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Our legal system is one of our society's crowning achievements. But for
all of its grandeur, our legal system is not without its flaws. Among other
things, our system encourages litigiousness that all too often involves
frivolous suits and lawyers'-fee driven litigation, including the recent
phenomenon of multi-jurisdiction derivative litigation driven by plaintiffs'
lawyers competing to get control of the dispute in order to try to capture the
Two separate opinions this past week - one out of the Seventh Circuit
and one from the Delaware Court of Chancery - harshly criticized these kinds of
practices. Both of the opinions were entered in shareholders' derivative
lawsuits, too. Though both of the cases are sharply critical of fee-driven
plaintiffs' lawyers' practices, only one of the cases resulted in the dismissal
of the suit. Interestingly, in the Delaware case, owing to the Court's disdain
for the practices of "fast-filing" plaintiffs' firms in parallel California
proceedings, the Delaware case will be going forward.
The Allergan Case in Delaware
In September 2010, Allergan pled guilty to a criminal misdemeanor for
misbranding its Botox product and paid a total of $600 million in civil and
criminal fines. Various plaintiffs' firms filed multiple derivative suits both
in federal court in California and in Delaware. The California cases went
forward more quickly, while in Delaware, at least one of the plaintiffs sought
to pursue a books and records action against the company, in order to obtain
further information pertinent to the company's board. The Delaware plaintiff
used the information and documentation to amend its complaint. The California
plaintiffs ultimately also obtained the same information and documentation and
supplemented their complaint as well.
The defendants moved to dismiss the California action on the ground that
the plaintiffs had not made a demand on the Allergan board to pursue the
claims, nor had they established demand futility. The California court granted
the defendants' motion to dismiss. The defendants then sought to have the
Delaware action dismissed, arguing that the collateral estoppel effect of the
California dismissal was preclusive of the demand futility issue.
In a massive and muscular June 11, 2012 opinion (here), Delaware Chancery
Court Vice Chancellor Travis Laster firmly
rejected the suggestion that the California court's prior ruling compelled him
to dismiss the Delaware action. He relied on two grounds in rejecting the
argument that the California judgment is preclusive; first, he found that the
California judgment was preclusive only as to the individual California
shareholder plaintiffs, and second, he found that the California plaintiff did
not adequately represent Allergan.
Both of these lines of analysis are interesting and so I discuss both
below, but it is the inadequate representation issue that is the main interest
to this blog post.
Vice Chancellor Laster first held that question of whether or not
pre-suit demand is futile is controlled by the internal affairs doctrine and
therefore governed by the law of the state of incorporation - in this case,
Delaware. It should not, he said, be governed by potentially different rules
across "twelve different circuits, fifty states and the District of Columbia,
Puerto Rico and the other territories."
He held further that under Delaware law a shareholder seeking to pursue
a derivative claim on behalf of a corporation represents only his own
individual interest until it is established that he has the right to pursue the
claim. Because the California plaintiff was found not to have the right to
pursue the claim, the California court's judgment is preclusive only the
California plaintiff alone, not on all other shareholders or the corporation
(that is, the California plaintiff is not in "privity" with the other
As an independent basis for rejecting the preclusive effect of the
California judgment, Laster held that the California plaintiffs did not
adequately represent Allergan. In concluding that the California plaintiff had
not provided adequate representation, Laster launched a lengthy disquisition of
the motivations and actions of the specialized plaintiffs' shareholder bar and
the specific actions taken on this case.
These specialized firms face a competitive environment where they often
can only control the case and capture the fee if they are the first-to-file.
The first-filed rule "incentivizes the plaintiffs' lawyers to file as fast as
possible in an effort to gain control of the litigation." These firms, facing
first-to-file pressure "rationally eschew conducting investigations and making
books and records demands, fearing that any delay would enable to gain control
of the litigation." As he put it, "No role, no result, no fee."
For the "fast-filing lawyers" their lawsuit "has the dynamic of a
lottery ticket," since in most cases their hastily prepared complaint will risk
dismissal. However "in the rare case, fate may bless the fast-filer with
something implicating the board," which will make the case likelier to survive
the motion to dismiss and improve the settlement value of the case
"A fast-filer" can "readily build a portfolio of cases in the hope
that one will hit." Filing a derivative claim "is relatively cheap" and search
costs are minimal. Indeed, derivative plaintiffs "often piggyback on the
efforts of other specialized plaintiffs' firms." The lawyer's "most difficult
task will be finding a suitable plaintiff.'
