Litigation: Defending the shareholder derivative action and avoiding multiple forums

Recent decisions suggest at least two mechanisms that can limit exposure to derivative litigation in multiple forums

Corporations of all sizes, public and private, are susceptible to shareholder derivative suits. These cases, ostensibly brought on behalf of the corporation, are frequently used by aggressive shareholder-plaintiffs and their counsel to challenge all manner of corporate action. Moreover, corporations often do business and are subject to jurisdiction in various states. As a result, a single corporate act may be challenged in various jurisdictions at the same time in multiple derivative actions filed by geographically dispersed shareholders. The result is that the corporation (which is, ironically, supposed to be the beneficiary of the derivative action) is saddled with the burden and costs of defending virtually identical cases in multiple far-flung venues. Fortunately, recent decisions from the Delaware courts suggest at least two mechanisms that corporations and their counsel can employ to limit the corporation’s exposure to derivative litigation in multiple forums, and to minimize the burden of those cases once commenced.

Exclusive forum selection bylaws

As an initial step, Delaware corporations can proactively define the forum in which they will be subject to shareholder derivative litigation by adopting bylaw provisions making Delaware the exclusive jurisdiction for disputes relating to internal corporate affairs. The boards of directors of Chevron and FedEx did just that. Thereafter, shareholders of each company initiated separate derivative challenges claiming that these bylaws were statutorily and contractually invalid on their face (the plaintiffs’ complaints were nearly identical and were filed within days of each other by the same law firm).

On June 25, 2013, in Boilermakers Local 154 Ret. v. Chevron Corp. and IClub Inv. P’ship v. FedEx Corp., the Chancery Court of Delaware issued a combined decision dismissing plaintiffs’ claims in both the Chevron and FedEx cases. The court’s decision was grounded in two key concepts. First, the Chancery Court held that forum selection clauses establish procedural rules by regulating the forum in which stockholders may bring suit and, thus, are statutorily valid under the Delaware General Corporation Law, which explicitly permits boards to adopt bylaws relating to internal corporate affairs and stockholders’ rights. Second, the court held that under well-settled U.S. Supreme Court and Delaware precedent these bylaws are valid and enforceable contractual forum selection clauses, even though they were enacted unilaterally by the corporation’s board without shareholder vote.

The Chancery Court pointed out that shareholders do have available other mechanisms for challenging the operation of exclusive jurisdiction bylaws, including by voting to repeal the bylaws or replacing the board. In addition, in specific instances (not present in the Chevron/FedEx cases) shareholders may argue that enforcing the forum selection clause would be unreasonable or in breach of the board’s fiduciary duties. Despite these caveats (and the Chevron plaintiff’s pending appeal to the Delaware Supreme Court), the court’s decision constitutes clear support for the legality of exclusive jurisdiction bylaws. Corporations and their boards should consider whether they would be well-served by such a provision as a means of better limiting their exposure to derivative claims.

Collateral estoppel: Win one, win them all

Once virtually identical derivative suits have been commenced in multiple venues, the corporation can limit its exposure by a seemingly obvious strategy: secure the dismissal of one of the cases as quickly as possible. By doing so, the corporation may be able to invoke principles of collateral estoppel against “copycat” suits in other jurisdictions, notwithstanding that those cases were brought by different shareholders.

The Delaware Supreme Court recently considered that strategy. On April 4, 2013, in Pyott v. Louisiana Mun. Police Emps.’ Ret. Sys., the high court, sitting en banc, held that the trial judge was required to dismiss a Delaware derivative action after a California federal court issued a final judgment dismissing essentially the same complaint brought by a different group of shareholders. That case arose out of parallel derivative cases brought by shareholders of Allergan, Inc. in Delaware Chancery Court and the United States District Court for the Central District of California. The defendants moved to dismiss both cases, arguing in both forums that the derivative plaintiffs had failed to make the requisite pre-suit demand, or adequately plead that such demand would be futile. The federal court in California ruled first and dismissed the California action with prejudice. Defendants then moved to dismiss the Delaware complaint on collateral estoppel grounds, arguing that the California final judgment barred the Delaware action. The Court of Chancery denied the motion to dismiss.

On appeal, the Delaware Supreme Court unanimously reversed. The court held that the Full Faith and Credit Clause of the United States Constitution required the Chancery Court to apply California’s collateral estoppel law, notwithstanding the Delaware court’s interest in adjudicating derivative claims involving Delaware corporations. Had it done so, the Supreme Court held, the California court’s dismissal on demand futility grounds — the exact issue being litigated in Delaware — would have necessarily barred the Delaware case. Notably, the court recognized that under the laws of numerous jurisdictions (including California and New York) shareholder plaintiffs in multiple forums are “in privity” with each other for purposes of claim preclusion. As such, a judgment against one shareholder in one forum could operate to preclude the same claim of a different, unrelated shareholder in a different forum. The court also noted that preclusion may be appropriate even if the first derivative plaintiff was a “fast filer” who brought suit without making a books-and-records demand or other pre-suit inquiry.

Corporations may never be able to eliminate derivative claims altogether. But by taking corporate governance steps to limit the corporation’s exposure, and then strategically litigating those cases that are brought, the corporation can minimize the cost, burden, and disruption stemming from the cases. Efficiency in derivative litigation will result in tangible cost savings for the corporation, savings which ultimately inure to the shareholders’ benefit.

Contributing Author

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Brett D. Jaffe

Brett D. Jaffe is a partner in Cohen & Gresser LLP’s Litigation and Arbitration practice group.

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Contributing Author

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Niraj J. Parekh

Niraj J. Parekh is an associate in Cohen & Gresser LLP’s Litigation and Arbitration practice group.

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