Delaware Supreme Court Decision Affirming Chancery Court’s Dismissal of Wal-Mart Derivative Suit Creates New Hurdle for Derivative Plaintiffs
On January 25, 2018, the Delaware Supreme Court affirmed the Court of Chancery’s prior dismissal of a shareholder derivative complaint filed on behalf of Wal-Mart Stores Inc. on collateral estoppel grounds. The allegations in the shareholder derivative action focused on an alleged bribery scheme and cover-up involving executives at Wal-Mart de Mexico (“WalMex”), Wal-Mart’s Mexican affiliate. After The New York Times reported on the alleged misconduct in April 2012, several shareholder derivative lawsuits were filed and consolidated in the United States District Court for the Western District of Arkansas (the “Arkansas Action”) and in the Delaware Court of Chancery (the “Delaware Action”), all of which primarily involved claims for breach of fiduciary duty against certain current and/or former directors and officers of Wal-Mart (“Defendants”) in connection with the board’s failure to maintain proper oversight over WalMex.
While the substantive and procedural history of the Arkansas Action and Delaware Action is lengthy and involves complex issues of law and fact that are not discussed in detail herein, the following is a brief synopsis of the relevant issues. Prior to filing their derivative complaint, the plaintiffs in the Delaware Action (the “Delaware Plaintiffs”) made a books and records demand on Wal-Mart’s board of directors pursuant to Section 220 of the Delaware General Corporation Law (“220 Demand”) – a step that the Delaware Courts frequently encourage plaintiffs to take prior to filing suit. Unlike the Delaware Plaintiffs, the plaintiffs in the Arkansas Action (the “Arkansas Plaintiffs”) did not make a 220 Demand prior to filing their derivative complaint. While the Delaware Plaintiffs were engaging in a contentious battle involving deficiencies in Wal-Mart’s first document production that lasted nearly three years, Defendants moved to dismiss the Arkansas Action for failure to plead demand futility under Federal Rule of Civil Procedure 23.1. Although they were concerned that the Arkansas Action may be dismissed for failing to adequately plead demand futility, the Delaware Plaintiffs failed to intervene in the Arkansas Action.
On March 31, 2015, the Arkansas court granted Defendants’ motion and dismissed the Arkansas Action with prejudice. Defendants’ subsequently moved to dismiss the Delaware Action on the ground that the decision in the Arkansas Action collaterally estopped the Delaware Plaintiffs from relitigating the issue of demand futility. In May 2016, the Court of Chancery, applying Arkansas law, granted Defendants’ motion to dismiss the Delaware Action based on issue preclusion and found that the dismissal of the Arkansas Action did not violate the Due Process rights of the Delaware Plaintiffs.
On appeal, the Delaware Supreme Court remanded the case back to the Court of Chancery on a limited basis and posed the following question to Chancellor Andre G. Bouchard:
In a situation where dismissal by the federal court in Arkansas of a stockholder plaintiff’s derivative action for failure to plead demand futility is held by the Delaware Court of Chancery to preclude subsequent stockholders from pursuing derivative litigation, have the subsequent stockholders’ Due Process rights been violated? See Smith v. Bayer Corp., 564 U.S. 299 (2011).
In a supplemental opinion, Chancellor Bouchard answered the question in the negative, stating that the subsequent stockholders’ Due Process rights have not been violated, “unless the representative plaintiff’s management of the first derivative action was ‘so grossly deficient as to be apparent to the opposing party’ or failed to satisfy one of the Restatement’s other criteria for determining adequacy of representation.” Chancellor Bouchard also recommended that the Supreme Court adopt a new rule that would prevent subsequently filed cases from being dismissed on issue preclusion grounds until after a suit has survived a motion to dismiss and discovery has been completed.
In the January 25, 2018 Opinion written by Justice Karen L. Valihura affirming the Court of Chancery’s dismissal of the Delaware Action, the Delaware Supreme Court found that the Arkansas Plaintiffs’ failure to make a 220 Demand prior to filing their complaint did not render them inadequate representatives. Further, the Delaware Supreme Court declined to adopt the rule suggested by the Court of Chancery, and stated:
[O]ur state’s interest in governing the internal affairs of Delaware corporations must yield to the “stronger national interests that all state and federal courts have in respecting each other’s judgments.” This delicate balance would be impaired were we to adopt the Chancellor’s suggestion to follow the EZCORP dicta as the rule for determining the preclusive effect of other courts’ dismissals based on demand futility.
The impact of the Delaware Supreme Court’s decision is yet to be seen on the future of derivative litigation. However, the decision adds one more hurdle to the already difficult challenges derivative plaintiffs face in filing and prosecuting these lawsuits.
A copy of the Delaware Supreme Court’s opinion and order can be found here.
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Faruqi & Faruqi focuses on complex civil litigation, including securities, antitrust, consumer and wage and hour class actions, as well as shareholder derivative suits. The firm is headquartered in New York, and maintains offices in California, Delaware, Pennsylvania and Georgia. Since its founding in 1995, Faruqi & Faruqi has served as lead or co-lead counsel in numerous high-profile cases which ultimately provided significant recoveries to investors, consumers, and employees.
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About Nina Varindani
Nina Varindani is a Partner in Faruqi & Faruqi, LLP’s New York office and focuses her practice on securities litigation and shareholder derivative litigation, representing investors in federal and state class action and derivative lawsuits, books and records demands and litigation demands. Please feel free to contact Nina regarding any questions concerning this blog post or any questions related to F&F’s practice areas.