District Court Dismissed Derivative Suits Under Delaware Law

New Jersey Building laborers Pension Fund v. Ball, D. Del. No. 11-1153-LPS-SRF (March 13, 2014) and Freedman v Mulva,  D.Del., No. 11-686-LPS-SRF (March12, 2014)

In these 2 decisions, the U.S. Magistrate shows a sound understanding of Delaware corporate law. She recommends the dismissal of these 2 derivative suits under Rule 23.1 because the complaints do not show the directors were disqualified from considering a demand they sue.  The directors' interest in a compensation plan that was only currently applicable to employees did not make them interested under Delaware law.

Court Of Chancery Explains Scienter Requirement In Insider Trading Claim

Silverberg v. Gold, C.A. 7646-VCP (December 31, 2013)

Under Delaware law, a so-called Brophy claim seeks to recover the profits made by trading on insider information. Showing that material insider information was available is not too hard.  What is harder is showing the intent to use that information, the scienter requirement.  After all, an insider may trade for a variety of reasons, such as a favorable public announcement of good future prospects.  Here the Court explains, in the context of a motion to dismiss, how to interpret the circumstances surrounding insider trades to find that they were done with the intent to benefit from the insider information.  Among the key facts are the timing of the trades in reference to obtaining the information, the failure to disclose the insider information until after the trades are completed, and the size of the trades in comparison to any prior trading.

Supreme Court Explains Merger Effect On Derivative Claims

Arkansas Teacher Retirement System v. Countrywide Financial Corp, No. 14, 2013 (September 10, 2013)

When does a derivative suit survive a merger?  This decision says "not very often."   There seems to be two rules at play here. First, when the merger's sole purpose is to eliminate the standing of the derivative plaintiff, then the derivative suit may continue.  Second, the merger may be attacked when it is an "inseparable" part of a fraud alleged as part of a direct pre-merger suit.  Note the word "direct."  A direct claim is not a derivative claim, but instead alleges wrongs for which the plaintiff may recover for herself.  Hence, even if the merger is cast as part of some fraud inseparable from pre-merger acts, a derivative suit will not survive the merger just for that reason.

Court Of Chancery Again Explains Demand Excused Rules

In Re China Automotive Systems Inc. Derivative Litigation, C.A. 7145-VCN (August 30, 2013)

The rules for determining when demand on the directors is excused apply even to Chinese-based companies despite their bad press.  This decision in a direct and clear way spells out when demand is not excused.  For example, merely being on the audit committee does not mean a director faces a serious risk of personal liability for auditing mistakes.  More "red flags" are required.

District Court Follows Carsanaro

Fares v. Lankau, No. 12-1381-SLR (August 15, 2013)

This federal decision follows the recent Chancery explanation of the Gentile doctrine that permits a direct claim for equity dilution.  In short, the dilution can be by paying too little cash for the additional shares and the so-called "controlling" stockholder requirement for the buyer can be satisfied by a group of buyers operating though their elected directors that are a majority of the board.

District Court Upholds Option Complaint

Halpert v Zhang, C.A. 12-1339-SLR (August 1, 2013)

This federal decision illustrates when a complaint does state a proper derivative claim because it alleges that a majority of the Board violated a clear restriction on its right to award stock options. Such violations of an option plan are akin to violations of the law that are almost always beyond the business judgment of the directors to do.

Federal Court Upholds Option Timing Complaint

Ausikaritis v. Kiani, No. 12-1175-SLR (D. Del. July 16, 2013)

When stock options are awarded may be important to their actual value.  Get an option when the market price is in the toilet and you will do better when the market turns than with an option granted at the top of the market.  But is option grant timing itself actionable?  This decision says that it is and that a complaint that alleges such timing may withstand a motion to dismiss.

Court Of Chancery Upholds Caremark Complaint

In re China Agritech Inc. Shareholder Derivative Litigation, C.A. 7163-VCL (May 21, 2013)

One of the harder aspects of practicing Delaware corporate law is dealing with all the decisions. This is an excellent summary of current Delaware law on Rule 23.1, Caremark and a lot of other aspects of Delaware law that are implicated by derivative complaints.  It is also yet another example of a Chinese-based entity whose controllers seem to have no concern about compliance with our law.

Court Of Chancery Explains When Board Must Respond To Demand

Rich v. Chong, C.A. 7616-VCG  (April 25, 2013)

The rules governing when a demand on a board to file suit is excused are well known.  Less well known is what happens when a demand is made and nothing happens.  This decision explains that the failure to even respond is itself evidence that the board cannot be trusted to fairly evaluate the need to sue.  While each such case turns on its own facts, this decision is an excellent summary of Delaware law on when a Caremark claim is well pled to excuse demand.

Supreme Court Reverses Important Decision Giving Delaware Primacy

Pyott v. Louisiana Municipal Police Employees' Retirement System, No. 380, 2012 (April 4, 2013)

In a major decision, the Delaware Supreme Court dismissed a derivative suit on the basis that a prior dismissal of essentially the same suit by a different stockholder barred the Delaware litigation.  This reverses the Court of Chancery that held the suit might proceed despite the dismissal of the other litigation by a Federal Court in California.

Pyott may have major implications for derivative litigation, at least when multi-state cases are filed. Defendants may be expected to race to file motions to dismiss in what they see as the most favorable jurisdiction or in those cases where they see less formidable opponents.

It is also noteworthy that the Supreme Court rejected any presumption that a "fast filer" is an inadequate plaintiff.

Court Of Chancery Explains The Gentile Case

Carsanaro v. Bloodhound Technologies, Inc., C.A. 7301-VCL (March 15, 2013)

This is a major decision.  For some time lawyers have struggled to understand when a claim is derivative or direct. The distinction is important if for no other reason than derivative claims may be mooted by a merger that eliminates the plaintiff as a stockholder with standing to sue.  Under the Delaware Supreme Court's Gentile decision, some claims alleging a wrongful stockholder dilution may be direct, derivative or both.  Which ones qualify?  This decision answers that question with a thoughtful analysis that is useful in dealing with other factual patterns besides the controlling stockholder that was involved in Gentile.

This decision is also important for its holding that when a stockholder consents to any corporate action by a written consent form that refers to other documents that define the transaction consented to, the other documents must be given to the consenting stockholder for her consent to be effective.

Court Of Chancery Explains The Gentile Doctrine

In re Nine Systems Corporation Shareholders Litigation, C.A. 3940-VCN (February 28, 2013)

When is a claim that stockholders were wrongly diluted by the issuance of stock a derivative claim and not a direct claim?  Under the Gentile rule, such a claim is derivative unless the dilution was done to benefit a controlling stockholder of a control group.  Determining when several stockholders constitute a "group" for this purpose is not easy.  Just acting together is not enough. This decision explains what else is required, such as acting to carry out a preconceived goal.

Court Of Chancery Applies McWane Doctrine

In re Diamond Foods Inc. Derivative Litigation, C.A. 7657-CS (February 28, 2013)

Under the McWane doctrine, a Delaware court will dismiss  a case if another proceeding filed elsewhere is more advanced and will provide complete relief for any valid claim.  As this decision illustrates, while Delaware does not too often apply McWane, it will do so when it is the plaintiff in the Delaware litigation who has chosen to first seek relief in another state's court. The lesson is to not treat the Delaware court as your second choice.

Court Of Chancery Requires Effective Pre-Suit Investigation

South v. Baker, C.A. 7294-VCL (September 25, 2012)

Many lawyers believe that it may be okay to file suit and do an investigation of the facts later through discovery. Not so in some derivative litigation. This decision explains what pre-suit investigation is required to sustain a derivative suit alleging a Caremark claim.  It is required reading for its detailed review of the current law.

Briefly, at least when a Caremark claim is asserted, it is almost mandatory that a Section 220 action to inspect the corporation's records be done before filing suit.  Absent that inspection, a plaintiff better have a very good factual basis to allege that the directors violated their duty to oversee their company's compliance with the law.

Court Of Chancery Upholds Compensation Claim In Derivative Suit

Seinfeld v. Slager, C.A. 6462-VCG (June 29, 2012)

Derivative suits alleging excess compensation are hard to plead.  To avoid dismissal, the plaintiffs must show the directors were interested in the compensation awarded and their customary director fees do not count.  Indeed, even bonus awards to themselves are not enough when the bonuses are approved by a stockholder vote.  But this decisions shows why there is an exception to this general rule.

Here the bonus plan did not contain any limit on the board's discretion, except for a cap on the total awarded.  Finding that this made the awards free from any real stockholder control, the Court held the complaint stated a valid derivative claim.  The lesson then is to put some guidance on the awards into the plan when it is submitted for the stockholders' approval.

