Posts tagged Derivative Claims

Court Of Chancery Upholds Derivative Claim Despite Prior Dismissal

Louisiana Municipal Police Employees' Retirement System v. Pyott, C.A. 5795-VCL  (June 11, 2012)

This is one of the most important decisions on derivative litigation in many years. There are 3 key holdings, at least one of which may reverse prior law.  First, the Court held that a derivative suit dismissed for failure to plead sufficient grounds to proceed under the demand rules may be refiled by a different plaintiff who has a better complaint.  This may modify prior law  that had held that once dismissed with prejudice, the suit could not be revived by a better complaint from a new plaintiff.

Second, this decision effectively kills off the old first-filed rule that held that the plaintiff who files the first complaint will control the litigation even if other complaints are filed later by different plaintiffs.  From now on, the better plaintiff will be the lead plaintiff.

Third, the decision again stresses the value of inspecting a company's records before filing a derivative suit.  Indeed, the failure to do so may cause the Court to view the complaint as presumptively meritless, at least with respect to whether the demand rules have been meet.

The opinion is worth reading for many other reasons as well.  Its discussion of the Caremark case alone is a good reason to study the decision.

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Court Of Chancery Crafts Settlement Options

Forsythe v. ESC Fund Management Co. (U.S.) Inc., C.A. 1091-VCL (May 9, 2012)

When the Court tasked with reviewing a settlement proposal in a derivative action is faced with apparently well-intentioned objectors who want to go to trial and not settle, deciding what to do is not easy.  This decision comes up with an ingenious solution - let the objectors "buy the settlement."   This is accomplished by giving the objectors time to put up a bond to effectively guarantee the recovery of the settlement amount and then permit the objectors to take over the litigation and go to trial.

It will be interesting to see if the objectors take the Court up on its proposal.  After all, the recovery in any derivative suit goes first to the entity involved.  Any one who funds such litigation needs to be aware of the risk that sharing in the recovery is its only reward.

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Court Of Chancery Applies Corporate Law To Statutory Trust Case

Protas v. Cavanagh, C.A. 6555-VCG (May 4, 2012)

This decision answers the question of what law will apply to decide if a beneficiary of a Delaware statutory trust may bring a derivative suit.  The court held that the established law under the DGCL and Rule 23.1 applies.  Hence, the beneficiary must show that either the director defendants are conflicted or that there is a substantial basis to believe that they will be liable because their actions are so outlandish that they are not protected by the business judgment rule.

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Court Of Chancery Resolves Who May Bring Derivative Claims After Dissolution

Matthew v. Laudamiel, C.A. 5957-VCN (February 21, 2012) This decision resolves who may bring a derivative claim after an LLC has been dissolved.  The argument made by 1 of the parties was that after dissolution, any member may bring a derivative claim directly.  The Court rejected that argument and concluded that the claim still must be brought in the name of the LLC and that a petition might also be filed to have the entity restored to bring such a claim or for a trustee to be appointed to do so. This decision also dealt with an important jurisdictional issue under the so-called conspiracy theory.  It holds that the alleged conspirator must be aware that the conspiracy involves an action in Delaware in furtherance of the conspiracy, before the conspiracy is completed and the harm done. Share

Court Of Chancery Explains What Is A Control Group

Dubroff v. Wren Holdings LLC, C.A. 3940-VCN (October 28, 2011)

What is a derivative claim is sometimes hard to decide but may be central to a plaintiff's right to bring suit.  Under the Supreme Court's Gentile decision, a claim that the controlling stockholder has improperly diluted the minority shareholders' stock may be filed as a direct claim on behalf of those stockholders and does not have to pass the tough rules governing the filing of derivative litigation.  Who then constiutes a "controlling stockholder?"  This decision holds that a group may be in "control" for the purposes of the Gentile rule and explains how to decide if that control group exists.

The decision also further explains what sort of dilution qualifies to invoke Gentile, when disclosures after action by stockholder consent must be complete and that a pending class action tolls the statue of limitations until the class certification process is complete.

