Walmart is Winner in Derivative Suit Race to the Finish Line
On January 25, 2018, a full panel of the Delaware Supreme Court ruled that the dismissal of arguably underprepared derivative claims by stockholders in Arkansas arising from bribery allegations involving a Walmart unit barred a different group of stockholders from pursuing similar but more robustly supported claims in Delaware.
This decision should raise concerns for stockholders and their attorneys who spend the time to carefully prepare a well-supported derivative complaint as they may risk being precluded from pursuing an action because they were beat to court by a hurried complaint that is dismissed for lack of substance. The Court described this dichotomy as “troubling,” and suggested ways to address such concerns, such as moving to intervene, submitting a statement of interest or amicus curiae briefing, or seeking to stay the less-prepared lawsuit.
These prophylactic measures, however, are not likely to adequately address concerns that outcomes in competing, underprepared litigation will negatively affect stockholders who take the time and effort to better prepare their claims for suit.
The Path to the Delaware Supreme Court
A derivative lawsuit is one that is brought by stockholders on behalf of the company, and a key prerequisite to the bringing of such suit is that it would be futile to demand that the board commence the action (a standard referred to as demand futility). These types of suits are often brought in situations where stockholders are claiming that the board would not bring the suit because the claims involve board misconduct.
Several derivative lawsuits were filed against Walmart in Arkansas and Delaware following media reports of a bribery scandal involving the company’s Mexican unit. The Delaware litigants followed the judiciary’s oft-repeated suggestion to support a derivative complaint with information gathered through a request for the company’s books and records under section 220 of the Delaware General Corporation Law. The Arkansas litigation was initially stayed, recognizing in part the ongoing Delaware books and records acquisition efforts.
Disputes over production of the company’s books and records became contentious and dragged on for almost three years. As a result, the Arkansas court grew weary of the delay, and lifted its stay of the Arkansas litigation permitting such case to proceed. Efforts to reinstitute a modified stay running only until determination that the stockholders in the Delaware case had established a valid basis for pursuit of the litigation on the company’s behalf were rejected by the Arkansas court. The Arkansas court then granted a motion to dismiss the Arkansas litigation, finding that the complaint failed to set forth a sufficient factual basis to establish demand futility so as to support the bringing of a derivative suit on the company’s behalf.
This prompted the Chancery Court to dismiss the Delaware litigation, citing that the Arkansas dismissal precluded the same claims from being litigated in Delaware, even though pursued by different stockholders than the Arkansas litigation. Perhaps recognizing the potential inequity of binding a litigant who was taking steps to prepare a substantive complaint by the dismissal of more hastily pursued litigation, the Chancery Court included in its ruling a suggestion that the Delaware Supreme Court consider a rule whereby the dismissal of a derivative lawsuit does not have preclusive effect on competing litigation until after the demand futility stage (e.g., until the derivative plaintiff’s ability to pursue a claim on behalf of the company is established).
The Delaware Supreme Court’s View
The Supreme Court declined the Chancery Court’s invitation to set demand futility determination as a bright-line for the blocking of subsequent derivative litigation. Instead, the Supreme Court canvassed applicable law on concepts of privity, issue preclusion, and fundamental due process rights to conclude that the outcome of the Arkansas litigation doomed the Delaware litigation. The Supreme Court reminds us that stockholders in competing derivative litigation do not pursue individual claims, but rather pursue the company’s claims. As such, the Arkansas and Delaware stockholders were found to be in privity (i.e., adequate representatives of the others’ claims). The Supreme Court also found sufficient similarity between the issues raised in Arkansas and Delaware for the Arkansas decision to control their outcome.
The Supreme Court next addressed the due process considerations of precluding a stockholder’s right to pursue litigation based upon the outcome of litigation to which she was not a party. While ordinarily the historical notion of due process would allow the stockholder to pursue her own subsequent litigation, there is an exception where she was adequately represented by someone with similar interests in the prior litigation. The Supreme Court succinctly found that based upon its privity and issue preclusion analysis there was plainly a commonality of interest between the Arkansas and Delaware litigation. The due process evaluation thus turned on adequacy of representation, which the Supreme Court described as a combination of: (a) alignment of interest between the parties, (b) an understanding by the party that she was representing the interests of the non-party, and (c) sometimes notice of the other litigation.
It was undeniable that the parties had full notice of the competing litigation and were aware that the outcome in Arkansas could impact the Delaware litigation. The Supreme Court therefore focused on the accusations that the Arkansas litigants were not aligned with the Delaware litigants because they failed to take actions to seek appropriate substantiation for their claims before filing suit and were acting for their own economic interest. Reiterating that good practice is to seek information through a books and records action to best substantiate a derivative complaint, the Supreme Court concluded that counsels’ decision in the Arkansas litigation to forego such efforts “might have been a tactical error,” but it did not rise to the level of a constitutional inadequacy “in this instance.”
The Supreme Court also pointed out that the constitutionality test turns on the economic interest of the parties, and not their counsel. The Arkansas and Delaware litigants shared an economic interest in pursuing claims on behalf of the company. Opportunity to pursue discovery regarding alleged conflicts of the Arkansas counsel was lost because it was not an issue properly presented on appeal.
Despite the unfortunate outcome for the Delaware litigants in this case, it remains prudent to properly evaluate the merits of, and substantiate where warranted, a derivative claim by first pursuing an action to review the company’s books and records. The Supreme Court qualified its assessment of counsel’s failure to pursue a pre-suit books and records analysis as adequate in this instance, suggesting that this is a fact-intensive inquiry where such failure could be deemed inadequate under other circumstances. While an imperfect solution, the Supreme Court’s suggested protective maneuvers (i.e., a stay, intervention, a statement of interest) should be considered when there is a risk of competing litigation affecting the outcome of a Delaware derivative claim. Lastly, record of any conflicts between litigants should be explored and preserved to contest the preclusive effect of competing litigation.