Court Of Chancery Rejects Compensation Claim

Zucker v. Andreessen, C.A. 6014-VCP (June 21, 2012)

This is a run -of -the mill dismissal of a derivative suit for failure to justify the lack of demand on the board, but with a twist.  For the decision highlights just how hard it is to show that a board is liable for paying an executive too much.  Hence, curbs on compensation are left to the stockholders' vote to control.

Court Of Chancery Upholds Derivative Claim Despite Prior Dismissal

Louisiana Municipal Police Employees' Retirement System v. Pyott, C.A. 5795-VCL  (June 11, 2012)

This is one of the most important decisions on derivative litigation in many years. There are 3 key holdings, at least one of which may reverse prior law.  First, the Court held that a derivative suit dismissed for failure to plead sufficient grounds to proceed under the demand rules may be refiled by a different plaintiff who has a better complaint.  This may modify prior law  that had held that once dismissed with prejudice, the suit could not be revived by a better complaint from a new plaintiff.

Second, this decision effectively kills off the old first-filed rule that held that the plaintiff who files the first complaint will control the litigation even if other complaints are filed later by different plaintiffs.  From now on, the better plaintiff will be the lead plaintiff.

Third, the decision again stresses the value of inspecting a company's records before filing a derivative suit.  Indeed, the failure to do so may cause the Court to view the complaint as presumptively meritless, at least with respect to whether the demand rules have been meet.

The opinion is worth reading for many other reasons as well.  Its discussion of the Caremark case alone is a good reason to study the decision.

Court Of Chancery Crafts Settlement Options

Forsythe v. ESC Fund Management Co. (U.S.) Inc., C.A. 1091-VCL (May 9, 2012)

When the Court tasked with reviewing a settlement proposal in a derivative action is faced with apparently well-intentioned objectors who want to go to trial and not settle, deciding what to do is not easy.  This decision comes up with an ingenious solution - let the objectors "buy the settlement."   This is accomplished by giving the objectors time to put up a bond to effectively guarantee the recovery of the settlement amount and then permit the objectors to take over the litigation and go to trial.

It will be interesting to see if the objectors take the Court up on its proposal.  After all, the recovery in any derivative suit goes first to the entity involved.  Any one who funds such litigation needs to be aware of the risk that sharing in the recovery is its only reward.

Court Of Chancery Applies Corporate Law To Statutory Trust Case

Protas v. Cavanagh, C.A. 6555-VCG (May 4, 2012)

This decision answers the question of what law will apply to decide if a beneficiary of a Delaware statutory trust may bring a derivative suit.  The court held that the established law under the DGCL and Rule 23.1 applies.  Hence, the beneficiary must show that either the director defendants are conflicted or that there is a substantial basis to believe that they will be liable because their actions are so outlandish that they are not protected by the business judgment rule.

Court Of Chancery Resolves Who May Bring Derivative Claims After Dissolution

Matthew v. Laudamiel, C.A. 5957-VCN (February 21, 2012)

This decision resolves who may bring a derivative claim after an LLC has been dissolved.  The argument made by 1 of the parties was that after dissolution, any member may bring a derivative claim directly.  The Court rejected that argument and concluded that the claim still must be brought in the name of the LLC and that a petition might also be filed to have the entity restored to bring such a claim or for a trustee to be apponted to do so.

This decision also dealt with an important jurisdictional issue under the so-called conspiracy theory.  It holds that the alleged conspirator must be aware that the conspiracy involves an action in Delaware in furtherance of the conspiracy, before the conspiracy is completed and the harm done.

Court Of Chancery Explains What Is A Control Group

Dubroff v. Wren Holdings LLC, C.A. 3940-VCN (October 28, 2011)

What is a derivative claim is sometimes hard to decide but may be central to a plaintiff's right to bring suit.  Under the Supreme Court's Gentile decision, a claim that the controlling stockholder has improperly diluted the minority shareholders' stock may be filed as a direct claim on behalf of those stockholders and does not have to pass the tough rules governing the filing of derivative litigation.  Who then constiutes a "controlling stockholder?"  This decision holds that a group may be in "control" for the purposes of the Gentile rule and explains how to decide if that control group exists.

The decision also further explains what sort of dilution qualifies to invoke Gentile, when disclosures after action by stockholder consent must be complete and that a pending class action tolls the statue of limitations until the class certification process is complete.

 

Court Of Chancery Explains Domination Law

New Jersey Carpenters Pension Fund v. Infogroup, Inc., C.A. 5344-VCN (September 30, 2011)

To decide whether a derivative suit may proceed without first asking the Board of Directors to bring the suit, one test that is applied is whether the Board is "dominated or controlled" by an alleged wrongdoer.  For if the Board is so dominated, then it cannot be expected to independently decide if the suit should proceed.  Some cases under this rule are easy to decide, such as when there is a parent-child relationship involved.  [Those of us who have had teenagers might wonder why this is so.]

There are harder cases and this is one. Here the Court decided that the threats of a dominant stockholder and board member had so affected the rest of the Board that the other directors could not be expected to independently decide if the dominating board member should be sued. Hence, it permitted the suit to proceed without a demand on the rest of the Board.

The obvious lesson here is not to be a bully.

Supreme Court Affirms Creditors May Not Sue Derivatively In LLC

CML V LLC v. Bax,  C.A. 735, 2010 (September 2, 2011, corrected September 6, 2011)

This decision upholds the prior decision of the Court of Chancery that creditors of an insolvent LLC may not bring a derivative claim against its managers.  This follows because the Delaware LLC Act limits such claims to members.  This result is another example of the differences between LLCs and corporations.  For in the corporate context, a creditor may file a derivative claim when the entity is insolvent.

Unliquidated Derivative Claims Continue to Have Little Value

This article was original published in The Delaware Business Court Insider | 2011-07-06

On May 31, Vice Chancellor Leo E. Strine Jr. issued an opinion denying a motion for preliminary injunction to halt a merger between Massey Energy Company and an affiliate of Alpha Natural Resources Inc. One of the critical issues in the opinion was the value of the derivative claims Massey had against certain current and former directors and officers arising out of Massey's compliance with federal mining safety regulations.

Massey's attitude toward federal mining safety regulations arguably manifested itself in the Upper Big Branch mine disaster, which resulted in the loss of 29 lives. In his opinion, Strine found that the plaintiffs had probably stated a Caremark claim against the directors of Massey and criticized the board of Massey for failing to assess the value of the derivative claims but ultimately refused to enjoin the merger, concluding that the derivative claims did not have the value plaintiffs believed.

While this result has received some negative commentary, is it really a surprise? In fact, the court's analysis is consistent with prior analyses addressing the value of derivative claims in the context of a merger. The fact that the party here is more infamous than many others did not change the analysis under Delaware law.

The plaintiffs valued the derivative claims based on the "aggregate negative financial effect on Massey that the Upper Big Branch Disaster and its Fall-Out has caused." According to the plaintiffs' expert, these damages range from at least $900 million to $1.4 billion. The court, however, rejected this theory, in large part because the computation of the value of the derivative claims was far more complicated than the plaintiffs' theory.

First, even though the plaintiffs had stated a viable Caremark claim against the directors, because of the business judgment rule and the exculpatory provisions in Massey's certificate of incorporation, in order to obtain a monetary judgment against the directors, they would have to prove that the directors acted with scienter — a difficult standard to meet, particularly with independent directors.

Second, the court also found that even as to the autocratic former leader of Massey, Don Blankenship, who was arguably responsible for Massey's approach to mining safety, meeting this standard would be difficult. The court noted that there is a large gap between pushing the limits of federal regulations while accepting minimal loss of life and knowingly endangering the mine itself by putting its very operations at risk. Moreover, Blankenship was not directly in charge of any specific mine, and tying his policies directly to any disaster would be challenging.

Third, proving that the directors acted with scienter may entitle the corporation to a monetary judgment from the directors, but it would simultaneously expose the company to third-party civil liability and potential criminal liability, and potentially deprive the directors of the ability to rely on insurance coverage, all of which would harm the company.

Fourth, after the merger, Alpha will continue to have to address direct claims against Massey from its lost and injured miners, regulatory consequences of the company's mining safety approach, and other elements of the "Disaster Fall-Out." To the extent possible, Alpha will have every incentive to shift that liability to the former directors.

Fifth, it is impossible to determine the potential derivative liability of the directors until Massey's direct liability is determined. Indeed, it is not even in the interest of Massey's stockholders to press their claims of derivative liability now, before third-party civil and criminal adjudication, lest the plaintiffs expose the company to additional liability.

Sixth, the plaintiffs' expert put no value on the ability of the company or its stockholders to collect on a potential $1 billion judgment. The company's insurance policy, even assuming it is available to cover claims against the former directors, is only $95 million. While this is no small amount, it is, as the court put it, "not material in the context of an $8.5 billion merger."

While the vice chancellor was quick to note that the Massey board's approach to valuation of the derivative claims was less than ideal, because of the factors noted above, he found that the plaintiffs had not persuaded him that the merger was unfairly priced because of the failure to value separately the derivative claims. Was this conclusion so unprecedented, however, to justify criticism of the valuation?

