Federal Court Rejects Court Of Chancery’s Privity Analysis

by Allen Matkins
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Two years ago, I wrote about La. Mun. Police Emples. Ret. Sys. v. Pyott, 46 A.3d 313 (Del. Ch. 2012) in which Vice Chancellor J. Travis Laster refused to give preclusive effect to federal district court’s dismissal of a derivative action.  See Delaware Court of Chancery “Overrules” Federal Court.  Among other things, the Court of Chancery concluded that there is no privity between derivative stockholders because, until a stockholder survives a motion to dismiss based on failure to make demand, the stockholder is not acting for the corporation.  On appeal, the Delaware Supreme Court reversed, but did not address the issue of privity under Delaware law because it found that the Court of Chancery should not have applied Delaware law.  Pyott v. La. Mun. Police Emples.’ Ret. Sys., 74 A.3d 612, 617-18 (Del. 2013).

Earlier this week, U.S. District Judge Kent J. Dawson rejected the Court of Chancery’s privity analysis as a matter of Nevada law.   In re Mgm Mirage Derivative Litig., 2014 U.S. Dist. LEXIS 88967 (D. Nev. 2014) involved two derivative suits – one filed in state court and the other in federal court.  After the state court action had been dismissed and the judgment affirmed by the Nevada Supreme Court, the corporation moved to dismiss the federal court action on the basis of issue preclusion.  See Kim v. MGM Mirage, 2013 Nev. Unpub. LEXIS 1989 (Nev. 2013).

Judge Dawson, citing 28 U.S.C. § 1738, applied Nevada’s issue preclusion law, under which he found four elements must be satisfied: identical issue, final and on the merits, same party or in privity with the party to the previous action, and issue actually and necessarily litigated.  He found that while it is unclear under Nevada law whether the plaintiff is the same party or in privity with the shareholders of the other action, the plaintiff was either one or the other.  Notably, Judge Dawson rejected the plaintiff’s invocation of Vice Chancellor’s privity analysis:

Plaintiff’s convoluted attempt to raise “standing” is without merit.  Plaintiff argues that the previous shareholders lacked “standing” because they insufficiently pled demand futility.  Then, Plaintiff argues that because the previous shareholders lacked “standing” there exists no privity between Plaintiff and the previous shareholders. Finally, Plaintiff argues that because there exists no privity between Plaintiff and the previous shareholders, Plaintiff is not barred from pleading demand futility. However, Plaintiff’s argument is without merit because (1) the argument is based on a single, overruled Delaware case, and (2) here, Nevada law governs issue preclusion, not Delaware law.  Further, the issue of demand futility (here, “standing”) examines whether or not the corporation’s board is independent and disinterested in making decisions on behalf of the corporation.  Demand futility is not concerned with the character of the shareholders.  Thus, “standing” is the same for all shareholders irrespective of which shareholder brings a derivative action.

Of course, this not to say that Vice Chancellor Laster was wrong about privity under Delaware law and it is even possible that the Nevada Supreme Court will see the question differently from Judge Dawson.

For more on Nevada corporate law, including derivative suits, see my book.

 

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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