CLIENT ALERT: Delaware Supreme Court Affirms Dismissal of Stockholder Derivative Action On Collateral Estoppel Grounds
In this unanimous opinion, the Supreme Court of Delaware affirmed the Court of Chancery’s decision to dismiss a derivative action on the basis of collateral estoppel. In that lower court decision, the Court of Chancery held that derivative claims filed by Walmart stockholders in Delaware were precluded because a federal court in Arkansas had already dismissed a derivative complaint filed by different Walmart stockholders for failure to satisfy the demand requirement. In affirming the Court of Chancery, the Supreme Court also concluded that the application of collateral estoppel did not violate the federal Due Process rights of the Delaware plaintiffs.
The derivative actions in Arkansas and Delaware were filed following news reports suggesting that employees of a foreign subsidiary of Walmart had bribed government officials. The defendants, faced with parallel litigation, obtained a stay of the Arkansas action in favor of the Delaware action. After the stay order was vacated by the Eighth Circuit, the Arkansas defendants filed a motion to dismiss for failure to plead demand futility, which the court granted with prejudice. Shortly after that ruling, the Delaware plaintiffs, who had until then been pursuing books and records in an attempt to bolster their demand futility allegations, filed an amended complaint in the Court of Chancery. The Delaware defendants moved to dismiss on the grounds, among others, that the Delaware plaintiffs were collaterally estopped from arguing that demand was futile because that issue had been finally decided in Arkansas federal court. The Court of Chancery granted the motion to dismiss, finding that the preclusive effect of the Arkansas federal court’s dismissal was governed by Arkansas state law, subject to Constitutional standards of Due Process, and that all of the requisite elements for preclusion under Arkansas law, including privity and adequacy of representation, had been satisfied.
On appeal, the Supreme Court directed the Court of Chancery to reconsider the Due Process implications of giving preclusive effect to the dismissal by the Arkansas federal court. In answering the question posed by the Supreme Court, the Court of Chancery concluded that the Delaware plaintiffs’ Due Process rights were not violated under existing law, but nonetheless recommended that the Supreme Court adopt a rule that would not give preclusive effect in Delaware to prior dismissals based on demand futility. In so recommending, the Court of Chancery relied on the then-recent decision in In re EZCORP Inc. Consulting Agreement Derivative Litigation, 130 A.3d 934 (Del. Ch. 2016), which suggested in dicta that, as a matter of Delaware law and Due Process, a derivative plaintiff may not bind a later derivative plaintiff unless and until the first derivative plaintiff survives a motion to dismiss, or the board of directors has given the plaintiff authority to proceed by declining to oppose the suit.
The Supreme Court declined to adopt the Court of Chancery’s recommendation, however, and instead affirmed the Court of Chancery’s original decision to dismiss the Delaware action on the basis of collateral estoppel. The Supreme Court concluded that, under existing federal Due Process law, an exception to the general rule against nonparty preclusion was appropriate because the interests of the plaintiffs in Arkansas and Delaware were sufficiently aligned and the Arkansas plaintiffs were adequate representatives, despite their decision not to seek books and records.
This opinion is consistent with the Delaware Supreme Court’s prior decisions acknowledging that, although Delaware has an “undisputed interest” in governing the internal affairs of its corporations, on occasion that interest “must yield to the stronger national interests that all state and federal courts have in respecting each other’s judgments.” In addition, while this decision emphasizes Delaware courts’ repeated encouragement of stockholders to use the “tools at hand,” including books and records, to substantiate allegations in a derivative complaint, it also confirms that a stockholder’s failure to seek books and records will not necessarily render that stockholder an “inadequate” representative in stockholder litigation.
Lauren Kornsey, Senior Manager, Marketing and Business Development
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