 

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Court Of Chancery Explains Domination Law

New Jersey Carpenters Pension Fund v. Infogroup, Inc., C.A. 5344-VCN (September 30, 2011)

To decide whether a derivative suit may proceed without first asking the Board of Directors to bring the suit, one test that is applied is whether the Board is "dominated or controlled" by an alleged wrongdoer.  For if the Board is so dominated, then it cannot be expected to independently decide if the suit should proceed.  Some cases under this rule are easy to decide, such as when there is a parent-child relationship involved.  [Those of us who have had teenagers might wonder why this is so.]

There are harder cases and this is one. Here the Court decided that the threats of a dominant stockholder and board member had so affected the rest of the Board that the other directors could not be expected to independently decide if the dominating board member should be sued. Hence, it permitted the suit to proceed without a demand on the rest of the Board.

The obvious lesson here is not to be a bully.

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Supreme Court Affirms Creditors May Not Sue Derivatively In LLC

CML V LLC v. Bax,  C.A. 735, 2010 (September 2, 2011, corrected September 6, 2011)

This decision upholds the prior decision of the Court of Chancery that creditors of an insolvent LLC may not bring a derivative claim against its managers.  This follows because the Delaware LLC Act limits such claims to members.  This result is another example of the differences between LLCs and corporations.  For in the corporate context, a creditor may file a derivative claim when the entity is insolvent.

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Unliquidated Derivative Claims Continue to Have Little Value

This article was original published in The Delaware Business Court Insider | 2011-07-06

On May 31, Vice Chancellor Leo E. Strine Jr. issued an opinion denying a motion for preliminary injunction to halt a merger between Massey Energy Company and an affiliate of Alpha Natural Resources Inc. One of the critical issues in the opinion was the value of the derivative claims Massey had against certain current and former directors and officers arising out of Massey's compliance with federal mining safety regulations.

Massey's attitude toward federal mining safety regulations arguably manifested itself in the Upper Big Branch mine disaster, which resulted in the loss of 29 lives. In his opinion, Strine found that the plaintiffs had probably stated a Caremark claim against the directors of Massey and criticized the board of Massey for failing to assess the value of the derivative claims but ultimately refused to enjoin the merger, concluding that the derivative claims did not have the value plaintiffs believed.

While this result has received some negative commentary, is it really a surprise? In fact, the court's analysis is consistent with prior analyses addressing the value of derivative claims in the context of a merger. The fact that the party here is more infamous than many others did not change the analysis under Delaware law.

The plaintiffs valued the derivative claims based on the "aggregate negative financial effect on Massey that the Upper Big Branch Disaster and its Fall-Out has caused." According to the plaintiffs' expert, these damages range from at least $900 million to $1.4 billion. The court, however, rejected this theory, in large part because the computation of the value of the derivative claims was far more complicated than the plaintiffs' theory.

First, even though the plaintiffs had stated a viable Caremark claim against the directors, because of the business judgment rule and the exculpatory provisions in Massey's certificate of incorporation, in order to obtain a monetary judgment against the directors, they would have to prove that the directors acted with scienter — a difficult standard to meet, particularly with independent directors.

Second, the court also found that even as to the autocratic former leader of Massey, Don Blankenship, who was arguably responsible for Massey's approach to mining safety, meeting this standard would be difficult. The court noted that there is a large gap between pushing the limits of federal regulations while accepting minimal loss of life and knowingly endangering the mine itself by putting its very operations at risk. Moreover, Blankenship was not directly in charge of any specific mine, and tying his policies directly to any disaster would be challenging.

Third, proving that the directors acted with scienter may entitle the corporation to a monetary judgment from the directors, but it would simultaneously expose the company to third-party civil liability and potential criminal liability, and potentially deprive the directors of the ability to rely on insurance coverage, all of which would harm the company.

Fourth, after the merger, Alpha will continue to have to address direct claims against Massey from its lost and injured miners, regulatory consequences of the company's mining safety approach, and other elements of the "Disaster Fall-Out." To the extent possible, Alpha will have every incentive to shift that liability to the former directors.

Fifth, it is impossible to determine the potential derivative liability of the directors until Massey's direct liability is determined. Indeed, it is not even in the interest of Massey's stockholders to press their claims of derivative liability now, before third-party civil and criminal adjudication, lest the plaintiffs expose the company to additional liability.

