Sitting en banc, the Delaware Supreme Court this month delivered an important message on two of the most hotly debated issues in corporate litigation: how courts should handle dueling shareholder lawsuits in multiple jurisdictions, and whether fast-filing class action and derivative plaintiffs should be accorded an advantage over late filers who prepare a more complete complaint. Pyott v. Louisiana Municipal Police Employees Retirement System, No. 380, 2012 (Del. April 4, 2013).

The case concerns Allergan Inc., the Delaware-incorporated, California-head­quartered company that makes Botox. In September 2010, Allergan entered into a settlement with the U.S. Department of Justice in which it pleaded guilty to misdemeanor charges of marketing Botox for "off-label uses" — that is, uses other than the specific uses approved by the U.S. Food and Drug Administration. Under the terms of the settlement, Allergan agreed to pay a total of $600 million in fines.

As is so often the case, the announcement of Allergan’s bad news on September 1, 2010, prompted a race to the courthouse. On September 3, the Louisiana Municipal Police Employees Retirement System (Lampers) filed a derivative suit in the Delaware Court of Chancery. Then other Allergan stockholders filed three separate derivative suits in the U.S. District Court for the Northern District of California, which were later consolidated. All the cases alleged that Allergan’s directors were liable for the company’s losses because they had failed to stop the illegal activity that caused the corporation’s losses.

In November 2010, an Allergan stockholder sent a demand to the company pursuant to Section 220 of the Delaware General Corporation Law for corporate books and records related to the company’s off-label marketing practices. After obtaining company documents, the stockholder joined forces with Lampers in the Delaware action, and together they filed an amended complaint in the Court of Chancery. The Delaware plaintiffs then shared the documents they had received with the California plaintiffs, who also filed an amended complaint in the California federal court.

The defendants responded to all this by moving to dismiss both amended complaints on the ground that the plaintiffs should have demanded that the Allergen board pursue the asserted claims before bringing suit themselves. Briefing concluded in California first, and the California federal court granted the motion with prejudice. (It had already dismissed an earlier complaint without prejudice.) The defendants then argued in Delaware that the California order of dismissal had preclusive effect and required dismissal there too.

In an 82-page opinion, the Court of Chan­cery disagreed, holding that collateral estoppel did not bar the Delaware action. As the court acknowledged, its ruling deviated from a body of case law holding that dismissal of one derivative suit for failure to make demand precludes other stockholders from bringing similar suits elsewhere, because all stockholders asserting derivative claims sue as representatives of the corporation and are accordingly in privity with one another. Rejecting this reasoning, the court held that Delaware stockholder plaintiffs do not have standing to bring a derivative suit until they establish that demand was either excused as futile or improperly denied. Because the California court had dismissed that suit on the ground that demand was not excused, the court ruled, the plaintiff there had sued in its own name and was not in privity with other stockholders. Accordingly, the California judgment did not bind the Delaware plaintiffs.

As an alternative ground for refusing to give the California ruling preclusive effect, the Court of Chancery announced a "fast-filer presumption" that derivative plaintiffs who file a complaint without making a books-and-records demand first are presumptively inadequate. Applying the presumption to the facts of the case, the court observed that "to give preclusive effect to the California Judgment would favor the lawyers who filed hastily, penalize the diligent counsel who used Section 220, and confer a case-dispositive advantage on the defendants at the potential expense of the corporation." To avoid that result, the court proceeded to the merits, found that demand was excused as futile, and denied the motion to dismiss.

Chancery’s Pyott decision provoked significant commentary. From a practical perspective, the defense bar fretted that the ruling invited derivative plaintiffs to relitigate the issue of demand futility in parallel suits in multiple jurisdictions, exacerbating the already acute problem of duplicative corporate litigation in different courts. And from a doctrinal perspective, observers questioned whether the issue of preclusion was properly evaluated under California law (as a matter of the constitutional requirement that each state accord full faith and credit to another’s judgments) or under Delaware law (in deference to the internal-affairs principle that corporate law matters are governed by the law of the state of incorporation).

DELAWARE HIGH COURT REVERSES

The Court of Chancery granted the defendants leave to seek an interlocutory appeal, and the Delaware Supreme Court agreed to hear the case. In a 12-page opinion issued on April 4, the Delaware Supreme Court reversed. The court held that once a court of another state has issued a final judgment, the effect of that judgment on a Delaware case "is governed by the principles of collateral estoppel, under the full faith and credit doctrine, and not by demand futility, under the internal affairs doctrine." The court held that the trial court erred by treating the issue as one of Delaware law, thus failing to recognize that concerns of "federalism, comity, and finality" required the "interest that Delaware has in governing the internal affairs of its corporations" to "yield to the stronger national interests that all state and federal courts have in respecting each other’s judgments."

The court explained that the relevant question was whether, under California law, the Delaware plaintiffs were in privity with their earlier-filing California counterparts. The outcome-determinative answer was yes. The court thus had no occasion to address the privity question under Delaware law, but noted that "numerous other jurisdictions have held that there is privity between derivative stockholders."

The court next considered the adequacy of the California plaintiffs’ representation. Under widely recognized limits to the preclusion doctrine, the dismissal of the California suit would not bar the Delaware suit, privity or no privity, if the plaintiffs in California had not adequately prosecuted their suit. On this issue, too, the Supreme Court reversed, holding that the trial court erred in creating "an irrebuttable presumption that derivative plaintiffs who file their complaints without seeking books and records…are inadequate." Although the Supreme Court noted that it "understands the trial court’s concerns about fast filers," and recognized that "[u]ndoubtedly there will be cases where a fast filing stockholder is also an inadequate representative," there was "no record support" for such a holding in this case. The court then went on to conclude that "remedies for the problems" fast filers create "should be directed at the lawyers, not the stock-holder plaintiffs." With no presumption to apply, the Supreme Court found no basis to find that the California plaintiffs were inadequate, especially given the substantial similarities between the California and Delaware complaints.

Pyott provides guidance on several important questions. The decision makes clear (contrary to the views of some practitioners) that there is no per se rule that a Delaware derivative plaintiff must investigate alleged wrongdoing before suing by inspecting corporate books and records. The adequacy of a plaintiff’s investigation will instead be judged case by case on the basis of the facts in the trial court record. And the decision likewise shows that, despite the occasional forum battles over corporate law cases between Delaware courts and those of other states, Delaware remains respectful of the authority of sister states’ courts to apply Delaware law.

Although the decision reduces the likelihood of duplicative derivative lawsuits in multiple forums, duplicative litigation arising from mergers and acquisitions proliferates unabated. Recent research shows that more than 95 percent of public company mergers draw shareholder litigation, and well more than half result in duplicative class lawsuits in multiple forums. Because these merger claims are nearly always brought directly as individual claims on behalf of stockholders, the derivative and demand futility analysis of Pyott — which applies only to derivative claims brought indirectly on behalf of corporations — is not likely to slow the torrent. Nevertheless, the decision demonstrates that the Delaware Supreme Court is sensitive to the unfairness that multiple parallel lawsuits can work on corporations, their directors and ultimately stockholders, and is prepared to enforce scrupulously rules of interstate comity that limit this mischief.