Court of Chancery Stays Tag-Along Litigation

Authored by Edward M. McNally
This article was originally published in the Delaware Business Court Insider | February 8, 2012

Litigation in multiple courts over the same basic claim continues to be a serious problem for corporate defendants. Indeed, some commentators argue the problem is getting worse. It is now almost certain that any merger or going-private transaction involving a publicly traded company will generate multiple suits. In fact, even the suits themselves now generate tag-along litigation.

There are several possible reasons for this phenomenon. Newer, more aggressive plaintiffs firms are said to be replacing the old guard in the plaintiffs bar. Trolling for clients is now commonplace, with plaintiffs firms posting Internet advertisements saying they are "investigating" any public transaction and asking to be contacted by stockholders. This has even occurred when a controlling owner just announces it is considering a transaction that will only occur much later, if at all. Suits follow, nonetheless, in apparent hope that a deal will actually occur.

One variation of this practice is particularly troubling. When almost any sort of securities class action or enforcement proceeding is filed, tag-along suits soon follow alleging derivative claims. The plaintiffs' theory is that if the company did something wrong, as the initial litigation alleges, then that wrong must be the fault of the officers and directors and they should pay for any damages their company incurs in the initial litigation.

These tag-along suits create a potential dilemma for defense counsel. If the securities litigation is settled, that will provide a basis to claim damages in the tag-along derivative litigation. Moreover, the potential for facing conflicting positions is all too real - do you defend the securities claim by denying wrongdoing while you argue in the derivative litigation that the board of directors is independent and capable of deciding whether to pursue such a claim on behalf of the corporation? Derivative plaintiffs will attack the defendants' credibility, while the same witness will be defended in the securities litigation.

Recently, the Delaware Court of Chancery decided that such dual litigation should not be permitted. It entered a stay in the tag-along derivative suit until the securities class action was concluded in the court's Jan. 27 ruling in Brenner v. Albrecht. While that will not stop tag-along litigation, at least a "Brenner stay" will help to bring order to a potentially chaotic situation.

Brenner involved several class action securities law claims that alleged SunPower had falsely stated its earnings due to fraudulent accounting reports by its employees in the Philippines. The several federal complaints alleged that SunPower's top officials were aware of those fraudulent reports. While the federal class actions were pending, plaintiff Martin J. Brenner filed a derivative suit in Delaware claiming the SunPower directors had failed to protect it from wrongdoing that they knew or should have known about and were therefore responsible for any damages asserted against SunPower in the federal class actions. The court then stayed the derivative suit until the federal cases were concluded.

The Brenner decision does not mean that every tag-along suit will be stayed, however. The court was careful to note that a stay should issue only when the initial securities litigation involves claims that substantially overlap with the claims in the tag-along litigation. This substantial overlap test involves a detailed analysis of the nature of the claims in the first-filed class action litigation compared to the claims in the later-filed tag-along case. When the "same facts or circumstances" are central to both cases, there is clearly overlap between them. Next, the court reviewed if that overlap might require SunPower to consider taking different positions in each case, one denying the directors' knowledge while in the other litigation cross-claiming against those same directors. The court decided that potential challenge to consistency made the two actions substantially overlap.

Moreover, the decision on whether to grant a stay may be dependent on whether the outcome of the derivative suit is dependent on the prior outcome of the initially filed litigation. Brenner claimed that some of the damages he sought for already advanced defense costs did not depend on the final outcome of the securities class action. Holding that those current damages did not "even in large measure" represent all that Brenner claimed, the court rejected his argument.

Finally, any potential prejudice to the derivative plaintiff needs to be considered as well. For example, if the discovery generated in the first-filed litigation will be available for use later in the derivative litigation, a plaintiff suffers less prejudice by delaying discovery when a stay is ordered. Indeed, a few years ago, in Beiser v. PMC-Sierra Inc., the Court of Chancery dismissed a books and records complaint that sought discovery to use in prior federal securities litigation. The court held that was an improper attempt to get around the discovery stay imposed by the Private Securities Litigation Reform Act of 1995. While both state and federal decisions have permitted books and records actions to proceed despite the PSLRA, they have limited the use of records, then produced and limited who may file such actions. Hence, there is no automatic right to discovery in Delaware litigation filed after a federal securities case is commenced.

Brenner is another example of how the Delaware courts are dealing with multiple litigation of the same basic dispute. The courts will continue to develop methods to control that type of litigation.

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