Delaware courts previously have been asked to consider the value of unliquidated, contingent claims belonging to the company in the valuation context. These courts have never valued derivative claims at the full value of all potential damages, but instead have considered many of the factors Strine addressed in Massey.

For instance, in Onti Inc. v. Integra Bank Inc., petitioners in an appraisal action argued that their derivative claims should have been valued as an asset of the company in the appraisal proceeding. The stockholders' expert valued the claims at more than $19 million, while the company's expert valued the claims at negative $2.5 million. The court determined that the claims had no value. In reaching that conclusion, the court adopted the theory advanced by the company's expert, that all litigation factors should be considered, including the likelihood of success on the merits, the attorney fees necessary to obtain that result and any indemnification that the company would owe to its directors. Citing to prior precedent, the court noted that "there would be strong logic in including the net settlement value of such claims as an asset of the corporation for appraisal purposes."

Later that same year, the court took a similar approach in Bomarko Inc. v. International Telecharge Inc. The court valued the claim in that case by multiplying the probability of success by the likely amount of recovery while subtracting costs incurred to obtain that result.

More recently, in Arkansas Teacher Retirement System v. Caiafa, the Court of Chancery overruled an objection to a settlement that released claims that the board failed to ascribe any value to federal derivative claims in a merger. After noting that there is no case law supporting the proposition that the board was required to undertake a separate and discrete valuation of the derivative claims pending at the time of the challenged merger, the court reached the same result as Strine did in Massey, albeit with less analysis. That is, the court noted that the claims asserted in the federal action were difficult to win, and even those that had a higher probability of success could not have the $2 billion value the objectors claimed they did. On appeal, the Delaware Supreme Court affirmed the Court of Chancery's decision to overrule the objection for the reasons set forth in the Court of Chancery's opinion.

Given these precedents, is the result in Massey all that surprising? While some contingent claims have been given value, it is the exception, and not the rule, to assign material value to contingent derivative claims. Moreover, in the context of a merger worth billions of dollars, the likelihood is low that derivative claims have material value, particularly when reasonable defenses can be interposed.

But does this decision mean that boards can just eschew any analysis of the value of a derivative claim in the context of a merger? Probably not. The Court of Chancery certainly did not condone the practice, and had the court not been persuaded that the board otherwise acted properly, the failure to do so could have had more importance.

Further, because the exception to the derivative standing rule that entering into a merger for the purpose of extinguishing derivative claims remains viable, particularly in light of the Supreme Court's opinion in Caiafa, failure to value the claims could support the conclusion that a merger was negotiated simply to avoid liability. Finally, not all derivative claims are equal in this context. As Strine noted in Massey, if Massey had a liquidated claim against a former fiduciary reduced to a judgment but failed to get any value for this claim, he could see the substantial unfairness in failing to obtain value for that claim in a merger. Alternatively, if recovery on any derivative claim after a cash-out merger would inure solely to the benefit of the acquirer, then perhaps there would be value to the buyer in obtaining that claim.

Put simply, as with many issues of fiduciary law, the context of the situation is important. What is fairly clear, however, is that unliquidated contingent derivative claims are not ascribed much value, if any, in a merger context, unless a party can demonstrate a reasonable likelihood that the net value of the claim to the company is material.

Peter B. Ladig (pladig@morrisjames.com) is a partner at Morris James in Wilmington and a member of its corporate and fiduciary litigation group. He represents both stockholders and directors in corporate litigation. The majority of his practice is in the Delaware Court of Chancery, although he has extensive experience in the other state and federal courts in Delaware and has been involved in over 50 published decisions. The views expressed herein are his alone and do not necessarily reflect the firm or any of the firm's clients.
 

Court Of Chancery Resolves Demand Requirement For Statutory Trust

Hartsel v. The Vanguard Group Inc.,  C.A. 5394-VCP ( June 15, 2011)

Recently Delaware enacted a statute to authorize business trusts, such as used in the mutual fund industry, the Delaware Statutory Trust Act.  This decision establishes that the normal rules for derivative litigation apply in actions brought by trust interestholders.  For example, whether the action is direct or derivative and when demand is excused will be decided applying established Delaware law.

The decision also squarely establishes that the alleged mismanagement of investments by a mutual fund manager is a derivative claim.

Court Of Chancery Explains How To Value A Derivative Claim In Merger

In re Massey Energy Company Derivative and Class Action Litigation, C.A. 5430-VCS (May 31, 2011)

When a company that is subject to derivative litigation is sold in a merger, the value of the derivative claim may be significant.  After all, in most cases, that claim passes to the buyer who arguably should pay something for it.  Here the Court carefully evaluated a derivative claim that it found would survive a motion to dismiss and explains why, in the circumstances of this case, that claim and its possible value did not mean the merger consideration was inadequate.

The way the Court does the analysis here is an excellent example of the way to value such a claim in the merger context.

Court Of Chancery Establishes Law On Double Derivative Litigation

Hamilton Partners LP v.  Englard, C.A. 4476-VCL ( December 15, 2010)

This is an important decision dealing with the often confusing law on double derivative suits. Briefly, the decision holds:  (1) there is no need for there to be jurisdiction over a parent in a double derivative suit when there is jurisdiction over the Delaware subsidiary;  (2) demand futility is measured at the parent level and (3) there is a derivative claim for the breach of duties owed to the subsidiary.  This last point is worth closer examination as the board of a subsidiary may act at the direction of its parent without liability.   Here some very odd facts lead to this result.

Court Of Chancery Holds Creditors Lack Standing

CML V, LLC v. Bax, C.A. 5373-VCL (November 3, 2010)

Creditors of a Delaware corporation have standing to sue derivatively when the corporation is insolvent.  However, this decision holds that creditors of an LLC [and presumably an LLP] lack standing to sue derivatively.  The difference is that the LLC statute expressly says who has standing to bring a derivative suit and does not mention creditors.  In contrast, the corporate code only says when stockholders have standing and does not then actually define who else may have standing.

As the Court rightly points out, the solution to this problem is for creditors to have  any rights they want set out in the LLC agreement before they invest.  This again highlights the Delaware law that LLCs and LLPs are creatures of contract, not of judge-made fiduciary duties.  Buyer beware.

Supreme Court Clarifies Standing Rule In Double Derivative Actions

Lambrecht v. O'Neal,  Del Supr., C.A. 135, 2010 (August 27, 2010)

This decision sets out the standing requirement for a double derivative suit following a merger.  In a stock-for stock merger, stockholders of the acquired company lose their stock in that company in return for stock in the new parent company who, in turn, becomes the sole stockholder of the company acquired in the deal.  A derivative suit by the former stockholder of the acquired company is then a "double derivative" suit because it really is on behalf of the new parent company for damages done to its subsidiary.  May the stockholder bring such a suit considering he is no longer a stockholder of the subsidiary?

The Delaware Supreme Court says he may do so long as he continues to hold stock in the parent company.

Court Of Chancery Discusses Role Of Bankruptcy Appointee

Shandler v. DLJ Merchant Banking Inc., C.A. 4797-VCS (July 26, 2010)

This decision is interesting for its discussion of the role of an appointee of the bankruptcy court and the pursuit of post-bankruptcy derivative claims.

Supreme Court Hints How To Avoid Losing Standing After A Merger

Arkansas Teacher Retirement System v. Caiafa, C.A. 530, 2009 (May 21, 2010)

This is the odd case whose dicta may be more important than we now appreciate.  It has long been Delaware law that a plainitff loses standing to pursue a derivative case when he is ceases to be a stockholder after a merger. The exception is when the merger is done solely to deprive the stockholders of standing to sue.

Here the Court seems to be saying that when a merger is the only way out for a corporation that has been devastated by wrongful conduct, the former stockholders may have a claim for damages even after they cease to be stockholders.  If so, that is new law and this bears watching.

Court Of Chancery Upholds Derivative Suit By Preferred Stockholder

MCG Capital Corporation v. Maginn, C.A. 4521-CC (May 5, 2010)

This decision addresses the prevously unanswered question of whether preferred stockholders may bring a derivative suit.  They can.  While to some this may seem obvious, the answer was by no means all that certain.  In recent years the Delaware courts have consistently cut back on the rights of preferred stockholders and creditors to allege fiduciary duty claims. Now warrant holders and creditors may not sue derivatively [except when the entity is insolvent].  Hence, the right of preferred stockholders to do so was at least questionable.

This decision is also an excellent collection of the law on what claims preferred stockholders may bring, particularly on the limits to assert breach of fiduciary duty claims.

Court of Chancery Explains the "Parnex Exception"

In re NYMEX Shareholders Litigation, C.A. 3621-VCN (September 30, 2009).

