Delaware Supreme Court rebukes Chancery for litigation territorialism

April 5, 2013

There is little doubt that the judges on Delaware’s Chancery Court believe they are unrivalled in the business of overseeing corporate litigation. Their challenge in recent years has been to persuade plaintiffs’ lawyers – who, after all, decide where to file their cases – of Delaware’s primacy. Chancery’s waxing and waning share of the booming market in shareholder M&A and derivative suits is an issue that gets considerable attention at securities conferences, and Chancellor Leo Strine in particular has been so unabashed an advocate for his court that New York State Supreme Court Justice Shirley Kornreich recently complained to my Reuters colleague Tom Hals about Delaware’s proprietary attitude.

Chancery’s grabby ways reached their apex last year with Vice Chancellor’s Travis Laster’s controversial ruling in derivative litigation against the board of Allergan, which was sued in connection with the company’s off-label marketing of Botox. Competing plaintiffs’ firms brought cases in both Delaware Chancery and California federal court. Before Chancery ruled on Allergan’s motion to dismiss, the judge in California tossed the case in his court, finding that shareholders hadn’t established the futility of demanding action from the board before bringing their suit. The Allergan defendants argued before Laster that the Delaware case should also be tossed under the doctrine of collateral estoppel. The vice chancellor disagreed, finding that the Delaware plaintiffs and California plaintiffs weren’t equivalent under the internal affairs doctrine, and that the California shareholders weren’t adequate representatives because they didn’t conduct a presuit books-and-records investigation.

The ruling created considerable furor, with defendants complaining that Laster’s reasoning would give shareholders a chance to relitigate derivative claims in Delaware after they failed in other jurisdictions. In July, Laster said in an extraordinary transcript decision that he’d been misconstrued, but nevertheless granted the Allergan defendants – who are represented by Gibson, Dunn & Crutcher and Morris, Nichols, Arsht & Tunnell– leave to seek an interlocutory appeal.

On Thursday, the Delaware Supreme Court issued its decision. In a definitive 12-page opinion by JusticeCarolyn Berger, the state high court not only said that Laster was wrong in this particular case, but also cited the Full Faith and Credit Clause of the U.S. Constitution (and the related Full Faith and Credit Act) to signal that Chancery Court has got to give more deference to other state and federal courts. “In the Court of Chancery, (Allergan’s) motion to dismiss, based on collateral estoppel, was about federalism, comity and finality,” the opinion said. “It should have been addressed exclusively on that basis. Under this court’s precedents, 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.”

Delaware law, the justices said, requires the state’s courts to pay heed to rulings by out-of-state judges. Laster wrongly “conflated collateral estoppels with demand futility,” according to the opinion. “Once a court of competent jurisdiction has issued a final judgment … a successive case is governed by the principles of collateral estoppels, under the full faith and credit doctrine, and not by demand futility law, under the internal affairs doctrine.”

According to securities litigator Boris Feldman of Wilson Sonsini Goodrich & Rosati, the opinion indicates that the state justices are not happy about turf battles over corporate litigation. “The Delaware Supreme Court is less motivated to drive the cases to Delaware than Chancery Court,” he said. “It’s one thing for Chancellor Strine to talk about different lanes,” Feldman added, in a reference to Strine’s oft-cited quip that other courts “should stay in their own lane” and not encroach on Delaware’s authority. “But when the Constitution replaced the Articles of Confederation,” Feldman said, “it’s not clear that Chancery’s ‘different lanes’ theory survived.”

Theodore Mirvis of Wachtell, Lipton, Rosen & Katz similarly read the Allergan ruling as confirmation that Delaware courts will ultimately play well with others. “It’s a reminder, with all the overheated rhetoric criticizing Delaware for supposedly trying to take the whole road in deal cases, that Delaware is quite respectful of the authority of other courts, and will gladly yield to their decisions where their interests are paramount,” he told me in an email. (Wachtell also wasted no time in putting out a client alert on the ruling, writing that “as the plague of duplicative, multijurisdictional corporate litigation continues to proliferate, (this decision) makes clear that Delaware is sensitive to the unfairness that multiple parallel lawsuits can work on corporations and their directors and is prepared to enforce scrupulously rules of interstate comity that limit this mischief.”)

The Supreme Court opinion also puts an end to Chancery’s recent insistence that shareholder lawyers seek corporate books and records before filing derivative complaints. Though the justices said they understand Chancery’s concern about so-called “fast filers” who rush to stake a claim without obtaining a factual foundation for their complaint, the Supreme Court held that Chancery cannot presume shareholders who sue right away are inadequate representatives. “We reject the ‘fast filer’ irrebuttable presumption of inadequacy,” the opinion said. “Undoubtedly there will be cases where a fast filing stockholder also is an inadequate representative. But there is no record support for the trial court’s premise that stockholders who file quickly, without bringing a … books and records action, are a priori acting on behalf of their law firms instead of the corporation.”

The Supreme Court ruling indicates that the problem of multiforum corporate litigation won’t be solved by Chancery Court intimidation of other judges. And while the ruling holds that defendants who’ve gotten resolution in one jurisdiction don’t have to worry about litigating the same case again in Delaware, it doesn’t directly address the bigger question about how to avert simultaneous litigation of parallel cases in different courts. One of these days, whether by corporate charter amendments or legislative action, that problem will find a solution. That day isn’t here yet.

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