In this opinion, the Court of Chancery held plaintiffs had plead a Caremark-claim sufficient to withstand defendants’ motion to dismiss pursuant to Court of Chancery Rules 23.1 and 12(b)(6). In so holding, the Court determined, among other things, that a California court’s prior dismissal of a related first-filed, derivative action pursuant to Rule 23.1 did not have preclusive effect on a different stockholder plaintiff’s later-filed derivative action in Delaware.
In response to Allergan, Inc. (“Allergan”) pleading guilty to criminal misdemeanor misbranding in connection with a settlement with the United States Department of Justice, Allergan stockholders (“stockholders”) filed derivative actions in Delaware (the “Delaware Action”) and California (the “California Action”). In the California Action, the court (the “California Court”) dismissed an amended and consolidated complaint pursuant to Rule 23.1 with prejudice (the “California Judgment”). In the Delaware action, the Court of Chancery (the “Court”) postponed briefing on defendants’ motion to dismiss to allow one stockholder (“UFCW”) to obtain books and records using Section 220 of the General Corporation Law of the State of Delaware (the “DGCL”). UFCW later intervened in the Delaware Action and plaintiffs jointly filed an amended complaint. Defendants moved to dismiss the amended complaint, arguing that (i) the California Judgment mandated dismissal of the Delaware Action with prejudice under the doctrine of collateral estoppel, (ii) the amended complaint failed to plead demand futility under Rule 23.1, and (iii) the complaint failed to state a claim under Rule 12(b)(6). The Court rejected defendants’ arguments and denied the motion to dismiss.
In assessing the preclusive effect of the California Court’s prior dismissal, the Court primarily focused on the privity requirement. First, the Court determined that whether successive stockholders are sufficiently in privity with the corporation and each other is a matter of substantive Delaware law governed by the internal affairs doctrine. As a matter of Delaware law, the Court held that a stockholder whose litigation efforts are opposed by the corporation does not have authority to sue on behalf of the corporation until there has been a finding of demand excusal or wrongful refusal. The Court explained that the nature of the derivative action is two-fold: (i) it is the equivalent of a suit by stockholders to compel the corporation to sue, and (ii) it is a suit by the corporation, asserted by the stockholders on its behalf, against those liable to it. Accordingly, the granting of a Rule 23.1 motion does not address claims brought in the name of the corporation; it only addresses the first phase of the derivative action in which stockholders sue individually. The Court held that until the derivative action passes the Rule 23.1 stage, the stockholder does not have authority to assert the corporation’s claims and is not suing in the name of the corporation. At that point, the stockholder only sues to compel the corporation to sue. In other words, the Court posited, the first step of a derivative action is the stockholder asking the court for authority to sue in the name of the corporation. Because granting a Rule 23.1 motion dismisses a stockholder’s individual claim to obtain equitable authority to sue, the corporation’s stockholders are not in privity for purposes of the preclusion analysis. Stockholder plaintiffs are precluded only from asserting issues raised by other stockholder plaintiffs with authority to assert the corporation’s claims. Although the same stockholder cannot attempt to plead demand futility after the Court dismisses that stockholder’s complaint under Rule 23.1, the Rule 23.1 dismissal does not have preclusive effect on a separate stockholder’s attempt to plead demand futility. The Court noted, however, that the earlier decision remains persuasive authority and could operate as stare decisis.
The Court also declined to give collateral estoppel effect to the California Judgment on the independent basis of inadequate representation. The Court acknowledged that where the first plaintiff provides inadequate representation, another stockholder may nevertheless sue on the same issue. The Court adopted and applied the fast-filer presumption, which is based upon Chancellor Strine’s previous suggestion that Delaware law presumes that a fast-filing stockholder with a nominal stake, who sues derivatively after the public announcement of a corporate trauma in an effort to shift the still-developing losses to the corporation’s fiduciaries, but without first conducting a meaningful investigation, has not provided adequate representation. The Court discussed the issues presented by fast-filing, acknowledging that while specialized law firms serve a critical role in our legal system, those firms’ ultimate receipt of compensation for awards of attorneys’ fees can cause a divergence in interests from the class or entity they represent. The Court posited that the first-filed rule incentivizes plaintiffs’ lawyers to file as fast as possible in an effort to gain control of the ligation instead of first conducting investigations and making books and records demands. The Court opined that hastily filed complaints have little chance of surviving a Rule 23.1 motion, yet impose real costs on corporations and their stockholders. The Court explained that as a matter of best practices, plaintiff stockholders should use Section 220 to investigate their claims and obtain corporate books and records before filing derivative litigation to increase the likelihood that the action can survive a Rule 23.1 motion. Although filing a Section 220 demand before derivative litigation is not mandatory, the Court held that when stockholder plaintiffs sue in a representative capacity, first-to-file does not control which plaintiff has the substantive right to proceed. In lieu of first-to-file, the Court balances the factors pertinent to a forum non conveniens analysis to determine where it makes sense for a representative action to proceed. The Court explained that it will not favor lawyers who file hastily and penalize diligent counsel who use Section 220.
Following its determination that collateral estoppel did not require dismissal, the Court considered independently whether Rule 23.1 required dismissal, noting that the California Judgment was potentially persuasive. Ultimately, the Court determined that the analysis in the California Judgment was unpersuasive. The Court explained that a court can draw the inference of wrongful conduct when supported by particularized allegations of fact. The Court held that the complaint contained sufficient allegation to support a reasonable inference of wrongful conduct on the part of the Allergan directors to survive the Rule 23.1 motion. The Court further noted that a complaint that pleads a substantial threat of liability for purposes of Rule 23.1 will also survive a Rule 12(b)(6) motion to dismiss. Because the complaint survived plaintiffs’ Rule 23.1 motion to dismiss, it also survived Rule 12(b)(6).
The full opinion is available here.