When is a claim that the merger was unfair a derivative and not a direct claim? This is a perplexing question under Delaware law. Generally, a claim that the merger price is too low because management manipulated the process to drive down value is derivative, because the claim asserts it is the company that was hurt by the actions taken. When, however, the price was unfairly reduced by the actions of a corporate fiduciary, then the so-called "Parnex exception" may apply, and a direct stockholder class action may be brought.

This decision explains the Parnex Exception. In general, a direct claim may be brought when the alleged breach of fiduciary duty was intended to benefit a particular fiduciary at the expense of all the other stockholders. The breach of duty must be directly connected to the reduced price, however, and any large gap in time may be fatal to the direct claim.

Keep in mind that all claims challenging a merger are not derivative, and it is only because this was an entrenchment claim that the court held it was derivative. This points out the importance of picking your legal theory wisely. A mistake can cost you the case in this complicated area.

Rales Test Applied to Allegation of Board Inaction

In re Intel Corp. Derivative Litig., C.A. No. 08-93-JJF (D. Del. June 4, 2009)

This opinion discusses when a court will apply the Rales test rather than the Aronson test in deciding whether a derivative plaintiff has pled particularized facts establishing demand futility.  Here, the district court applied the Rales test requiring that allegations establish a reason to doubt that the board could have properly exercised its independent and disinterested business judgment in responding to a demand.  The complaint alleged that the directors made a decision not to act which was not made in good faith and was contrary to the best interests of the company.  Despite plaintiff’s contention that Aronson should apply, the district court noted that Delaware courts have found that they cannot address the business judgment of an action not taken and, therefore, should apply what is now known as the Rales test.

Court of Chancery Upholds In Pari Dilecto Defense

American International Group Inc. Consolidated Derivative Litigation, C.A. 769-VCS (June 17, 2009)

This is the latest decision in the continuing saga of the AIG litigation. In this case, the Court declined to permit a derivative stockholder of AIG to sue the co-conspirators of AIG in the various frauds alleged to have hurt AIG and its stockholders. The Court upheld the in pari dilecto defense that generally prohibits one wrongdoer from suing her fellow wrongdoers. This scholarly opinion covers all the reasons for upholding that defense and why the only exception it will  permit is for the corporation to sue its own directors who caused it to do wrong.

Court of Chancery Defines When a "Controlling Stockholder" Exists

Dubroff v. Wren Holdings LLC, C.A. 3940-VCN (May 22, 2009)

A claim that stockholders were wrongly diluted by the issuance of additional stock is generally consider a derivative claim that must meet tough pleading standards. However, when the dilution is caused by a controlling stockholder, the claim is also a direct claim that may be filed without meeting  the rules for derivative suits. This is a big advantage.

This decision holds that a group may be consider a "controlling stockholder" for purposes of determining when a direct claim may be filed. Note that acting in parallel or voting together on an issue is evidence of acting as a group but is not enough to meet the rule requiring the pleading of facts that show an agreement to act together as a group.

This decision is also important as the first time the Court has addressed what must be disclosed in the information statement that must be sent to stockholders after stockholder consent under Section 228 is executed.  Fair, if not full, disclosure is required, including whether corporate insiders benefited from the action taken by consent.

Court of Chancery Explains how To Infer Scienter

American International Group Consolidated Derivative Litigation, C.A. 769 (Del. Ch. Feb. 10, 2009)

 

The Court of Chancery is often faced with the difficult task of deciding when a complaint has enough factual allegations to survive a motion to dismiss, particularly when there is no self dealing by directors and the business judgment rule is raised as a defense. This detailed 102-page decision illustrates the thought process that the Court uses.

 

The basic question presented was whether the plaintiff, could at the pleading stage, state sufficient facts to show that the case should go forward. As is typical, the defendants argued that all the complaint really alleged is that they made some bad decisions or that others below them in the corporate entity were the parties at fault. The Court denied the motion to dismiss because there was enough in the complaint to warrant an inference that the defendants must have known of the corporate wrongdoing. The keys to this result were: (1) the defendants were in position to know of the wrongs that had been committed; (2) they had practiced tight control over the entity so that they generally were aware of all that was going on; and (3) the bad acts were massive in scale and unusual in nature so as to have been unlikely to have been done without the defendants' knowledge.

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Court of Chancery Explains "Validly In Litigation"

In re: Affiliated Computer Services, Inc. Shareholders Litigation, C.A. 2821-VCL (Del. Ch. Feb. 6, 2009)

 

Determining when a derivative complaint should be dismissed becomes complicated when the composition of the board of directors changes. What board do you look to to determine if a demand must be made on the board before suit may proceed? You start by looking at the board that existed at the time the complaint was filed. If demand on that board was excused, then the case was "validly in litigation" and may proceed even if the board composition later changes to include a majority of disinterested directors.

Court of Chancery Rejects Settlement

Off v. Ross, C.A. 3468-VCP (Del. Ch. Nov. 26, 2008)

The Court of Chancery rejected the proposed settlement of this derivative suit for two reasons. First, the transaction under attack in the litigation was completed after a modification favorable to stockholders before the settlement was presented for approval, the modification was considered by the board before suit was filed, and the transaction was not dependent on approval of the settlement. Thus, the Court concluded that there was no consideration for the settlement because the modification to the deal that plaintiff relied upon to justify the settlement would have happened anyway without the suit.  A benefit received by stockholders that is not caused by litigation is not valid consideration for the settlement of the litigation.

In addition, the Court was troubled by the effect of the release that was part of the settlement on related litigation in New York. Given that the stockholders received virtually nothing for the release, it was wrong to affect their rights in the litigation elsewhere that might benefit them.

 

Court of Chancery Permits Settlement of Suit with Suit To Be Filed Against Insurers

In re Electronics for Imaging Inc. S’holders Litig., C.A. 2797-VCL (Del. Ch. Sept. 4, 2008)

 

It is common for the settlement of a derivative suit to be funded by the D&O insurers. Here, however, in a twist to that common event, the Court upheld a settlement where the company is permitted to sue the D&O insurers, with counsel for the stockholder plaintiff as its attorneys, to force the insurers to fund.

 

Court of Chancery Dismisses Derivative Suit for Bad Conduct and Lack of Standing

Parfi Holding A.B. v. Mirror Image Internet Inc., C.A. 18507-VCS (Del. Ch. Sept. 4, 2008)

In this highly unusual case, the Court of Chancery dismissed the complaint because the plaintiff had not told the truth as to why it was not proceeding promptly and because the named plaintiff had lost standing by conveying away any economic interest in the stock it held in the company.

 

The standing decision sets new precedent. The Court held that when a plaintiff retains only technical title to stock and assigns all economic interest in that stock to a third party, that is effectively the sale of the stock. Of course, under established law, the sale of stock while a suit is pending violates the Delaware continuous ownership rule and warrants dismissal of a derivative suit.

 

Court of Chancery Permits Discovery for a Settlement Hearing

In re Countrywide Corp. S'holders Litig., C.A. 3464-VCN (Del. Ch. Sept. 3, 2008)

In this admittedly unusual case, the Court of Chancery has expanded the limited discovery available to an objector of a proposed settlement of a derivative case. The discovery includes the valuation of the derivative claims' value to the company. The Court also notes the potential privilege problems that may be involved.

Delaware Supreme Court Sets Pleading Rules

Wood v. Baum, Del Sup. C.A. 621, 2007 (Del. July 1, 2008)

The Delaware Supreme Court has clarified the pleading standard that must be met to excuse demand on a board in a derivative suit. When a non-exculpated claim is plead, such as fraudulent conduct, the plaintiff must state particularized facts to support her claim.

Court of Chancery Upholds Complaint Over Options

London v Tyrrell, C.A. 3321-CC (Del Ch. June 24, 2008)

One of the tests for whether a board of directors is interested in a transaction under attack in a derivative suit so as to excuse demand on them before suit is filed is if they have personally benefited from the transaction. This decision makes clear that in the case of the grant of a stock option, the directors who have received the option will always be deemed interested in the outcome of an attack on that grant, even without showing the amount of the option is material to their financial condition.

Court of Chancery Permits Special Committee Discovery

Young v. Klaassan, C.A. 2770-VCL (Del. Ch. April 25, 2008)

The use of a special committee of the board to avoid derivative suits over allegations of breach of duty is well recognized. What is less well known is how to use the work of such a committee. Here the defendants improperly argued that a derivative suit should be dismissed because of the conclusions of a special committee formed after the complaint was filed. That use of information not alleged in the complaint converted the motion to dismiss into a motion for summary judgment and thereby permitted discovery into the work of the special committee.

The opinion also notes the "unusual" nature of the special committee in this case. The committee did not issue a report, barely had its existence disclosed, and otherwise proceeded irregularly. One has to wonder why it was even formed if it was to act so poorly.

 

SLC Formed After Demand Excused is Not "Too Late"

In re infoUSA, Inc. Shareholders Litigation, Consol. C.A. No. 1956-CC (March 17, 2008).