The "first-to-file" regime "disserves stockholder interests across
multiple dimensions." It prevents plaintiffs' lawyers from "acting optimally"
and "forces defendants to respond to multiple complaints in multiple
jurisdictions" but at the same time gives defendants litigation advantages,
because the hastily filed complaints are more likely to be dismissed. Noting
Delaware's courts' resistance to the first-to-file regime, Laster commented
that "a state that ritualistically favored defendants might embrace such a
regime, but Delaware has a long history of striving to balance the interests of
stockholders and managers to craft an efficient corporation."
Laster found that the California proceedings demonstrate all of the
shortcomings with the race-to the courthouse phenomenon:
By leaping to litigate without first conducting a meaningful
investigation, the California plaintiffs' firms failed to fulfill the fiduciary
duties they voluntarily assumed as derivative action plaintiffs. Rather than
seeking to benefit Allergan, they sought to benefit themselves by rushing to
gain control of a case that could be harvested for legal fees. In doing so, the
fast-filing plaintiffs failed to provide adequate representation.
Moreover, the California plaintiff's shortcomings were not later redeemed
when the California plaintiff belatedly asked for and received the fruits of
the Delaware plaintiff's books and records action. Laster concluded that
"rather than representing the best interests of the corporation, the California
plaintiffs sought to maximize the potential returns of the specialized law
firms who filed the suit on their behalf."
Having rejected the defendants' suggestion that the California court's
determination was preclusive on the issue of demand futility, Laster then went
on and rejected the basis on which the California court had determined that
demand was futile. He said that he found the California court's analysis
"unpersuasive." He concluded that the Delaware plaintiffs, pleading with the
benefit of the results of their books and records action, had established that
demand was excused as futile.
The Seventh Circuit's Decision in the Sears Case
Following the 2005 merger of Kmart and Sears, the merged company board
included two individual directors who also served on the boards of other
companies that competed with Sears. Two Sears shareholders filed a derivative
lawsuit alleging that the two directors' interlocking directorships violated
the Clayton Act. Sears moved to dismiss the suit on the grounds that the
plaintiffs had not made a pre-suit litigation demand on the Sears board.
Northern District of Illinois Judge Ronald Guzman denied the motion to dismiss.
Faced with the prospect for further litigation, Sears agreed to a settlement of
the case that consisted of agreements for one of the two directors to step down
and for the defendants not to object to the plaintiffs' attorneys' fee request
Sears shareholder Theodore Frank moved to intervene in the case in order
to object to the settlement. Judge Guzman denied Frank's request to intervene.
Frank appealed the denial of his request to intervene. In a June 13, 2012
opinion written by Chief Judge Frank Easterbrook for a three-judge panel of
the Seventh Circuit, the appellate court
ruled that Frank's motion to intervene had been improperly denied. That
determination would seem to represent all that the appellate court was called
upon to do. But the Court did not stop there; it went on to add a few choice
words about the case (and perhaps about the District Court as well).
The district court's reason for denying Frank's motion to intervene, the
Seventh Circuit said, is "unsound." The district court denied the motion
because the existing plaintiffs adequately represented Frank's interests. But
as the Seventh Circuit said, "that the plaintiffs say they have the other
investors' interests at hear does not make it so." The Seventh Circuit
emphasized that its case decisions encourage liberal allowance of intervention.
"We could," the Court said, "stop at this point and leave the parties to
slug it out In the district court." But, "this litigation is so feeble that it
is best to end it immediately." The only goal of this suit "appears to be fees
for the plaintiffs' lawyers." It is "impossible to see how the investors could
gain from it - and therefore impossible to see how Sears' directors could be
said to violate their fiduciary duty by declining to pursue it." The court went
on to note how unlikely it is that a consumer or regulator would pursue any
claim based on the interlocking directorates.
It is "an abuse of the legal system to cram unnecessary litigation down
the throats of firms whose directors serve on multiple boards, and then use the
high costs of antitrust suits to extort settlements (including undeserved
attorneys' fees) from the targets."
In short, the Court said, "the suit serves no goal other than to move
money from the corporate treasury to the attorney's coffers, while depriving
Sears of directors whom its investors have freely elected."
In both of these two decisions, the courts criticized derivative actions
motivated by plaintiffs' attorneys' desire to collect a legal fee but otherwise
to the detriment of the company involved. To the extent the views expressed in
these opinions represent an evolving judicial view of how some plaintiffs'
firms are conducting business, they could represent a troubling threat to the
business model of at least certain parts of the plaintiffs' bar.