Sixth, the plaintiffs' expert put no value on the ability of the company or its stockholders to collect on a potential $1 billion judgment. The company's insurance policy, even assuming it is available to cover claims against the former directors, is only $95 million. While this is no small amount, it is, as the court put it, "not material in the context of an $8.5 billion merger."

While the vice chancellor was quick to note that the Massey board's approach to valuation of the derivative claims was less than ideal, because of the factors noted above, he found that the plaintiffs had not persuaded him that the merger was unfairly priced because of the failure to value separately the derivative claims. Was this conclusion so unprecedented, however, to justify criticism of the valuation?

Delaware courts previously have been asked to consider the value of unliquidated, contingent claims belonging to the company in the valuation context. These courts have never valued derivative claims at the full value of all potential damages, but instead have considered many of the factors Strine addressed in Massey.

For instance, in Onti Inc. v. Integra Bank Inc., petitioners in an appraisal action argued that their derivative claims should have been valued as an asset of the company in the appraisal proceeding. The stockholders' expert valued the claims at more than $19 million, while the company's expert valued the claims at negative $2.5 million. The court determined that the claims had no value. In reaching that conclusion, the court adopted the theory advanced by the company's expert, that all litigation factors should be considered, including the likelihood of success on the merits, the attorney fees necessary to obtain that result and any indemnification that the company would owe to its directors. Citing to prior precedent, the court noted that "there would be strong logic in including the net settlement value of such claims as an asset of the corporation for appraisal purposes."

Later that same year, the court took a similar approach in Bomarko Inc. v. International Telecharge Inc. The court valued the claim in that case by multiplying the probability of success by the likely amount of recovery while subtracting costs incurred to obtain that result.

More recently, in Arkansas Teacher Retirement System v. Caiafa, the Court of Chancery overruled an objection to a settlement that released claims that the board failed to ascribe any value to federal derivative claims in a merger. After noting that there is no case law supporting the proposition that the board was required to undertake a separate and discrete valuation of the derivative claims pending at the time of the challenged merger, the court reached the same result as Strine did in Massey, albeit with less analysis. That is, the court noted that the claims asserted in the federal action were difficult to win, and even those that had a higher probability of success could not have the $2 billion value the objectors claimed they did. On appeal, the Delaware Supreme Court affirmed the Court of Chancery's decision to overrule the objection for the reasons set forth in the Court of Chancery's opinion.

Given these precedents, is the result in Massey all that surprising? While some contingent claims have been given value, it is the exception, and not the rule, to assign material value to contingent derivative claims. Moreover, in the context of a merger worth billions of dollars, the likelihood is low that derivative claims have material value, particularly when reasonable defenses can be interposed.

But does this decision mean that boards can just eschew any analysis of the value of a derivative claim in the context of a merger? Probably not. The Court of Chancery certainly did not condone the practice, and had the court not been persuaded that the board otherwise acted properly, the failure to do so could have had more importance.

Further, because the exception to the derivative standing rule that entering into a merger for the purpose of extinguishing derivative claims remains viable, particularly in light of the Supreme Court's opinion in Caiafa, failure to value the claims could support the conclusion that a merger was negotiated simply to avoid liability. Finally, not all derivative claims are equal in this context. As Strine noted in Massey, if Massey had a liquidated claim against a former fiduciary reduced to a judgment but failed to get any value for this claim, he could see the substantial unfairness in failing to obtain value for that claim in a merger. Alternatively, if recovery on any derivative claim after a cash-out merger would inure solely to the benefit of the acquirer, then perhaps there would be value to the buyer in obtaining that claim.

Put simply, as with many issues of fiduciary law, the context of the situation is important. What is fairly clear, however, is that unliquidated contingent derivative claims are not ascribed much value, if any, in a merger context, unless a party can demonstrate a reasonable likelihood that the net value of the claim to the company is material.

Peter B. Ladig (pladig@morrisjames.com) is a partner at Morris James in Wilmington and a member of its corporate and fiduciary litigation group. He represents both stockholders and directors in corporate litigation. The majority of his practice is in the Delaware Court of Chancery, although he has extensive experience in the other state and federal courts in Delaware and has been involved in over 50 published decisions. The views expressed herein are his alone and do not necessarily reflect the firm or any of the firm's clients.
 