A special litigation committee was formed by the board of infoUSA, Inc. at the end of December, after a motion to dismiss derivative litigation had been denied and after a finding had been made by the Court of Chancery that demand was excused.   The SLC moved to stay the ongoing derivative litigation in January, seeking a period of 150 days in which it could investigate the substance of the claims in the action.  The plaintiffs opposed such a stay, asserting that the SLC was formed "too late" and should not be allowed to derail the ongoing litigation.

The Court of Chancery rejected this position:  "The fact that I have already determined that demand is excused demonstrates why the board must act by means of a special committee; it does not in any way explain why it cannot act through an SLC."  Consequently, the requested stay was granted.  The Court also rejected as premature any challenge to the independence of the SLC, finding it serves the purposes of judicial economy to do so after the SLC issues its report.  The letter opinion can be viewed here.

Court of Chancery Explains Options Cases

Weiss v. Swanson, C.A. No. 2828-VCL (Del Ch. March 7, 2008)

In the latest of the Chancery decisions on complaints challenging the grant of options, the Court has explained what it takes to state a derivative complaint that excuses demand on the Board. Briefly, the Court here focused on what was disclosed to the stockholders when they were asked to approve option plans or elect directors who had received option grants. First, full disclosure is required, particularly of practices that are likely to lead to increasing the value of the options, such as the bullet-dodging alleged in this case.

Second, the fact that a majority of the board received the options also made them interested enough to excuse demand.

Court of Chancery Denies Standing For Lost Shares

Postorivo v. AG Paintball Holdings Inc., C.A. No. 2991-VCP (Del. Ch. February 29, 2008)

It has long been recognized that a stockholder may lose her standing to bring derivative litigation by losing her shares in a merger.  There is a recognized exception to this rule for mergers designed just to eliminate derivative litigation.

Here, the plaintiff  sold the assets of his company in return for cash and stock in the buyer. The stock was held in escrow and when a dispute arose, the buyer revoked the stock as compensation for its claims against the seller. When the seller brought a derivative suit, the court dismissed it as he no longer owned stock in the buyer. Thus, the court refused to make another exception to the rule that a derivative plaintiff must continue to be a stockholder through out the litigation.

 

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Additional Complaints Filed Against Yahoo! in Delaware

Yesterday, February 27, 2008, two new complaints were filed against Yahoo! in the Court of Chancery. The first is a class and derivative action, Plumbers and Pipefitters Local Union No. 630 Pension-Annuity Trust Fund v. Yahoo!, C.A. 3578, which you can access here. The second, Mercier v. Yahoo!, C.A. 3579, an additional class action to those previously filed, can be found here

The plaintiff in the second action, Vernon A. Mercier, was also the lead plaintiff in Mercier v. Inter-Tel (Delaware), Inc., 929 A.2d 786 (Del. Ch. 2007), which you can access here. In a decision in that action last August, Vice Chancellor Strine denied the plaintiff’s application for a preliminary injunction and found that directors fearing that stockholders are about to make an unwise decision that poses the threat that all stockholders will irrevocably lose a unique opportunity to receive a premium for their shares have a compelling justification for a short postponement in the merger voting process to allow more time for deliberation.  The decision is worth reviewing for its interesting discussion of the interplay between the Blasius and Unocal doctrines.    

Court of Chancery Explains Requirements For SLC Report

Sutherland v. Sutherland, C.A. No. 2399-VCL (February 14, 2008).

This is another decision that explains what must be done to have the report of a special litigation committee ("SLC") respected by the court. To begin with, the use of a single board member for the SLC "pressed the theory of Zapata to the extreme". Thus, one-member SLCs are generally not a good idea.

In addition, the report of an SLC needs to include sufficient detail to support its conclusions. It is better practice to include documentation of the report's conclusions, such as the documents it relied on, the interviews it conducted and the advice it received. This is controversial for a good reason. If the court refuses to dismiss the derivative litigation despite the SLC recommendation, then the report may serve as a roadmap for the plaintiff going forward.  Thus, the decision on whether to use a SLC should be considered carefully. There are still excellent reasons for using a SLC, but it must be done correctly.

District Court Applies Delaware Statute of Limitations Carve Out For Fiduciary Claims, Denies Summary Judgment

Norman v. Elkin, 2007 WL 2822798 (D.Del. Sept. 26, 2007)

In this action the District Court evaluated the application of the statute of limitations to claims that a corporate fiduciary engaged in self-dealing at the corporation’s expense. Plaintiff was a 25% shareholder in a closely-held Delaware corporation with Pennsylvania headquarters, formed to participate in the wireless communications industry. Defendant #1 owned the remaining shares of the corporation, and also served as its President and sole director. Plaintiff alleged that Defendant #1 breached his duties to the corporation when he personally obtained newly-issued communications licenses from the FCC, then sold them along with the corporation’s pre-existing licenses to a third party, keeping the proceeds of the sale himself. Plaintiff further alleged that Defendant #1 took the action without notifying Plaintiff in his capacity as a shareholder, without holding an annual meeting, and without making any disclosure of the sale. Plaintiff sued Defendant #1, along with his wholly owned corporation and another corporate officer, in the Delaware Court of Chancery for breach of contract, unjust enrichment, declaratory relief, and breach of various fiduciary duties. Defendants removed the action to District Court based on diverse citizenship and moved for summary judgment, arguing that all claims were time-barred.

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Court of Chancery Permits Option Backdating Case To Proceed

Conrad v. Blank, C.A. No. 2611-VCL (September 7, 2007).

In the latest of the Delaware option cases, the Court of Chancery permits the action to go forward when it appears that the Board considered the option backdating and did nothing about it. It is noteworthy from its decision that this apparent indifference to a wrong served to distinguish this case from others where the backdating appeared to be a simple mistake.  In the case of a simple mistake, the error would not be enough to expose the board to liability and that would excuse demand before the derivative suit was filed.

The Court also declined to apply the "continuing wrong" theory. Under that theory, a plaintiff who acquires her stock during the series of wrongful acts has the right to challenge all the actions including even those that occurred before she acquired her stock. Instead, here the court held that each backdated option was a separate wrong and the plaintiff could only sue for those that had occurred  after she bought her stock.

Court of Chancery Limits Dilution Claims

Feldman v. Cutaia, C.A. No. 1656-VCL (August 1, 2007), affrimed, Del Supr. (May 30, 2008).

Classifying a claim as derivative has big consequences. Among those is that the claim is then subject to the continuous ownership rule that requires the plaintiff to hold his shares throughout the litigation to maintain his standing. A merger that eliminates the plaintiff's ownership thus also eliminates his ability to proceed with a derivative suit.

In an effort to avoid this problem, plaintiffs that bring dilution claims asserting their interests have been wrongfully diminished need to fit into an exception to the general rule that dilution claims are derivative. This decision illustrates the limits on such claims. Basically, a dilution claim is derivative unless the claim is that a controlling stockholder has wrongly diluted the interests of the minority stockholders. For this purpose, "control" means having a greater than 50% interest or active domination of a board. Moreover, it is not possible to aggregate the stock holdings of a group of stockholders to get over the 50% threshold.

This opinion also discusses the exceptions to the general rule that a merger deprives a stockholder of standing, such as when the merger itself is an attempt to fraudulently end the derivative suit. It also notes that aiding and abetting claims based on derivative claims are themselves also derivative and subject to the same standing rules.

Court of Chancery Expands Right To Bring Direct Claims

Rhodes v. Silkroad Equity LLC, C.A. No. 2133-VCN (July 7, 2007).

The line between what is a direct claim and a derivative claim is frequently critical. Derivative claims can only be brought by stockholders and have other procedural hurdles to jump to survive a motion to dismiss. In this decision, the Court permitted what appeared to be a derivative claim to go forward as a direct claim by a former stockholder. Thus, the Court has expanded the type of claim that may be brought as a direct claim. While the facts of this case may seem unusual, the claims made in this case have come up before and now will certainly take on new life.

Briefly, the plaintiff alleged that the majority stockholder had run down the business of the company to force out the plaintiffs as minority owners at a reduced price under a stockholders' agreement. The damage to the company from their actions would seem to be a classic derivative claim for it was the company that suffered the injury and to whom damages would seem to flow for such a claim. However, the Court held that this conduct also would support a direct claim because the conduct in effect permitted the majority to increase its interest in the company while diluting the interest of the minority stockholders. In that sense, the claim of the minority interest was also a direct claim suffered by them alone.

Court of Chancery Broadens Discovery of Single Member Special Committee

Sutherland v. Sutherland, C.A. No. 2399-VCL (July 2, 2007).

On several occasions, the Delaware courts have questioned why only a single member is appointed to a special committee. However, the practice continues.This decision illustrates the price to be paid by such a bad practice.

