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South v. Baker: Court of Chancery Dismisses Caremark Claim with Prejudice to Named Plaintiffs Only

March 11, 2013

In South v. Baker, 2012 WL 4372538 (Del. Ch. Sept. 25, 2012), Vice Chancellor Laster of the Court of Chancery dismissed a derivative claim for breach of fiduciary duty based on the Caremark theory of liability, finding that because the plaintiffs failed adequately to represent the company, dismissal of their complaint would be with prejudice to the named plaintiffs only and would not preclude the litigation efforts of other stockholders.

Plaintiffs Steven and Linda South (“Plaintiffs”) sought to recover on behalf of Hecla Mining Company (“Hecla”) damages Hecla might suffer from pending federal securities actions filed in response to numerous incidents that occurred at Hecla’s mines, the citations Hecla received from the United States Mine Safety and Health Administration (“MSHA”) for such safety violations, and a January 2012 press release that lowered Hecla’s projections for silver production in light of losses anticipated to arise from compliance with an MSHA. Id. at *1, *6. The Court noted that in order to survive a motion to dismiss for failure to plead demand futility, Plaintiffs’ complaint—one of several purported derivative complaints asserting Caremark theories of liability arising from Hecla’s compliance issues and the related earnings adjustment—would have had to contain “facts sufficient to establish board involvement in conscious wrongdoing.” Id. at *1. Specifically, Plaintiffs needed to plead facts establishing a sufficient connection between the corporate trauma and a substantial threat of director liability. Id. at *9. However, the complaint was found to negate its own premise; i.e., the “very existence” of Hecla’s “Safety Committee,” comprised of the four most experienced members of Hecla’s seven-member, majority-independent board tasked with reviewing issues relating to health, safety and environmental policies, was “inconsistent with the complaint’s central premise of intentionally indolent directors.” Id. at *3, *12. The Court therefore dismissed the “cursory complaint” under Court of Chancery Rule 23.1 for failure to make a demand or adequately plead demand futility, and the dismissal was with prejudice with respect to the named plaintiffs. Id. at *1.

Having determined to dismiss the complaint, the Court evaluated the options available to courts confronted with such inadequate derivative complaints, as articulated by the Delaware Supreme Court in King v. VeriFone Holdings, Inc., 12 A.3d 1140, 1151-52 (Del. 2011). Id. at *13-14 (citing King at 1151-52 (offering three options: (1) “deny the plaintiff lead plaintiff status,” (2) “dismiss the derivative complaint with prejudice and without leave to amend as to the named plaintiff,” as contemplated by Rule 15(aaa), or (3) “grant leave to amend one time, conditioned on the plaintiff paying the defendants’ attorneys’ fees incurred on the initial motion to dismiss”)). The Court determined to dismiss the complaint with prejudice with respect to the named plaintiffs because Plaintiffs failed to engage in an adequate pre-suit investigation, including failing to seek an inspection of corporate records under 8 Del. C. § 220, and because such a result would not prejudice Hecla. Next, the Court concluded that Plaintiffs were inadequate representatives by applying “a presumption that when a stockholder hastily files a Caremark claim after the public announcement of a corporate trauma, in an effort to shift the still-developing losses to the corporation’s fiduciaries, but without first conducting a meaningful investigation, the plaintiff has not adequately represented the corporation.” Id. at *7, *17. Because Plaintiffs’ counsel confirmed the Court’s suspicions that a “plaintiff who hurries to file a Caremark claim after the announcement of a corporate trauma behaves contrary to the interests of the corporation but consistent with the desires of the filing law firm,” the Court determined that the circumstances “support an inference of disloyalty and a finding of inadequacy.” Id. at *17, *20. Therefore, the dismissal was with prejudice to the named plaintiffs, but would not prejudice other litigants. The Court noted that this result would “freshen[] the litigation environment so other plaintiffs whose lawyers . . . conducted a pre-suit investigation might feel that they could now lead the case.” Id. at *14 (citation omitted).