Posts tagged Derivative Claims

Court Of Chancery Upholds Derivative Suit By Preferred Stockholder

MCG Capital Corporation v. Maginn, C.A. 4521-CC (May 5, 2010)

This decision addresses the prevously unanswered question of whether preferred stockholders may bring a derivative suit.  They can.  While to some this may seem obvious, the answer was by no means all that certain.  In recent years the Delaware courts have consistently cut back on the rights of preferred stockholders and creditors to allege fiduciary duty claims. Now warrant holders and creditors may not sue derivatively [except when the entity is insolvent].  Hence, the right of preferred stockholders to do so was at least questionable.

This decision is also an excellent collection of the law on what claims preferred stockholders may bring, particularly on the limits to assert breach of fiduciary duty claims.

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Court of Chancery Explains the "Parnex Exception"

In re NYMEX Shareholders Litigation, C.A. 3621-VCN (September 30, 2009).

When is a claim that the merger was unfair a derivative and not a direct claim? This is a perplexing question under Delaware law. Generally, a claim that the merger price is too low because management manipulated the process to drive down value is derivative, because the claim asserts it is the company that was hurt by the actions taken. When, however, the price was unfairly reduced by the actions of a corporate fiduciary, then the so-called "Parnex exception" may apply, and a direct stockholder class action may be brought.

This decision explains the Parnex Exception. In general, a direct claim may be brought when the alleged breach of fiduciary duty was intended to benefit a particular fiduciary at the expense of all the other stockholders. The breach of duty must be directly connected to the reduced price, however, and any large gap in time may be fatal to the direct claim.

Keep in mind that all claims challenging a merger are not derivative, and it is only because this was an entrenchment claim that the court held it was derivative. This points out the importance of picking your legal theory wisely. A mistake can cost you the case in this complicated area.

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Rales Test Applied to Allegation of Board Inaction

In re Intel Corp. Derivative Litig., C.A. No. 08-93-JJF (D. Del. June 4, 2009)

This opinion discusses when a court will apply the Rales test rather than the Aronson test in deciding whether a derivative plaintiff has pled particularized facts establishing demand futility.  Here, the district court applied the Rales test requiring that allegations establish a reason to doubt that the board could have properly exercised its independent and disinterested business judgment in responding to a demand.  The complaint alleged that the directors made a decision not to act which was not made in good faith and was contrary to the best interests of the company.  Despite plaintiff’s contention that Aronson should apply, the district court noted that Delaware courts have found that they cannot address the business judgment of an action not taken and, therefore, should apply what is now known as the Rales test.

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Court of Chancery Upholds In Pari Dilecto Defense

American International Group Inc. Consolidated Derivative Litigation, C.A. 769-VCS (June 17, 2009)

This is the latest decision in the continuing saga of the AIG litigation. In this case, the Court declined to permit a derivative stockholder of AIG to sue the co-conspirators of AIG in the various frauds alleged to have hurt AIG and its stockholders. The Court upheld the in pari dilecto defense that generally prohibits one wrongdoer from suing her fellow wrongdoers. This scholarly opinion covers all the reasons for upholding that defense and why the only exception it will  permit is for the corporation to sue its own directors who caused it to do wrong.

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Court of Chancery Defines When a "Controlling Stockholder" Exists

Dubroff v. Wren Holdings LLC, C.A. 3940-VCN (May 22, 2009)

A claim that stockholders were wrongly diluted by the issuance of additional stock is generally consider a derivative claim that must meet tough pleading standards. However, when the dilution is caused by a controlling stockholder, the claim is also a direct claim that may be filed without meeting  the rules for derivative suits. This is a big advantage.

This decision holds that a group may be consider a "controlling stockholder" for purposes of determining when a direct claim may be filed. Note that acting in parallel or voting together on an issue is evidence of acting as a group but is not enough to meet the rule requiring the pleading of facts that show an agreement to act together as a group.

This decision is also important as the first time the Court has addressed what must be disclosed in the information statement that must be sent to stockholders after stockholder consent under Section 228 is executed.  Fair, if not full, disclosure is required, including whether corporate insiders benefited from the action taken by consent.

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Court of Chancery Explains how To Infer Scienter

American International Group Consolidated Derivative Litigation, C.A. 769 (Del. Ch. Feb. 10, 2009)

 

The Court of Chancery is often faced with the difficult task of deciding when a complaint has enough factual allegations to survive a motion to dismiss, particularly when there is no self dealing by directors and the business judgment rule is raised as a defense. This detailed 102-page decision illustrates the thought process that the Court uses.

 

The basic question presented was whether the plaintiff, could at the pleading stage, state sufficient facts to show that the case should go forward. As is typical, the defendants argued that all the complaint really alleged is that they made some bad decisions or that others below them in the corporate entity were the parties at fault. The Court denied the motion to dismiss because there was enough in the complaint to warrant an inference that the defendants must have known of the corporate wrongdoing. The keys to this result were: (1) the defendants were in position to know of the wrongs that had been committed; (2) they had practiced tight control over the entity so that they generally were aware of all that was going on; and (3) the bad acts were massive in scale and unusual in nature so as to have been unlikely to have been done without the defendants' knowledge. More ›

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Court of Chancery Explains "Validly In Litigation"

In re: Affiliated Computer Services, Inc. Shareholders Litigation, C.A. 2821-VCL (Del. Ch. Feb. 6, 2009)

 

Determining when a derivative complaint should be dismissed becomes complicated when the composition of the board of directors changes. What board do you look to to determine if a demand must be made on the board before suit may proceed? You start by looking at the board that existed at the time the complaint was filed. If demand on that board was excused, then the case was "validly in litigation" and may proceed even if the board composition later changes to include a majority of disinterested directors.