Normally, Zapata Corp. v. Maldonado, 430 A2d 779 (Del. 1981) limits discovery of a special committee to materials that reflect on the independence and diligence of the committee. Discovery into the merits of the committee's conclusions is limited. The theory behind this limitation is that to permit broad discovery into the allegations that lead to the committee's creation would effectively undermine the reasons the committee was appointed in the first place.

This decision permitted much broader discovery into the merits of the one person committee's conclusions because of the special circumstances involved in this battle between family members and the limited disclosures given about the reasons for selecting the single member of the committee. The rationale behind the decision still applies to increase discovery of other single member special committees.

District Court Declines to Exercise Supplemental Jurisdiction Over Fiduciary Duty Claims, Grants Motion to Dismiss

Lemon Bay Partners LLP v. Hammonds, C.A. No. 05-327 (D.Del. June 26, 2007)

 

In this shareholder derivative action for breach of fiduciary duties against various corporate defendants, the Court held that the state law claims asserted so predominated the lone federal claim that exercise of supplemental jurisdiction was inappropriate. Plaintiffs, former shareholders of MBNA Corporation, asserted various claims against the defendants based on breach of fiduciary duties in connection with earnings reports and the merger of MBNA with Bank of America. Defendants moved to dismiss based on lack of subject matter jurisdiction, arguing that the Plaintiffs’ sole claim that rested on federal jurisdiction was so predominated by the state law claims as to make the exercise of the Court’s supplemental jurisdiction inappropriate. The Court concurred with the defendants, concluding that Plaintiffs’ federal law claim bore only a tangential relationship to the rest of the claims. The Court therefore granted Defendants’ motion to dismiss for lack of subject matter jurisdiction. 

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Supreme Court Explains Its Rossette Decision

Gatz v. Ponsoldt, C.A. No. 298 (Del. Supr., April 16, 2007).

The dividing line between what is a derivative suit and what claims may be filed directly on behalf of stockholders is undergoing a rapid development in Delaware. This decision is the latest in that recent line of decisions.

This decision makes it clear that under the recent Rossette decision, claims for dilution may be filed by a class of stockholders whose interest in the entity have been diluted by the issuance of stock to "a significant or controlling stockholder'" in a dilutive transaction.  Before Rossette, it was generally thought those claims belonged to the entity that did not get fair consideration for its stock and thus, were derivative claims only.

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District Court Applies SEC Rules Amendments to Transaction, Grants Summary Judgment

Levy v. Sterling Holding Co., LLC, 2007 WL 582555 (D.Del. Feb. 13, 2007).

In this shareholder derivative action, the plaintiff shareholder sued two defendants, both of whom occupied board positions with the corporation, for allegedly purchasing stock in the corporation and then selling it at a profit within six months, in violation of Section 16(b) of the Securities and Exchange Act of 1934. After each side filed cross-motions for summary judgment, the SEC adopted Amendments to SEC Rules 16b-3 and 16b-7, which exempt certain transactions from the prohibitions of Section 16(b). Defendants argued that the transaction that formed the basis of Plaintiff’s complaint, whereby Defendant’s preferred stock in the corporation was “automatically” converted to common stock upon completion of an IPO, was an exempt “reclassification” transaction under the SEC Rules. Conversely, Plaintiff argued that the exemption did not apply. The Court found that the SEC had acted within its power in exempting reclassification transactions from Section 16(b), and that as a result of that exemption, Defendants were entitled to judgment as a matter of law. 

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District Court Grants Motion for Judgment on the Pleadings

Magten Asset Mgmt. Corp. v. Paul Hastings Janofsky & Walker LLP, No. 04-1256-JJF (D.Del. Jan. 12, 2007)

In this opinion, the District Court of Delaware found that both Montana’s substantive fraudulent transfer law and Plaintiff’s inability to establish standing warranted granting Defendant’s motion for judgment on the pleadings. Plaintiff, a creditor of a Montana limited liability company by virtue of an indenture agreement, sued Defendant, alleging that Defendant assisted the LLC in transferring assets to its parent corporation in order to defraud the LLC’s creditors. Defendant moved for judgment on the pleadings, arguing that as a non-transferee of the assets, it could not be held liable for any alleged fraudulent transfer under Montana’s fraudulent transfer act, and that as a creditor of the LLC, Plaintiff did not have standing to bring its derivative claims against Defendant on behalf of the LLC. The court agreed with Defendant, and granted the motion for judgment on the pleadings.

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Court of Chancery Approves Awards Large Fees!

A few recent articles have questioned the willingness of the Court of Chancery to award adequate fees in class and derivative litigation. These articles focus on one or two instances where fee requests were not met with full approval. This anecdotal approach is misleading. After all, it would be a sign of a failing system if every fee request were given blanket approval regardless of its merits.

Two more recent decisions by the Court of Chancery show it is fully responsive to appropriate fee requests and is willing to award large fees when appropriate. In the McKesson/HBOC litigation, Chancellor Chandler  awarded the plaintiff's attorneys $10 Million for their years of hard work on behalf of McKesson in a derivative suit. More recently, Vice Chancellor Strine in the Hollinger case awarded plaintiff's counsel $2,500,000 in fees for his work in a case where the actual litigation work was fairly brief, but the results were outstanding.

Both of these cases were what are known as Caremark cases alleging that the Board had failed to perform its oversight duty to avoid accounting and other problems. That type of case is fairly characterized as among the most difficult to prove, given the high standard to establish liability.  Thus, when the plaintiffs won a good settlement, their attorneys were rewarded, fairly and even generously.

In short, bring a good case, fight hard, achieve a decent result and the Court of Chancery will reward your effort. That is all we should expect.

Federal Court Permits Motion To Transfer Using Multi-Factor Balancing Test

Weisler v. Barrows, C.A. No. 06-362 GMS, 2006 WL 3201882 (D. Del. Nov. 6, 2006).

Plaintiff, a shareholder of Sycamore Networks, Inc. (“Sycamore”), a Delaware corporation with its principal place of business in Massachusetts, brought this derivative action against several of its directors and officers, including its chairman, CEO and CFO. The complaint alleged six counts: (1) a count against each director for section 14(a) violations of the Securities and Exchange Act of 1934 (“Exchange Act”); (2) one count of disgorgement against four directors under section 304 of the Sarbanes-Oxley Act of 2002 (“Oxley Act”); (3) one count of breach of fiduciary duty against all directors; (4) one count of unjust enrichment against five directors; (5) one count of gross mismanagement against all defendants; and (6) one count of waste of corporate assets against all defendants.

The defendants moved to transfer the matter pursuant to 28 U.S.C. § 1404(a) and the Court granted the motion because it would convenience the parties and witnesses and serve the interests of justice.

The plaintiff alleged that the defendants had jointly and severally breached their fiduciary duties of care, loyalty, good faith, and candor by failing to: (1) discover or prevent the intentional manipulation of stock option grants between 1999 and 2004; (2) prevent the misreporting of earnings that was caused by the manipulation of the option grants; (3) oversee the administration of Sycamore’s stock-based compensation plans; (4) ensure Sycamore operated in compliance with applicable state and federal laws pertaining to dissemination of financial statements; (5) ensure the company did not engage in any improper or illegal practices; and (6) ensure that the company’s financial statements were compliant with GAAP. The conduct is alleged to have violated section 14(a) of the Exchange Act and section 304 of the Oxley Act.

The Court permitted the transfer of the matter on its individualized consideration of the motion under section 1404(a) and on whether it would convenience the parties and witnesses and serve the interests of justice. The Court also held that it was the defendants’ burden to establish the need for transfer. The Court observed that the standard for transfer did not demand a demonstration of compelling circumstances; rather, the defendants only needed to show that the case would be better off if transferred to the other jurisdiction. That inquiry required a “multi-factor balancing test” that consisted of not only the convenience of the parties and the witnesses but also the examination of certain public and private interests. The Court listed the private interests as: (1) a plaintiff’s choice of forum; (2) the defendant’s preference; (3) where the claim arose; (4) the convenience of the parties and witnesses; and (5) the location of the books and records. The Court listed the public interests as: (1) the judgment’s enforceability; (2) practical trial considerations making it easy, expeditious or inexpensive; (3) the administrative difficulty presented in the two fora; (4) local interest in deciding the controversy at home; and (5) the public policies of the fora under consideration. The Court found that the private and public factors weighed in favor of transfer and therefore permitted the defendants’ motion.

Court of Chancery Explains When Directors Are Interested In The Deal

In Re Primedia Inc. Derivative Litigation, C.A. No. 1808-N (Del. Ch. November 15, 2006).

