Delaware Supreme Court Reverses Chancery and Gives Collateral Estoppel Effect to California Federal Court’s Dismissal of Derivative Claims

In its widely followed Allergan decision, the Delaware Court of Chancery declined to apply collateral estoppel to dismiss a Delaware derivative complaint even though a California federal court dismissed (with prejudice) essentially the same complaint brought by different stockholders. The Court of Chancery had reasoned that there was no privity between the derivative stockholders because, until a stockholder survives a motion to dismiss based on failure to make demand, the stockholder is not acting on behalf of the corporation. Moreover, the Court of Chancery found that the California plaintiffs were inadequate representatives because they filed suit before seeking corporate books and records. The Delaware Supreme Court granted interlocutory appeal and reversed. Pyott v. Louisiana Municipal Police Employees’ Retirement System, No. 380, 2012 (April 4, 2013).

The Delaware Supreme Court reasoned that the decision below “conflated collateral estoppel with demand futility,” and once a court of competent jurisdiction has issued a final judgment, a successive case is governed by the principles of collateral estoppel, under the full faith and credit doctrine, and not by demand futility law, under the internal affairs doctrine. The court wrote that “the undisputed interest that Delaware has in governing the internal affairs of its corporations must yield to the stronger national interests that all state and federal courts have in respecting each other’s judgments.”

The Delaware Supreme Court did not address the Court of Chancery’s privity analysis, saying instead that the Court of Chancery should have applied California, not Delaware, law to the question. However, the Delaware Supreme Court noted that “numerous other jurisdictions have held that there is privity between derivative stockholders,” and that the “Court of Chancery is divided on the privity issue as a matter of Delaware law.”

With respect to the adequacy of the California plaintiffs, the Delaware Supreme Court concluded that the Court of Chancery had applied an irrebuttable presumption of inadequate representation for “fast filers,” i.e., stockholder plaintiffs who file their complaints without first seeking corporate books and records pursuant to 8 Del. C. § 220. While the Delaware Supreme Court shared the lower court’s concern about “fast filers,” absent the application of the improper presumption, there was no basis to conclude the California plaintiffs were inadequate representatives. The court also noted that if the California plaintiffs were in fact inadequate representatives, then collateral estoppel would not bar the later derivative complaint.

A copy of the decision may be found here.