Delaware Supreme Court Confirms Preclusive Effect Of Dismissal Of Derivative Actions Based On Lack Of Demand Futility

The Delaware Supreme Court held yesterday that the dismissal of a shareholder derivative action for lack of demand futility can preclude other derivative actions as long as the plaintiff in the dismissed case adequately represented the corporation's interests. The Court's January 25, 2018 decision in California State Teachers' Retirement System v. Alvarez - a suit brought on behalf of Wal-Mart Stores, Inc. - refused to adopt the Delaware Court of Chancery's recommendation that, as a matter of federal due process, a judgment in one derivative action should not bind the corporation or its stockholders in another derivative action unless either (i) the first action has survived a motion to dismiss because a pre-suit demand on the corporation's board of directors would have been futile or (ii) the board has given the plaintiff authority to proceed on the corporation's behalf by declining to oppose the derivative suit.

The Court's decision should enhance derivative defendants' ability to obtain dismissal of duplicative derivative actions on preclusion grounds where a similar case has been dismissed because of lack of demand futility. But, if it does not discourage the filing of duplicative suits, the ruling also might cause derivative plaintiffs to take steps to appear in multiple forums to try to avoid preclusion risks.

Background

Court of Chancery's Original Decision

The dueling derivative actions at issue here began in the wake of an alleged bribery scandal involving a Wal-Mart subsidiary. Lawsuits asserting claims for breach of fiduciary duty against Wal-Mart's directors and officers were filed in Arkansas federal court and in the Delaware Court of Chancery.

During an initial conference in Delaware, the court warned plaintiffs' counsel that their complaints likely would not survive a motion to dismiss, and it urged counsel to take the time to examine Wal-Mart's books and records pursuant to § 220 of the Delaware General Corporation Law. The Delaware plaintiffs did so and spent nearly three years litigating their demand for corporate books and records. The Arkansas plaintiffs, in contrast, chose to proceed solely on the basis of publicly available information, and they asserted claims under Delaware and federal law. The Arkansas court eventually dismissed the case based on the plaintiffs' failure to show that making a demand on Wal-Mart's board before suing would have been futile.

Defendants then argued in Delaware that the Arkansas decision collaterally estopped the Delaware plaintiffs from raising demand futility in response to defendants' motion to dismiss. Chancellor Bouchard applied Arkansas preclusion principles and agreed that the Delaware plaintiffs' derivative claims were barred. The Delaware plaintiffs appealed.

Delaware Supreme Court's First Decision

The Delaware Supreme Court did not disagree with the Court of Chancery's analysis of Arkansas preclusion law as to two key elements of collateral estoppel: "whether the issue to be precluded [i.e., demand futility] was actually litigated" and whether the parties potentially subject to preclusion had been adequately represented in the first proceeding. The Court expressed "some sympathy" for the Delaware plaintiffs' plight, because those plaintiffs had "heeded the Chancellor's advice" to take the time to demand corporate books and records, while "the [Arkansas] plaintiffs who did not heed those warnings suffered dismissal of their complaint with the ultimate effect of barring the action of the Delaware Plaintiffs, who spent nearly three years fighting the books and records battle." However, the Court chided the Delaware plaintiffs for not seeking to intervene or otherwise participate in the Arkansas litigation "once it became apparent that the stay of the Arkansas litigation...