This case dealt with when directors would be considered interested in a deal so as to preclude the application of the business judgment rule and permit the suit to proceed.  Many of the directors were affiliated with the controlling stockholder who had purchased the corporation's preferred stock at a deep discount just before the board voted to redeem that stock at its face value. That decision was justified, it was argued, because the coupon rate on the stock was higher than market rate. The Court held that might well be so, but at the pleading stage it was too soon to accept that as a justification for the purchase that gave the controlling stockholder a big gain. The decision is particularly interesting for its discussion of when directors are considered sufficiently connected to a controlling stockholder so as to preclude application of the business judgment rule.

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Court of Chancery Rejects Attempt To Revive Derivative Suit

West Coast Management & Capital LLC v. Carrier Access Corporation, C.A. No. 2262-N (Del. Ch. November 14, 2006) is a classic example of what can go wrong in trying to plead a derivative suit. The Court of Chancery dismissed the complaint because the plaintiff had filed a prior complaint in federal court that had been dismissed for failure to establish that demand on the directors was excused. Here, the plaintiff tried to pursue a stockholder inspection claim to establish that demand was excused, but the Court held it was precluded from doing so by the dismissal of its prior complaint. This shows that a plaintiff better know what it is doing when it files a derivative suit because the chances to correct errors will be limited. Continue Reading...

Supreme Court Interprets The "Duty" To Act In Good Faith

Stone v. Ritter,  C.A. No. 93, 2006 (Del. Supr. November 6, 2006).

The Supreme Court has issued the latest Delaware decision to interpret the duty to act in good faith. Indeed, it is possible to read Stone as holding there is no separate duty of directors to act in good faith. While that would be a mistake, the implications of this decision may be far reaching. At the very least, Stone upholds the conventional wisdom in Delaware that under Caremark the directors' duty to act is most easily triggered when there are red flags indicating something is wrong with the way the entity is being operated. A complaint that fails to plead those red flags has a good chance of being dismissed.

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Court of Chancery Rejects Balancing Test Under Rule 23.1

Bakerman v. Frank Importing Co. Inc., C.A. No. 1844-N (Del. Ch. October 16, 2006).

When directors own shares in both the parent and its subsidiary, the question arises whether they are disinterested in considering a demand under Rule 23.1 in a case challenging a transaction between the two entities. This decision holds that the Court will test their interest in the transaction by focusing on their interest in the dominant party and will not also take into account their interest in the entity on the other side of the transaction. This makes sense because otherwise the Court would need to do a complex balancing to see if the interest in the subsidiary was as important as the interest in the parent. That involves tax and other issues that are difficult to determine. Note, however, that after discovery, those interests may be balanced in deciding on the merits if the directors should be given the benefit of the Business Judgment Rule.

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Court of Chancery Holds 5 Days Is Too Short For Merger Announcement

Berger v. Intelident Solutions Inc., C.A. No. 1527-N (Del. Ch. October 12, 2006).

Under Delaware law, when a stockholder files suit over a merger she may be limited to appraisal rights when her concern is only over the price to be paid. It is often difficult to decide when a complaint is limited to the price and does not also deal with unfair dealing claims that are appropriate for class litigation. Here, the Court held that a complaint that alleged only 5 days notice of a merger and the right to seek appraisal did properly allege unfair dealing and could proceed as a class claim.

District Court Applies Exception to Tooley Test and Rejects Argument That Exculpatory Provisions Create Contractual Obligations

Shamrock Holdings v. Arenson, C.A. 06-62-SLR, 2006 WL 2802913 (D. Del. Sept. 29, 2006).

This case involved a dispute between the Class A and Class B members of a Delaware LLC called ALH Holdings. The dispute arose after ALH faced financial trouble and the Class A members voted to sell the company over the objections of the Class B members, who eventually threatened to sue.

To preempt such a suit, the Class A members brought an action for a declaratory judgment that, among others, they did not breach their fiduciary duties or the LLC's operating agreement. In response, the Class B members counterclaimed, alleging breaches of the same. Plaintiffs subsequently moved for summary judgment as to four of the counts in their complaint, and they moved to dismiss the defendants' counterclaim. The Court denied the motion to dismiss and denied the motion for judgment on the pleadings in part (and granted it in part).

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Supreme Court Adopts "Validly In Litigation" Rule

Braddock v. Zimmerman, C.A. No. 489 (Del. Sup. September 12, 2006).

The Delaware Supreme Court has clarifed the rules as to when a plaintiff in a derivative suit must make a demand upon filing an amended complaint. The Court holds that if the derivative litigation has been properly instituted an amendment to the complaint does not need to be the subject of a demand on the board of directors as to those claims already "validly in litigation". Thus, even if the majority of the board has changed and is now independent under Rule 23.1 standards, no demand need be made in those circumstances.

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Court of Chancery Limits Creditor Fiduciary Duty Claims

North American Catholic Educational Programming Foundation, Inc. v. Gheewalla, C.A. No. 1456-N (Del. Ch. September 1, 2006).

This is another in a series of Court of Chancery decisions that limit the claims that creditors may make based on the theory the directors owe the creditors a duty when their corporation is insolvent or in the vicinity of insolvency. Ever since the famous footnote in Credit Lyonnais Bank Nederland, N.V. v. Pathe Communications Corp., 1991 WL 277613 (Del. Ch. Dec. 30, 1991), creditors have argued that directors should owe them a fiduciary duty to take their interests into account when the creditors are the residual interest holders in a corporation that is insolvent or nearly so. A series of recent decisions have limited those creditor arguments. See e.g. Production Resources Group, L.L.C. v. NCT Group, Inc., 863 A.2d 772 (Del. Ch. 2004) [holding most creditor claims must be brought as derivative claims]. This new decision further limits creditor claims by holding that creditors may not bring a direct claim for breach of fiduciary duty based on the theory the entity is in the vicinity of insolvency. Further, the decision holds that for clearly insolvent companies, only creditors whose claims are beyond fair dispute may claim the directors owe them a duty.

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Supreme Court Clarifies Tooley

Gentile v. Rossette, C.A. No. 573, 2005 (Del. Supr. August 17, 2006).

This Delaware Supreme Court decision significantly clarifies the Court's Tooley decision that governs when a claim is a derivative claim. Because a derivative claim must meet significant pleading requirements under Court of Chancery Rule 23.1, this decision affects much of the corporate litigation in the Delaware Court of Chancery and merits careful reading.

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Court of Chancery Rejects Deepening Insolvency Theory

Trenwick America Litigation Trust v. Ernst & Young LLP, C.A. No. 1571-N, 2006 WL 2333201 (Del. Ch. Aug. 10, 2006).

The Delaware courts have struggled for the last fifteen years over the scope of the duties of directors to creditors when their company is in the vicinity of insolvency. In two landmark decisions, the first in 2004, and just recently, the Court of Chancery sought to define the limits of that duty. Indeed, in this decision the Court rejected the very idea that there is a duty to avoid taking risks that may have the effect of deepening the insolvency of a Delaware corporation, at least in most circumstances.

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Court of Chancery Sustains Complaint Attacking Settlement

Kosseff v. Ciocia, C.A. No. 188-N, 2006 WL 2337593 (Del. Ch. Aug. 3, 2006).

In this decision, the Court dealt with a complaint attacking the transaction implemented to settle a proxy contest. The proxy contest was settled by an agreement that put the dissidents on the board and had the CEO resign. However, the CEO was given the right to buy certain lucrative businesses of the company, a right he later exercised. The complaint alleged that this deal was improvident. After reviewing the complaint, the Master declined to grant a motion to dismiss.

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Rule 23.1 Requirements Are Satisfied By Business Relationships

AIG Retirement Services, Inc. v. Barbizet, C.A. No. 974-N, 2006 WL 1980337 (Del. Ch. July 11, 2006).

Business relationships between directors may sometimes make them unqualified to pass upon demands their company sue their fellow directors. This is such a case where the board members derived substantial benefits from their relationships with the potential target of litigation the plaintiff demanded be brought. Under those circumstances, the futility of making a demand under Rule 23.1 was easily established.

Court of Chancery Grants Defendants' Motion to Dismiss Where Plaintiffs Asserted Derivative, Not Direct, Claim and Failed to Make Demand or Establish Demand Was Excused

Gatz v. Ponsoldt, C.A. No. 174-N, 2006 WL 1510467 (Del. Ch. May 26, 2006).

Plaintiffs asserted direct claim arising from recapitalization. Defendants moved to dismiss, arguing that Plaintiffs' claim was actually derivative, not direct, and Plaintiffs had failed to make demand or establish demand was excused.

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Court of Chancery Grants In Part Motion To Dismiss Class and Derivative Complaint

Khanna v. McMinn, C.A. No. 20545-NC, 2006 WL 1388749 (Del. Ch. May 9, 2006).

Defendants moved to dismiss class and derivative complaint under Court of Chancery Rules 23.1 and 12(b)(6). Defendants also moved to disqualify the plaintiffs, to strike portions of the complaint and for continued sealing of the complaint.

