In Lambrecht v. O’Neal, No. 135, 2010, 3 A.3d 277 (Del. Aug. 27, 2010), the Delaware Supreme Court answered a certified question of law submitted by the United States District Court for the Southern District of New York (the “Southern District Court”). In this en banc opinion, the Delaware Supreme Court clarified the standing requirements for maintaining a “double derivative” suit under Delaware law.
The underlying actions began as standard derivative lawsuits, filed on behalf of Merrill Lynch & Co., Inc. (“Merrill Lynch”), to recover for purported breaches of fiduciary duties by Merrill Lynch officers and directors prior to Bank of America Corporation’s (“BofA”) acquisition of Merrill Lynch in a stock-for-stock merger (the “Merger”). Following the Merger, BofA and Merrill Lynch (collectively, the “Defendants”) moved to dismiss the two pending derivative actions on the ground that the plaintiffs, who were no longer stockholders of Merrill Lynch by virtue of the Merger, had lost their standing to assert derivative claims on behalf of Merrill Lynch. The Southern District Court granted the motions but dismissed the actions without prejudice, allowing the plaintiffs to replead their claims as “double derivative” actions (i.e., actions to enforce a claim of Merrill Lynch through BofA). The Defendants again moved to dismiss plaintiffs’ claims for lack of standing, arguing that in order to have standing to sue double derivatively, the plaintiffs had to be able to demonstrate that: (1) they were (and remain) stockholders of BofA both after the Merger and also at the time of the alleged fiduciary misconduct prior to the Merger; and (2) BofA itself was a stockholder of Merrill Lynch at the time of the alleged fiduciary misconduct prior to the Merger. Following oral argument, the Southern District Court certified the following question to the Delaware Supreme Court:
Whether plaintiffs in a double derivative action under Delaware law, who were pre-merger shareholders in the acquired company and who are current shareholders, by virtue of a stock-for-stock merger, in the post-merger parent company, must also demonstrate that, at the time of the alleged wrongdoing at the acquired company, (a) they owned stock in the acquiring company, and (b) the acquiring company owned stock in the acquired company.
The Delaware Supreme Court ultimately concluded that the certified question must be answered in the negative. In so ruling, the Supreme Court overruled the Court of Chancery’s decision in Saito v. McCall, 2004 WL 3029876 (Del. Ch. Dec. 20, 2004), to the extent it is inconsistent with the Supreme Court’s reasoning and conclusions set forth in its opinion.
At the outset of its analysis, the Court noted that a double derivative action generally falls into one of two distinct categories with “different standing (and pre-suit demand) issues.” In the first category are actions that are originally brought as double derivative actions on behalf of a parent corporation that has a wholly owned subsidiary at the time of the alleged misconduct at the subsidiary level. The second category includes actions, such as the underlying actions at issue here, originally brought derivatively on behalf of a stand-alone corporation that is subsequently acquired by another corporation in a stock-for-stock merger. Because the merger deprives the original derivative plaintiff of its shares in the acquired corporation and the pending derivative claim is transferred, as an asset of the acquired corporation, to the acquiring corporation as a matter of statutory law, the original derivative plaintiff can no longer satisfy the “continuous ownership” requirement and loses standing to maintain the derivative claim. As the Court noted, what differentiates the two categories is that in the second category, the merger operates, as a matter of law, “to divest the original shareholder plaintiff of standing to maintain the standard derivative action brought originally on behalf of the acquired corporation.”
In determining whether the procedural requirements proposed by the Defendants were mandated under Delaware law, the Court first examined Defendants’ conceptual argument, which was premised on “a model of a double derivative action as being two separate derivative lawsuits, stacked on top of the other.” According to the Defendants, a double derivative action should be “viewed as two lawsuits in one,” consisting of both a standard derivative action by the parent corporation (through a stockholder of the parent corporation), asserting a claim on the subsidiary’s behalf, and a second derivative action asserting the same claim derivatively on the parent corporation’s behalf as the new owner of the subsidiary. The Court noted that under the Defendants’ model, all the procedural requirements for bringing each derivative action would need to be satisfied.
The Court found that Defendants’ conceptual model of a double derivative action as two separate derivative lawsuits was flawed for several reasons. First, the additional procedural requirements under the Defendants’ model “would render double derivative lawsuits virtually impossible to bring,” in contradiction of Delaware precedent affirming the validity of such actions “in cases where standing to maintain a standard derivative action is extinguished as a result of an intervening merger.”
Second, the Defendants’ model would require that BofA owned Merrill Lynch stock at the time of the alleged fiduciary misconduct prior to the Merger, which erroneously presumes that to enforce Merrill Lynch’s pre-Merger claim, BofA must proceed derivatively. As discussed above, as a result of the Merger, Merrill Lynch’s pre-Merger claim transfers to and becomes the property of BofA as a matter of statutory law. Accordingly, “[a]s the sole owner of Merrill Lynch, BofA is not required to proceed derivatively; it may enforce that claim by the direct exercise of its 100 percent control.”
Third, the Defendants’ model would require that the original derivative plaintiffs owned BofA shares at the time of the alleged fiduciary misconduct, which misapplies the contemporaneous requirement contained in 8 Del. C. § 327. Because plaintiffs are enforcing BofA’s post-Merger right (as the new owner of Merrill Lynch) to prosecute Merrill Lynch’s pre-Merger claim and BofA is not required to have owned shares of Merrill Lynch at the time of the alleged fiduciary misconduct, plaintiffs are also not required to have owned BofA shares at that point in time. Thus, in this particular case, “it suffices that the plaintiffs own shares of BofA at the time they seek to proceed double derivatively on its behalf.”
Finally, the Court concluded that a “post-merger double derivative action is not a de facto continuation of the pre-merger derivative action” but instead “a new, distinct action in which standing to sue double derivatively rests on a different temporal and factual basis—namely, the failure of the BofA board, post-merger, to enforce the premerger claim of its wholly-owned subsidiary.”
The Supreme Court also rejected the Defendants’ argument that Saito v. McCall provides legal support for Defendants’ proposed procedural requirements, finding that insofar as Saito addresses the standing requirements for maintaining a double derivative action, it does not represent sound Delaware law. The Supreme Court held that to the extent Saito is inconsistent with the Court’s reasoning and conclusions set forth in its opinion, it is overruled.