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Court of Chancery Rejects Settlement

Off v. Ross, C.A. 3468-VCP (Del. Ch. Nov. 26, 2008)

The Court of Chancery rejected the proposed settlement of this derivative suit for two reasons. First, the transaction under attack in the litigation was completed after a modification favorable to stockholders before the settlement was presented for approval, the modification was considered by the board before suit was filed, and the transaction was not dependent on approval of the settlement. Thus, the Court concluded that there was no consideration for the settlement because the modification to the deal that plaintiff relied upon to justify the settlement would have happened anyway without the suit.  A benefit received by stockholders that is not caused by litigation is not valid consideration for the settlement of the litigation.

In addition, the Court was troubled by the effect of the release that was part of the settlement on related litigation in New York. Given that the stockholders received virtually nothing for the release, it was wrong to affect their rights in the litigation elsewhere that might benefit them.

 

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Court of Chancery Dismisses Derivative Suit for Bad Conduct and Lack of Standing

Parfi Holding A.B. v. Mirror Image Internet Inc., C.A. 18507-VCS (Del. Ch. Sept. 4, 2008)

In this highly unusual case, the Court of Chancery dismissed the complaint because the plaintiff had not told the truth as to why it was not proceeding promptly and because the named plaintiff had lost standing by conveying away any economic interest in the stock it held in the company.

 

The standing decision sets new precedent. The Court held that when a plaintiff retains only technical title to stock and assigns all economic interest in that stock to a third party, that is effectively the sale of the stock. Of course, under established law, the sale of stock while a suit is pending violates the Delaware continuous ownership rule and warrants dismissal of a derivative suit.

 

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Court of Chancery Permits Settlement of Suit with Suit To Be Filed Against Insurers

In re Electronics for Imaging Inc. S’holders Litig., C.A. 2797-VCL (Del. Ch. Sept. 4, 2008)

 

It is common for the settlement of a derivative suit to be funded by the D&O insurers. Here, however, in a twist to that common event, the Court upheld a settlement where the company is permitted to sue the D&O insurers, with counsel for the stockholder plaintiff as its attorneys, to force the insurers to fund.

 

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Court of Chancery Permits Discovery for a Settlement Hearing

In re Countrywide Corp. S'holders Litig., C.A. 3464-VCN (Del. Ch. Sept. 3, 2008)

In this admittedly unusual case, the Court of Chancery has expanded the limited discovery available to an objector of a proposed settlement of a derivative case. The discovery includes the valuation of the derivative claims' value to the company. The Court also notes the potential privilege problems that may be involved.

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Delaware Supreme Court Sets Pleading Rules

Wood v. Baum, Del Sup. C.A. 621, 2007 (Del. July 1, 2008)

The Delaware Supreme Court has clarified the pleading standard that must be met to excuse demand on a board in a derivative suit. When a non-exculpated claim is plead, such as fraudulent conduct, the plaintiff must state particularized facts to support her claim.

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Court of Chancery Upholds Complaint Over Options

London v Tyrrell, C.A. 3321-CC (Del Ch. June 24, 2008)

One of the tests for whether a board of directors is interested in a transaction under attack in a derivative suit so as to excuse demand on them before suit is filed is if they have personally benefited from the transaction. This decision makes clear that in the case of the grant of a stock option, the directors who have received the option will always be deemed interested in the outcome of an attack on that grant, even without showing the amount of the option is material to their financial condition.

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Court of Chancery Permits Special Committee Discovery

Young v. Klaassan, C.A. 2770-VCL (Del. Ch. April 25, 2008)

The use of a special committee of the board to avoid derivative suits over allegations of breach of duty is well recognized. What is less well known is how to use the work of such a committee. Here the defendants improperly argued that a derivative suit should be dismissed because of the conclusions of a special committee formed after the complaint was filed. That use of information not alleged in the complaint converted the motion to dismiss into a motion for summary judgment and thereby permitted discovery into the work of the special committee.

The opinion also notes the "unusual" nature of the special committee in this case. The committee did not issue a report, barely had its existence disclosed, and otherwise proceeded irregularly. One has to wonder why it was even formed if it was to act so poorly.

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SLC Formed After Demand Excused is Not "Too Late"

In re infoUSA, Inc. Shareholders Litigation, Consol. C.A. No. 1956-CC (March 17, 2008).

A special litigation committee was formed by the board of infoUSA, Inc. at the end of December, after a motion to dismiss derivative litigation had been denied and after a finding had been made by the Court of Chancery that demand was excused.   The SLC moved to stay the ongoing derivative litigation in January, seeking a period of 150 days in which it could investigate the substance of the claims in the action.  The plaintiffs opposed such a stay, asserting that the SLC was formed "too late" and should not be allowed to derail the ongoing litigation.

The Court of Chancery rejected this position:  "The fact that I have already determined that demand is excused demonstrates why the board must act by means of a special committee; it does not in any way explain why it cannot act through an SLC."  Consequently, the requested stay was granted.  The Court also rejected as premature any challenge to the independence of the SLC, finding it serves the purposes of judicial economy to do so after the SLC issues its report.  The letter opinion can be viewed here.

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