It is often said that corporate fiduciary duties are a U.S. specialty. It would be more accurate to say that shareholder litigation is the U.S. specialty. Fiduciary duties or something resembling them exist in all corporate laws that I know of. Most jurisdictions, however, severely limit shareholder litigation that could enforce these duties, relying instead on prohibitions, shareholder approval requirements, or perhaps even criminal law enforcement. Not so the U.S., particularly Delaware.
Like most litigation, shareholder litigation presents an obvious dilemma. On the one hand, fiduciary duties are toothless without shareholder litigation to enforce them. That is why courts encourage it with generous fee awards(see Americas Mining below). On the other hand, litigation is extremely expensive, especially the corporate sort. In particular, defendants can incur substantial costs in discovery even if the case never goes to trial, let alone results in a verdict for the plaintiff. In fiduciary duty suits, the main cost is the disruption caused by depositions of directors and managers and, more generally, their distraction from ordinary business. Opportunistic plaintiffs may threaten such litigation costs to extract a meritless settlement.
In other words, Delaware’s reliance on fiduciary duties creates a conundrum: how to encourage meritorious suits while discouraging deleterious nuisance suits. Meritorious suits are necessary to enforce fiduciary duties and allow the courts to flesh out their content, whereas nuisance suits can be a costly drag on the system. Do the procedural peculiarities introduced in this section succeed in sorting the good shareholder litigation from the bad?
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|1||Show/Hide More||Aronson v. Lewis (Del. 1984)|
Having learned the substantive law of fiduciary duties, you are prepared to finally read Aronson itself. As you know by now, the case contains Delaware’s canonical statement of the business judgment rule. What Aronson is really about, however, is a procedural overlay to the business judgment rule (and other substantive fiduciary law): the so-called demand futility test.
The demand requirement is Delaware’s main procedural filter to address the danger of nuisance suits described above. The complaint must provide some initial reason for why a shareholder should be allowed to prosecute the suit instead of the board. In essence, courts will allow the case to proceed to discovery only if the derivative complaint alleges particularized facts that, if true, would create a reasonable doubt that a majority of the directors can impartially assess the expeditiousness of the suit. Directors can be partial either because they themselves are interested in the underlying transaction (not: the lawsuit!) or violated their fiduciary duties in dealing with it, or because they are beholden to others who are or did. In the case of a suit against the entire board for violation of their duties, this is simply a heightened pleading standard: In particular, it is not sufficient simply to name all directors as defendants; the complaint must allege particularized facts that suggest they may actually be liable. Courts address this question on a motion to dismiss. Even if they do not grant that motion, courts may dismiss the suit at any later time during discovery if a “special litigation committee” so recommends (see Zapata as reported by Aronson).
Reading Aronson is complicated by arcane and even misleading terminology. Some signposts may be helpful. Formally, the case arises under Delaware Chancery Rule 23.1(a), which states:
“The [derivative] complaint shall also allege with particularity the efforts, if any, made by the plaintiff to obtain the action the plaintiff desires from the directors [i.e., the plaintiff’s demand to the board to direct the corporation to sue] and the reasons for the plaintiff's failure to obtain the action or for not making the effort.” [emphasis added]
For this rule to make any sense, it must be read to require dismissal if the board rightfully rejected the plaintiff’s demand, or, if no demand was made, the plaintiff’s reasons for failing to make a demand were not legally compelling (why else insist that the reasons be stated?). In practice, serious derivative plaintiffs never make a formal demand — the directors will hardly agree to sue themselves, and the Delaware Supreme Court has ruled that making a demand waives the right to contest the independence of the board (such that challenging the demand refusal as “wrongful” is virtually impossible if the board does its homework and considers the demand with reasonable information – business judgment rule!). Hence the relevant question in Aronson and other cases is: when is demand “futile”? To answer that question, the Delaware courts have developed the test summarized in the preceding paragraph, and further explained in Aronson.
Both the demand requirement and the powers of the special litigation committee only apply to derivative suits; they do not apply to direct suits (which are usually filed as class actions). The test for distinguishing direct from derivative actions is “(1) who suffered the alleged harm (the corporation or the suing stock-holders, individually); and (2) who would receive the benefit of any recovery or other remedy (the corporation or the stock-holders, individually)?” Tooley v. Donaldson, Lufkin & Jenrette, 845 A. 2d 1031, at 1033 (Del. 2004). In practice, this means that shareholders can sue directly over mergers and other transactions that affect their status as shareholders, but not over transactions such as executive compensation that affect shareholders merely financially. For example, of the shareholder suit cases you have read so far, Weinberger and Van Gorkom were direct (class) actions, while Sinclair, Disney, and Stone were derivative actions.
1. Does it make sense to treat direct and derivative actions differently, erecting special procedural hurdles only for the latter?
