Delaware Court of Chancery “Overrules” Federal Court

by Allen Matkins

I’ve often heard the claim that one reason to incorporate in Delaware is that the courts won’t surprise you.  When I hear this, I recall the surprise, and even outrage, in the aftermath of Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985) .  See, e.g., Fischel, The Business Judgment Rule and the Trans Union Case, 40 Bus. Law. 1437, 1455 (1985) (“surely one of the worst decisions in the history of corporate law”) and Manning, Reflections and Practical Tips on Life in the Boardroom After Van Gorkom, 41 Bus. Law. 1, 1 (1985) (“The Delaware Supreme Court in Van Gorkom exploded a bomb.”).

This week, Vice Chancellor Laster issued what I consider to be another judicial bolt from the blue.  Louisiana Municipal Police Employees’ Retirement System v. Pyott, C.A. No. 5795-VCL (Del. Ch. June 11, 2012) involved stockholder derivative litigation in both the Delaware Court of Chancery and the U.S. District Court for the Central District of California.  After the federal court dismissed the plaintiffs’ complaint pursuant to FRCP Rule 23.1 with prejudice (In re Allergan, Inc. Shareholder Derivative Action, 2012 U.S. Dist. LEXIS 5590), the defendants in the Delaware action moved for dismissal on the grounds of collateral estoppel.  Vice Chancellor Laster denied the motion, finding the dismissal of the federal action persuasive but not dispositive.  In doing so, the Vice Chancellor staked out some remarkable legal positions.

  • He declines to follow numerous, recent federal and state precedents from around the country holding that a Rule 23.1 dismissal has preclusive effect. See, e.g., In re Sonus Networks, Inc. S’holder Deriv. Litig., 499 F.3d 47 (1st Cir. 2007); Arduini ex rel. Int’l Game Tech. v. Hart, 2012 U.S. Dist. LEXIS 34979 (D. Nev. Mar. 14, 2012); In re Bed Bath & Beyond Inc. Deriv. Litig., 2007 U.S. Dist. LEXIS 85213 (D.N.J. Nov. 19, 2007); Hanson v. Odyssey Healthcare, Inc., 2007 U.S. Dist. LEXIS 100072  (N.D. Tex. Sept. 21, 2007); LeBoyer v. Greenspan, 2007 U.S. Dist. LEXIS 96231 (C.D. Cal. June 13, 2007); Henik ex rel. LaBranche & Co. v. LaBranche, 433 F. Supp. 2d. 372 (S.D.N.Y. 2006)and Carroll ex rel. Pfizer, Inc. v. McKinnell, 19 Misc. 3d 1106(A), 2008 WL 731834 (N.Y. Sup. Ct. 2008)The Vice Chancellor also declines to follow Vice Chancellor Parsons’ decision to follow federal precedent in In re Career Educ. Corp. Deriv. Litig., 2007 Del. Ch. LEXIS 184 (Sept. 28, 2007).
  • He presumes to tell a California federal court how it should rule.  (“If the collateral estoppel issue were properly presented to the California Federal Court, that court should decline to follow Leboyer and hold instead that collateral estoppel does not bar a later derivative action by a different stockholder.”)
  • He holds that collateral estoppel is governed by the internal affairs doctrine.  (“It is therefore a matter controlled by the internal affairs doctrine and governed by the law of the state of incorporation.”)  However, the Ninth Circuit Court of Appeals has applied either federal law regarding collateral estoppel, when, for example, both the prior case and the subsequent case were brought in federal court under federal question jurisdiction or the law of the forum state when the prior case was not brought in federal court and the subsequent case was brought in federal court under diversity jurisdiction.  See Schoenleber v. Harrah’s Laughlin, Inc., 423 F. Supp. 2d 1109 (D. Nev. 2006).  More importantly, collateral estoppel is not a corporate law doctrine at all.  Rather, it is a doctrine concerned with the integrity of the judicial system, promotion of judicial economy, and protection of litigants from harassment and vexatious litigation.  Lucido v. Superior Court, 51 Cal. 3d 335, 343 (1990).  None of these policies underlying the collateral estoppel doctrine are peculiar to either derivative suits or the internal affairs of a corporation.
  • He rules on the adequacy of representation in a case in another jurisdiction.  As an independent grounds, the Vice Chancellor ruled that the California plaintiffs did not adequately represent the subject corporation.  Although the opinion includes a lengthy discussion of race-to-the-courthouse problems, the discussion of the plaintiffs’ inadequacies is meagre.  Basically, the court faults the plaintiffs’ motives in filing suit (to make money) and the rapidity with which they filed.  Ironically, the Vice Chancellor’s analysis puts defendants asserting collateral estoppel in the awkward position of defending the work of their erstwhile opponents while encouraging subsequent plaintiffs’ counsel to attack the work of other members of the plaintiffs’ bar.  Moreover, it requires the Court of Chancery to judge the work of the plaintiffs in a case that is not before it.   It’s unclear whether the Vice Chancellor in this case reviewed the entire record, including the opposition to the motion to dismiss filed by the plaintiffs, in the federal court case.

The fundamental objectives of the collateral estoppel doctrine have nothing to do with the internal affairs of corporations.  Unfortunately, this decision undermines those objectives by opening the door to relitigation of the issue of demand futility by successive plaintiffs.


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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