Court thus passed up an opportunity to craft a rule that would have had profound impact on all shareholder litigation, including merger cases.
But I doubt that the Full Faith and Credit aspect of the decision in Allergan will have a significant impact on merger litigation, the most prolific and meritless type of shareholder litigation. This is so for two reasons.
First, Allergan was a shareholder derivative action concerning the board’s alleged failure to prevent an off-label marketing problem, asserting the derivative claim that the corporation was damaged by the board’s breaches of fiduciary duties. Most merger cases are filed as class actions asserting shareholders’ direct claims, not as derivative actions asserting corporate claims. The collateral estoppel analysis in Allergan was dependent upon a determination of privity that is unique to the context of a shareholder derivative action. Thus, Allergan’s collateral estoppel analysis doesn’t break new ground regarding merger class actions, and therefore would have no direct effect on most merger litigation.
Second, few merger cases are litigated to dispositive decisions that a Delaware court is even asked to respect. The vast majority of them settle long before that point. As a result, there has hardly been a wave of Delaware decisions failing to honor another state’s dismissal of a merger case. Indeed, one of the central problems with merger litigation is the fact that there are too few decisions on the merits. In a prior post on merger litigation, I discuss some of the reasons why there is too little merits litigation in merger cases.
A rule requiring stockholders to use Section 220 would be a mixed bag – as discussed above, there may be fewer cases, but those that remained would be harder to dispose of on a motion to dismiss. But the Delaware Supreme Court’s rejection of such a rule was a bit of a letdown. Such a presumption against fast filers, even if fashioned strictly in the context of derivative actions, would likely have had a domino effect, and also led to greater investigation by stockholders before filing merger class actions. That would have had a positive impact; even a little more investigation would be better than the current system of no investigation at all.