Federal Court Requires Derivative Plaintiff Seeking Voluntarily Dismissal to Provide Notice to Shareholders

A federal court made it more difficult for derivative plaintiffs and their lawyers to cheaply exit derivative lawsuits they brought but no longer wish to maintain.  In June 2013, the Delaware Chancery Court dismissed stockholder claims challenging the validity of a forum-selection bylaw adopted by Chevron’s directors (Boilermakers Local 154 Retirement Fund v. Chevron Corp, 73 A.3d 934). Before the decision, a parallel derivative suit Bushansky v. Armacost (2012 WL 3276937), was filed in federal court, but stayed pending the outcome of the Delaware suit. After the decision, the plaintiff in Bushanksy sought court authorization to voluntarily dismiss the suit without providing notice under Fed.R.Civ.P. 23.1(c). Rule 23.1(c) requires court approval and notice of dismissal to voluntarily dismiss a derivative action. There are three exceptions to the notice requirement: the claim is dismissed after litigation on the merits, the claim is moot, or absent class members would not be prejudiced without notice and the expense is unduly burdensome. Bushansky alleged all three exceptions and claimed that because he lacked standing, the court had no jurisdiction to order notice. He also argued that other shareholders were already on notice, excusing any requirement.

The court rejected the lack of standing claim. Standing is irrelevant to the purpose of the rule – discouraging secret settlements and affording absent shareholders the opportunity to continue a potentially meritorious claim, so the lack of standing did not affect notice. The Court then rejected Bushansky’s argument that the Delaware ruling precluded the claims in the instant action. He argued at the stay hearing that fiduciary duty claims in the federal suit were separate and the Court held that those issues were neither litigated nor moot. Next, the Court found the possibility of prejudice, based on statute of limitations concerns barring subsequent suits. Additionally, any concerns of cost were unfounded. Even if notice by mail or publication was unduly burdensome, other means existed. Finally, Bushansky’s argument for prior notice failed. His arguments did not address notice of dismissal, but rather demonstrated notice for the adoption of the bylaw and the decision of the Delaware suit.

The court ordered the parties to file a proposed notice plan. If no shareholder sought to intervene during the notice period, the plaintiff could then file a motion to voluntarily dismiss.

Shareholders Denied Suit After Losing Merger - Securities Exchange Act §14(a)

The Ninth Circuit has recently affirmed the district court’s dismissal of In Re Diamond Foods, Inc. Derivative Litigation (2012 WL 1945814). The shareholders claimed that Diamond Foods false proxy statements violated §14(a) of the Securities Exchange Act, resulted in the collapse of a proposed merger, and injured them.  The Ninth Circuit affirmed dismissal for lack of subject matter jurisdiction. A few years prior, Diamond Foods entered into an agreement to merge with P&G’s Pringle Company; this move would make Diamond Foods the second largest snack company in the United States. Prior to the planned merger, in 2011, Diamond Foods made significant expenditures that it reported to the 2012 fiscal year. The plaintiffs claimed these expenses were improperly accounted for to inflate the company’s value prior to consummation of the merger. Eventually the company reported improper accounting, the stock value dropped, and the merger collapsed. Plaintiffs brought suit.

The court held that a §14(a) claim requires that the misstated proxy statement be the “essential link in the accomplishment of the proposed transaction.” Put otherwise, the statement must have affected the shareholders' decision. The claim failed because the plaintiffs pleaded that the merger was to their benefit. If the plaintiffs would have voted for the merger regardless, there was no action they relied on that caused harm. Although it would have made the deal less desirable, it did not make it undesirable and therefore was not an essential link.

California Court of Appeal Dismisses Derivative Suit Against Yahoo Directors

The Court of Appeal for California's Sixth District upheld the dismissal of a purported shareholder derivative suit against the directors of Yahoo (http://www.metnews.com/sos.cgi?1013//H037762).  The shareholder plaintiff asserted that five of Yahoo's twelve directors had engaged in insider trading in violation of the California Corporations Code.  The Court first correctly applied Delaware law in decided whether a pre-suit demand by the shareholder plaintiff was excused.  The Court assumed for the sake of the appeal that the five directors who allegedly committed insider trading were not independent for purposes of whether demand was excused.  However, the shareholder could not plead specific facts sufficient to taint the independence of the remaining seven directors.  As is common in these cases, plaintiff asserted a hodgepodge of allegations against the other seven directors including that some also engaged in some insider trading, were beholden to their comrades, and failed to fix the problems at Yahoo or otherwise prevent the insider trading.  The case provides an excellent explanation and summary of Delaware law on demand futility and properly applied that law to dismiss the claims asserted.

Delaware Supreme Court Limits Duplicative Shareholder Litigation

In an important recent decision (http://www.dandodiscourse.com/files/2013/04/Allergan-Del.-S.-Ct.1.pdf), the Delaware Supreme Court reversed a Chancery Court permitting a second derivative suit to go forward against Allergan, even though a California federal court had already dismissed a derivative suit asserting similar claims brought by different Allergan shareholders.  The Chancery Court reasoned that the California shareholders had filed their derivative suit too quickly and without having made a demand for books and records under Delaware Corporate Code Section 220.  Accordingly, the Chancery Court reasoned that the California plaintiffs were inadequate representatives of the corporation and should not prevent other shareholders from asserting derivative claims on behalf of the company. The Delaware Supreme Court held that the dismissal of the California case raising the same issues was entitled to preclusive effect under the Full Faith and Credit Clause of the Constitution.  Absent this result, shareholder plaintiffs could seek a quick bite at the apple outside of Delaware.  If their suit fails, other shareholders could try again in Delaware after making a books and records demand, effectively subjecting the corporation to at least two lawsuits in different states over the very same claims.  The flip side, however, is that the decision places shareholders who want to conduct an orderly investigation before filing in a bind:  their case might be lost by others before it can be filed.  The Allergan decision does leave open the prospect that the later shareholders can prove that the "fast filers" were inadequate -- but they must present a factual record of the inadequacy, not just presume it based upon the lack of a Section 220 demand.

Do Derivative Plaintiffs Have to Make a Books and Records Demand in Delaware?

The Delaware Supreme Court has long pressed shareholder plaintiffs in derivative suits to make a pre-suit books and records demand under 8 Delaware Code Secion 220.  In In re Freemont McMoRan Copper & Gold Derivative Litigation (http://www.delawarebusinesslitigation.com/uploads/file/Freeport%20McMoRan%20letter%20op%202%2014%202013.pdf), however, would-be derivative plaintiffs in the context of a merger and acquisition sought to stay a derivative action by other plaintiffs.  The basis of the stay request was that the would-be plaintiffs had made a books and records demand under Section 220.  They feared that the case brought by others without the benefit of the book and records, if unsuccessful, would preclude their later derivative suit.  The Chancery Court held that the case should proceed, reasoning that the merger was scheduled to close in a matter of weeks and that the expediency necessitated by that schedule outweighed the legitimate concern about obtaining the books and records and the possible res judicata effects of other plaintiffs proceeding without the books and records.  The Delaware Supreme Court this week declined to take up the matter.  The upshot seems to be that, in the face of an impending merger, the need for speed outweighs the need for plaintiffs to obtain pre-suit books and records.  If the derivative suit without the books and records fail yet the Section 220 demand uncovers additional facts, the Delaware courts will be keft with a messy issue of res judicata (and one the Delaware Supreme Court will speak on in the impending Allergan decision).