But though there are similarities of perception and expression between
these two cases, there are some very important differences between the two
cases as well. For example, as a result of the Seventh Circuit's opinion,
the Sears case, which was to have continued to go forward in the district court
(owing to the fact that the proposed settlement had for unrelated reasons come
apart), will now not be going forward. By contrast, owing to Vice Chancellor
Laster's opinion, the Allergan case, which seemed like it was over as a result
of the California court's opinion, will now be going forward in Delaware.
The Seventh Circuit was concerned that the district court had allowed a
fee-driven frivolous suit to go forward (and it certainly does seem as if its
opinion in the Sears case is a very carefully aimed slap at the district
court); Vice Chancellor Laster seems concerned that as a result of inadequate
actions of fee-driven plaintiffs' lawyers proceeding in another jurisdiction, a
potentially meritorious case was being threatened with being shut down.
The key may be Laster's insight that the hastily prepared "first to
file" complaints actually benefit the defendants, as the cobbled
together complaints are easier to get dismissed - which is what happened in
California. Laster also seemed troubled that the Delaware plaintiffs, who were
in his court and who had proceeded deliberately, could have deprived of the
benefit of their labors owing to the hasty actions of the inadequately prepared
An important context for Vice Chancellor Laster's opinion is the ongoing
problem of multi-jurisdiction litigation and the jurisdictional competition
that has ensued. Laster seems to have just about had it with courts in other
jurisdictions presuming to interpret and apply Delaware corporate law and
making a mess of it. You can imaging him shaking his head in disgust as he
notes, first, the plaintiffs' lawyers rushing to file actions in other
jurisdiction's court and making a hash of it, and then the courts in those
other jurisdictions making a further mess of the situation.
It will not be lost on any plaintiffs' lawyers in the room that the
outcome of Laster's opinion is that a case that appeared dead will now be going
forward. It is as if to say to the plaintiffs' bar, go ahead, rush off to those
other courts and file your actions if you want, maybe the lottery ticket will
produce a winner. But take your time and prepare appropriately, and file your
suit in Delaware, and you will receive a full and fair hearing. Laster
expressly contrasts Delaware with a (supposedly hypothetical) state "that
ritualistically favored defendants." Delaware, he said, "has a long history of
striving to balance the interests of stockholders and managers to craft an
efficient corporation law." The message to the plaintiffs ' bar seems to
be that Delaware's courts are open for business - and its courts are not going
to be put off by competing litigants pushing ahead on other courts.
Maybe I am reading too much into Judge Laster's opinion. But it sure
seems like there are some things for defendants to worry about here. Not just
the fact that the case is going forward after being dismissed in California. It
is this case, taken in combination with other developments - such as the
massive plaintiffs' award in the Southern Peru case-that
seemingly would give corporate defendants cause for concern. The question for
defendants is what to make of these developments and what they might mean as
Delaware tries to protect its turf in the jurisdictional competition.
There is still the problem of the lack of recognition given to the
California court's ruling on the demand futility issue. As Alison Frankel said
in her June 12, 2002 article in her On The Case blog (here) discussing Laster's
ruling, Laster's collateral estoppel analysis could prove to be "very
controversial." The principles of judicial efficiency militate very heavily in
favor of a presumption that issues are decided only once. Anything that
seemingly gives litigants a second bite at the apple flies in the face of these
The prospects of multiple, competing demand futility determinations is
potentially troubling. Multi-jurisdiction litigation may be the result of the
actions of a competitive, fee driven plaintiffs' bar, but it is not going to go
away any time soon. It is already a serious problem. But if courts stop giving
effect to determinations made in other courts, the problems of
multi-jurisdiction litigation could get a whole lot worse.
All of that said, it is very encouraging to see courts actively worrying
about problems caused by frivolous and fee-driven litigation. If these opinions
do represent an evolving judicial perception about the motivations driving
certain kinds and categories of litigation, the environment for that type of
litigation has become decidedly more hostile. And as Justice Laster's opinion
shows, eliminating the abuses would be a good thing not just for defendants,
but also for plaintiffs that proceed responsibly.
Lexis.com subscribers can access the Lexis
enhanced version of the decision with summary, headnotes, and Shepard's, La.
Mun. Police Emples. Ret. Sys. & v. Pyott, 2012 Del. Ch. LEXIS 130 (Del. Ch.
June 11, 2012).
Read other items of interest from the world of directors & officers
liability, with occasional commentary, at the D&O Diary, a blog by Kevin LaCroix.
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