Pyott v. Louisiana Municipal Police Employees’ Retirement System: Delaware Supreme Court Gives Preclusive Effect to Dismissal of Derivative Suit by California Federal Court and Rejects “Fast Filer” Presumption

June 18, 2013

Publication| Corporate Transactions| Corporate & Chancery Litigation

In Pyott v. Louisiana Municipal Police Employees’ Retirement System, 2013 WL 1364695 (Del. Apr. 4, 2013), the Delaware Supreme Court reversed a decision in which the Court of Chancery declined to dismiss a derivative suit after a federal court in California dismissed a parallel derivative suit with prejudice. 

In 2010, pharmaceutical company Allergan, Inc. announced a $600 million settlement with the Department of Justice related to alleged off-label marketing of its drug, BOTOX. Following the announcement, several Allergan stockholders filed derivative suits in the Court of Chancery and the United States District Court for the Central District of California (the “District Court”). Allergan and its directors moved to dismiss both actions for failure to plead demand futility, and in January 2012, the District Court granted the defendants’ motion to dismiss with prejudice.

Subsequently, the defendants asserted in the Court of Chancery that the dismissal of the California suit mandated dismissal of the Delaware suit based on the doctrine of collateral estoppel. Denying the defendants’ motion to dismiss, the Court of Chancery declined to give preclusive effect to the District Court decision for two reasons. First, the Court determined that collateral estoppel applies only where parties are in privity, and, by virtue of the internal affairs doctrine, Delaware law governs whether stockholders who bring derivative suits in different jurisdictions are in privity. The Court concluded that the California plaintiffs were not in privity with the Delaware plaintiffs under Delaware law, reasoning that until a derivative plaintiff survives a motion to dismiss under Court of Chancery Rule 23.1, the plaintiff is asserting an “individual claim to obtain equitable authority to sue” and does not act on behalf of the corporation. Second, the Court determined that the California plaintiffs were not adequate representatives of Allergan because they filed suit shortly after the announcement of Allergan’s settlement with the Department of Justice and without reviewing Allergan’s books and records pursuant to 8 Del C. § 220. In reaching this conclusion, the Court applied a presumption pursuant to which a “fast-filing stockholder with a nominal stake, who sues derivatively after the public announcement of a corporate trauma . . . but without first conducting a meaningful investigation, has not provided adequate representation.” After determining that it was not bound by the District Court decision, the Court held that the Delaware plaintiffs had adequately pleaded demand futility.

The Delaware Supreme Court reversed the Court of Chancery’s decision on appeal. The Supreme Court noted that pursuant to the Full Faith and Credit Clause of the U.S. Constitution, “a state court is required to give a federal judgment the same force and effect as it would be given under the preclusion rules of the state in which the federal court is sitting.” Consequently, the Court of Chancery erred by applying Delaware law rather than California law to determine the preclusive effect of the District Court’s judgment. The Supreme Court held that the Court of Chancery should have dismissed the Delaware suit, as the District Court’s judgment satisfied the requirements of collateral estoppel under California law. The Supreme Court emphasized that “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.” Because the Court of Chancery should have applied California law in determining the preclusive effect of the District Court judgment, the Supreme Court declined to address the Court of Chancery’s analysis of privity in the context of derivative litigation under Delaware law.

The Supreme Court next addressed the Court of Chancery’s conclusion that the California plaintiffs were inadequate representatives. The Supreme Court rejected the Court of Chancery’s irrebutable presumption against plaintiffs who file derivative suits shortly after a corporate trauma without first demanding inspection of corporate books and records, finding “no record support” for such a presumption. Absent application of the “fast filer” presumption, the Supreme Court found no basis in the record on which to conclude that the California plaintiffs were inadequate representatives. The Supreme Court also noted that remedies for the problems created by fast-filing plaintiffs “should be directed at the lawyers, not the stockholder plaintiffs or their complaints.”

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