2. The Aronson court ultimately rules that “demand was not futile” in this case, i.e., the shareholder-plaintiff was not entitled to prosecute this suit. What should the shareholder have done to achieve a different outcome, and was this feasible? In light of this, do you think Aronson's hurdle for derivative suits is appropriate, too high, or too low?
|3||Show/Hide More||Americas Mining Corp. v. Theriault (Del. 2012) (Attorney's fees)|
To generate a substantial amount of shareholder litigation, merely allowing shareholders suits, direct or derivative, is not sufficient. Somebody needs to have an incentive to bring the suit. If shareholder-plaintiffs only recovered their pro rata share of the recovery (indirectly in the case of a derivative suit), incentives to bring suit would be very low and, in light of substantial litigation costs, usually insufficient. Litigation would be hamstrung by the same collective action problem as proxy fights. Under the common fund doctrine, however, U.S. courts award a substantial part of the recovery to the plaintiff or, in the standard case, to the plaintiff lawyer. As Americas Mining shows, that award can be very substantial indeed.
The litigation incentives generated by such awards strike some as excessive. For a while, virtually every M&A deal attracted shareholder litigation, albeit mostly with much lower or no recovery. Corporations tried various tactics to limit the amount of litigation they face, prompting recent amendments of the DGCL (sections 102(f) and 115 – read!).
1. How does the court determine the right amount of the fee award? What criteria does it use, and what purposes does it aim to achieve? Are the criteria well calibrated to the purposes?
2. Who is opposing the fee award, and why?
3. Are the damage and fee awards sufficient to deter fiduciary duty violations similar to those at issue in this case?
Note: I excerpt here only the passages relevant to the attorney fee award. The case below was In re Southern Peru (Del. Ch. 2011).
|4||Show/Hide More||In re Trulia Inc. Stockholder Litigation (Del. Ch. 2016)|
Settlements of class and derivative actions require court approval under Del. Ch. Rules 23(e) and 23.1©, respectively. In Riverbed, Vice-Chancellor Glasscock explained the rationale for this requirement in the context of a class action:
“Settlements in class actions present a well-known agency problem: A plaintiff's attorney may favor a quick settlement where the additional effort required to fully develop valuable claims on behalf of the class may not generate an additional fee as lucrative to the plaintiff's attorney as accepting a quick and moderate fee, then pursuing other interests. The interest of the principal—the individual plaintiff/stockholder—is often so small that it serves as scant check on the perverse incentive described above, notwithstanding that the aggregate interest of the class in pursuing litigation may be great—the very problem that makes class litigation appropriate in the first instance.”
In re Riverbed Tech., Inc. S'holders Litig., 2015 WL 5458041, at *7 (Del. Ch. Sept. 17, 2015).
In particular, as class representatives, plaintiff attorneys have the power to forfeit claims on behalf of the entire class in a settlement. Plaintiff attorneys are thus in a position to “sell” shareholder claims—possibly below value but keeping the “price” (fees) for themselves:
“In combination, the incentives of the litigants may be inimical to the class: the individual plaintiff may have little actual stake in the outcome, her counsel may rationally believe a quick settlement and modest fee is in his best financial interest, and the defendants may be happy to “purchase,” at the bargain price of disclosures of marginal benefit to the class and payment of the plaintiffs' attorney fees, a broad release from liability."
Id., at *9.
In spite of these concerns, Delaware courts had developed a practice of approving settlements containing broad releases of shareholder claims in return for moderate corporate disclosures and six-figure attorney fees. Starting with Riverbed and culminating with Chancellor Bouchard’s authoritative opinion in Trulia, the Chancery Court announced a change in its practice.
Please consider the following questions when reading Chancellor Bouchard’s opinion:
1. Chancellor Bouchard’s “opinion further explains that … the Court will be increasingly vigilant in scrutinizing … settlements” (at 888). What precedential value does this language have, formally speaking? What precedential value do you think it has in practice?
2. Both Chancellor Bouchard and Vice-Chancellor Glasscock disapprove of settlements for disclosures “of marginal value.” Why are settlements for “plainly material” disclosures less suspicious? Do “plainly material” disclosures guarantee that the settlement is in the class’s best interest?
3. Both judges also disapprove of “broad releases from liability.” Can a broad release—including, e.g., antitrust claims—ever be justified?
4. Chancellor Bouchard is also concerned that (892) “defendants are incentivized to settle quickly in order to mitigate the considerable expense of litigation and the distraction it entails [and] to achieve closing certainty.” Is this problem specific to class and derivative actions? Is it a problem for the class members? Is it a problem for stockholders? Does blocking settlements solve this problem?
5. What settlements should be approved? What litigation should be encouraged, and, once encouraged, under which conditions should it be allowed to terminate?
December 07, 2017
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