Supreme Court Reverses Chancery on Collateral Estoppel/Demand Futility and Section 220 Issues

Pyott v. Louisiana Municipal Police Employees’ Retirement System, No. 380, 2012 (Del. Supr., April 4, 2013)

Issues Addressed:  (1) Whether or not a prior ruling by a California court dismissing a derivative suit served as a bar to subsequent Delaware derivative suits; and (2) Whether the failure to use Section 220 before filing suit created a presumption that the plaintiff was an inadequate representative.

Short Answers:  (1) Collateral estoppel prevented the second derivative suit; and (2) There is no irrebuttable presumption that applies simply because Section 220 was not used before the derivative suit was filed.

Brief Overview 

This 12-page Delaware Supreme Court decision reversed an 80-page decision by the Court of Chancery.  The trial court decision was highlighted on these pages here.  This decision also diminishes the impact of a separate decision by the Court of Chancery in South v. Baker, highlighted on these pages here, which had questioned the adequacy of plaintiffs who filed derivative cases with Caremark claims that had not used Section 220 beforehand.

The issue on appeal was whether the Court of Chancery was required to dismiss a Delaware derivative complaint after a California federal court entered a final judgment dismissing essentially the same complaint brought by different stockholders.

Procedural History 

The Court of Chancery held that it was not required to give preclusive effect to the California judgment for two reasons.  First, the Court of Chancery held as a matter of law that the stockholder plaintiffs in both jurisdictions are not in privity with each other.  Next, the Court of Chancery determined that the California stockholders were not adequate representatives of the defendant corporation.

The Delaware Supreme Court ruled that the Court of Chancery was wrong on both points.  The High Court of Delaware determined that California law controlled the issue of privity, and that the derivative stockholders were in privity when they acted on behalf of the corporation.  In addition, the trial court erred in holding that there was a presumption of inadequacy without any record to support the factual premise on which the presumption was based.

The background facts are described in more detail in the summary of the trial court opinion highlighted on these pages at this link.

Substantially similar complaints were filed in both California and in the Court of Chancery, although the Court of Chancery allowed the UFCW to intervene after it employed Section 220 to inspect books and records of the company involved, Allergan.  Motions to dismiss were filed in both courts and the federal court in California granted the motion to dismiss with prejudice prior to the ruling by the Court of Chancery.  The Court of Chancery held that the California judgment did not bar the Delaware action and denied the motion to dismiss the Delaware case.  An interlocutory appeal followed.

Short Overview of Reasoning by the Delaware Supreme Court 

The Delaware Supreme Court relied on the Full Faith and Credit Clause of the United States Constitution at Article IV, §1, which provides that:  “Full Faith and Credit shall be given in each State to the public Acts, Records, and Judicial Proceedings in every other state.”  This clause has been understood to encompass the doctrine of res judicata, claim preclusion, and collateral estoppel or issue preclusion.  The United States Supreme Court has held that a state court is required to give a federal judgment the same force of effect as it would be given under the preclusion rules of the state in which the federal court is sitting.  The Delaware Supreme Court applied this law to require the state of Delaware to give Full Faith and Credit to the California federal judgment.

The Delaware Supreme Court then determined that the Court of Chancery failed to apply this settled law because it “conflated collateral estoppel with demand futility.”  The Court reasoned that a motion to dismiss should have been addressed exclusively on the basis of federalism, comity, and finality.  The interest that Delaware has in the internal affairs of its corporations:  “must yield to the stronger national interests that all state and federal courts have in respecting each other’s judgments.”  See footnote 11.

Privity

The Supreme Court did not directly address the analysis under Delaware law about whether an individual derivative claim has preclusive effect on derivative claims of other stockholders because the Delaware Supreme Court determined that California law and not Delaware law applied to the preclusive effect issue.  The court also noted that “although the Court of Chancery is divided on the privity issue as a matter of law, we cannot address the merits of that issue in this case.”  See footnote 20.

Section 220 and Alleged Inadequacy of Representative Plaintiffs

The Delaware Supreme Court rejected the “fast filer” presumption of inadequacy referenced in the trial court, and reasoned that:

“undoubtedly there will be cases where a fast filing stockholder also was an inadequate representative.  But, there is no record support for the trial court’s premise that stockholders who file quickly, without bringing a Section 220 books and records action, are a priori acting on behalf of their law firms instead of the corporation.  This court understands the trial court’s concerns about fast filers, but remedies for the problems they create should be directed at the lawyers, not the stockholder plaintiffs or their complaints.”  See footnotes 23 and 24.

The net result of the foregoing quote is that the trial court decision in Pyott, and the separate Chancery decision in South v. Baker, highlighted on these pages here, will not likely be relied on for the imposition of a prerequisite of using Section 220 before a derivative claim is filed.

Alison Frankel of Thomson Reuters penned an insightful article about the case at this link. Ted Mirvis authored an insider’s viewpoint in a piece published on The Harvard Law School Corporate Governance Blog at this link. Kevin LaCroix provides insightful commentary about the case at this link.