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Court Of Chancery Resolves Demand Requirement For Statutory Trust

Hartsel v. The Vanguard Group Inc.,  C.A. 5394-VCP ( June 15, 2011)

Recently Delaware enacted a statute to authorize business trusts, such as used in the mutual fund industry, the Delaware Statutory Trust Act.  This decision establishes that the normal rules for derivative litigation apply in actions brought by trust interestholders.  For example, whether the action is direct or derivative and when demand is excused will be decided applying established Delaware law.

The decision also squarely establishes that the alleged mismanagement of investments by a mutual fund manager is a derivative claim.

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Court Of Chancery Explains How To Value A Derivative Claim In Merger

In re Massey Energy Company Derivative and Class Action Litigation, C.A. 5430-VCS (May 31, 2011)

When a company that is subject to derivative litigation is sold in a merger, the value of the derivative claim may be significant.  After all, in most cases, that claim passes to the buyer who arguably should pay something for it.  Here the Court carefully evaluated a derivative claim that it found would survive a motion to dismiss and explains why, in the circumstances of this case, that claim and its possible value did not mean the merger consideration was inadequate.

The way the Court does the analysis here is an excellent example of the way to value such a claim in the merger context.

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Court Of Chancery Establishes Law On Double Derivative Litigation

Hamilton Partners LP v.  Englard, C.A. 4476-VCL ( December 15, 2010)

This is an important decision dealing with the often confusing law on double derivative suits. Briefly, the decision holds:  (1) there is no need for there to be jurisdiction over a parent in a double derivative suit when there is jurisdiction over the Delaware subsidiary;  (2) demand futility is measured at the parent level and (3) there is a derivative claim for the breach of duties owed to the subsidiary.  This last point is worth closer examination as the board of a subsidiary may act at the direction of its parent without liability.   Here some very odd facts lead to this result.

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Court Of Chancery Holds Creditors Lack Standing

CML V, LLC v. Bax, C.A. 5373-VCL (November 3, 2010)

Creditors of a Delaware corporation have standing to sue derivatively when the corporation is insolvent.  However, this decision holds that creditors of an LLC [and presumably an LLP] lack standing to sue derivatively.  The difference is that the LLC statute expressly says who has standing to bring a derivative suit and does not mention creditors.  In contrast, the corporate code only says when stockholders have standing and does not then actually define who else may have standing.

As the Court rightly points out, the solution to this problem is for creditors to have  any rights they want set out in the LLC agreement before they invest.  This again highlights the Delaware law that LLCs and LLPs are creatures of contract, not of judge-made fiduciary duties.  Buyer beware.

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Supreme Court Clarifies Standing Rule In Double Derivative Actions

Lambrecht v. O'Neal,  Del Supr., C.A. 135, 2010 (August 27, 2010)

This decision sets out the standing requirement for a double derivative suit following a merger.  In a stock-for stock merger, stockholders of the acquired company lose their stock in that company in return for stock in the new parent company who, in turn, becomes the sole stockholder of the company acquired in the deal.  A derivative suit by the former stockholder of the acquired company is then a "double derivative" suit because it really is on behalf of the new parent company for damages done to its subsidiary.  May the stockholder bring such a suit considering he is no longer a stockholder of the subsidiary?

The Delaware Supreme Court says he may do so long as he continues to hold stock in the parent company.

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Court Of Chancery Discusses Role Of Bankruptcy Appointee

Shandler v. DLJ Merchant Banking Inc., C.A. 4797-VCS (July 26, 2010)

This decision is interesting for its discussion of the role of an appointee of the bankruptcy court and the pursuit of post-bankruptcy derivative claims.

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Supreme Court Hints How To Avoid Losing Standing After A Merger

Arkansas Teacher Retirement System v. Caiafa, C.A. 530, 2009 (May 21, 2010)

This is the odd case whose dicta may be more important than we now appreciate.  It has long been Delaware law that a plainitff loses standing to pursue a derivative case when he is ceases to be a stockholder after a merger. The exception is when the merger is done solely to deprive the stockholders of standing to sue.

Here the Court seems to be saying that when a merger is the only way out for a corporation that has been devastated by wrongful conduct, the former stockholders may have a claim for damages even after they cease to be stockholders.  If so, that is new law and this bears watching.

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