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Court of Chancery Permits Derivative Action to Proceed Because Alleged Facts Created Reasonable Doubt that Directors were Disinterested and Independent

Feldman v. Cutaia, C.A. No. 1656-N, 2006 WL 920420 (Del. Ch. Apr. 5, 2006).

This action involved a series of transactions in which the Telx defendant directors allegedly granted themselves a significant equity stake in the company for little or no consideration. Plaintiff alleged that these transactions significantly diluted his equity position. This action also involved a self tender-offer by the company for $5 million worth of its securities. Defendant argued that plaintiff did not make a demand on the Telx board before proceeding with the derivative action and that the complaint did not plead with particularity facts that created a reasonable doubt as to the ability of the Telx board to independently consider such a demand. The Court of Chancery denied the defendants' motion to dismiss and permitted the plaintiff to proceed with his derivative suit.

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District Court Denies Defendants' Motions to Dismiss Derivative Action for Failure to Comply with Demand Requirement and Lack of Subject Matter Jurisdiction and Denies Plaintiff's Motion for Summary Judgment.

Seinfeld v. Barrett, C.A. No. 05-298-JJF, 2006 WL 890909 (D. Del. Mar. 31, 2006).

Plaintiff filed a derivative action against defendants, alleging that they violated Section 14(a) of the Securities Exchange Act of 1934 (the "Exchange Act") and Rule 14a-8 and breached their fiduciary duties under Delaware law by making false and misleading statements in connection with a proxy statement issued by the defendants in March 2005. Plaintiff moved for summary judgment, and defendants moved to dismiss for lack of subject matter jurisdiction and for failure to comply with Rule 23.1.

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Court of Chancery Dismisses Complaint Because a Creditor Erroneously Asserted Derivative Claims as Direct in the Hope of Escaping Bankruptcy Court Jurisdiction

Big Lot Stores, Inc. v. Bain Capital Fund VII, LLC, C.A. No. 1081-N, 2006 WL 846121 (Del. Ch. Mar. 28, 2006).

In 2000, in a sponsored management buyout, a corporation sold a subsidiary business that operated a chain of toy stores (KB Toys) in exchange for $257.1 million in cash and a $45 million note due in 2010. In 2002, the new owners refinanced the business and distributed approximately $120 million to the buyout sponsor, affiliates, two officers and directors of the subsidiary that invested in the buyout, and others. In 2004, the KB Toys filed for Chapter 11 bankruptcy. Plaintiff Big Lots, Inc, an unsecured creditor and holder of the $45 million note, brought this action asserting direct claims of breach of fiduciary duties, fraud, and civil conspiracy. The plaintiff sought recovery for the amount due on the note and restitution for alleged unjust enrichment. The Court of Chancery dismissed the complaint namely because the claims were derivative in nature, not direct, and thus belong to the bankruptcy estate.

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Court of Chancery Finds Breach of Oral Contract Regarding Executive Compensation and Breach of Fiduciary Duty for Failure of Such Compensation to Satisfy Entire Fairness Test

Carlson v. Hallinan, C.A. Nos. 19808, 19466, 2006 WL 771722 (Del. Ch. Mar. 21, 2006).

This case involved a direct and derivative action arising out of a dispute between two men engaged in the business of making short term, unsecured loans. Plaintiffs asserted direct claims for breach of contract and derivative claims for breach of fiduciary duties. Specifically, plaintiffs alleged that defendant Hallinan breached an oral contract with plaintiffs by paying himself and another defendant executive compensation. Plaintiffs also asserted that the defendants breached fiduciary duties they owed nominal defendant CR Services Corp. by paying themselves an excessive amount of executive compensation. The Court of Chancery found, among other things, that Hallinan breached the oral contract with plaintiffs and defendants committed multiple breaches of their fiduciary duties to CR because they failed to meet the entire fairness standard regarding their compensation.

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Court of Chancery Dismisses Derivative Action for Failure to Establish Demand Futility

Highland Legacy Ltd. v. Singer, C.A. No. 1566-N, 2006 WL 741939 (Del. Ch. Mar. 17, 2006).

A large shareholder brought a derivative action alleging that the directors committed corporate waste by approving exorbitant fees to unqualified financial advisers. The defendants moved to dismiss the complaint under Court of Chancery Rule 23.1 for failure to allege with particularity facts establishing demand futility. The court's review of the complaint revealed that plaintiff did not allege with particularity facts from which the court could reasonably conclude that the majority of the directors were disabled from impartially considering a demand. The court therefore granted defendants' motion to dismiss under Rule 23.1.

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Court of Chancery Dismisses Caremark Claims But Retains Loyalty And Fraud Counts

Canadian Commercial Workers Industry Pension Plan v. Eric Alden, et al., C.A. No. 1184-N, 2006 WL 456786 (Del. Ch. Feb. 22, 2006).

In this derivative action brought against four former directors and officers of Case Financial, Inc., the nominal defendant, the two remaining defendants moved to dismiss after two others settled. Plaintiff alleged breach of loyalty, breach of the Caremark duty of oversight, corporate waste and common law fraud. The Court of Chancery partly granted the motions.

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Court of Chancery Denies Defendants' Demand For Intercontinental Depositions Approving Videoconferencing Under R.30(b) And Limits Number Of Deponents

Unisuper Ltd., et al. v. News Corporation, et al., C.A. No. 1699-N, 2006 WL 375433 (Del. Ch. Feb. 09, 2006).

Defendants filed cross-motions requiring depositions of thirteen named plaintiffs' under Ch. Ct. R. 30(b)(6) in either Delaware or New York. Plaintiffs filed motions for protective orders, to limit the numbers of deponents and contended depositions could occur outside the United States via videoconferencing.

The plaintiffs' Australian company had reincorporated in Delaware.

Plaintiff sought equitable relief requesting its shareholders to be permitted to vote on a poison pill's extension. The court treated this matter as a representative one, rather than an individual shareholder suit.

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Court Of Chancery Dismisses Complaint For R. 23.1 Failure Despite Corporation's Inadequate "Internal Controls" Attracting $50 million Fine

Stone, et al. v. Ritter, et al., C.A. No. 1570-N, 2006 WL 302558 (Del. Ch. Jan. 26, 2006).

This matter involved an attempt to institute a derivative proceeding against fifteen current and former director defendants of AmSouth Bancorporation for alleged failures of fiduciary duties through insufficient internal control systems to guard against statutory violations under the Bank Secrecy Act and the Anti-Money Laundering Regulations. The defendants filed a motion to dismiss and it was granted by the court for insufficiency of pleading under Chancery Court Rule 23.1.

On November 6, 2006, the Delaware Supreme Court affirmed this decision.

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Partial Summary Judgment Denied by Court Of Chancery On "Entire Fairness" And Disclosure Grounds

In re Tele-Communications Inc. Shareholders Litig., C.A. No. 16470, 2005 WL 3547674 (Del. Ch. Dec. 21, 2005), opinion revised and superceded by No. CIV. A. 16470, 2005 WL 3642727 (Del. Ch. Dec. 21, 2005), (revised Jan. 10, 2006)(Westlaw citation not available).

This summary judgment action originates from a Consolidated Amended Complaint that alleged nondisclosure of material information Continue Reading...

Class Representative Awarded Additional Fee Compensation For Shouldering Extra Burden By Court Of Chancery

Raider v. Sunderland, et al., C.A. No. 19357 NC, 2006 WL 75310 (Del. Ch. Jan. 04, 2006) (Revised Jan. 05, 2006).

This is a class action involving board actions and fee requests by the plaintiff representative.

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Court of Chancery Grants Partial Summary Judgment with Respect to Claims that Former Controlling Stockholder Extracted Excess Compensation from Acquirer in Exchange for Supporting Merger

Crescent/Mach I Partnership, L.P. v. Turner, C.A. No. 17455-NC, 2005 WL 3618279 (Del. Ch. Dec. 23, 2005).

Former stockholders who were cashed out in connection with merger sued the corporation's former controlling stockholder and the acquirer for breach of fiduciary duty and aiding and abetting breach of fiduciary duty, respectively. Plaintiffs complained of numerous side deals, allegedly negotiated by the controlling stockholder. Plaintiffs also complained that the controlling stockholder breached his fiduciary duty by supplying growth projections that he knew to be unduly pessimistic and inconsistent with management's view. Defendants moved for summary judgment, which the court granted in part and denied in part.

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Court Dismisses Claim That Board Breached Fiduciary Duty by Failing to Seek Recovery of Bonus that Turned Out to Be Unjustified After Accounting Restatement

Laties v. Wise, C.A. No. 1280-N, 2005 WL 3501709 (Del. Ch. Dec. 14, 2005).

In 2001, Defendant corporate executive received bonuses and other compensation near $9 million as CEO, due in some part to the corporation's reported profits that year. Several years later, after that executive's departure, the corporation restated its 2001 performance from a $93 million profit to a $447 million loss. Plaintiff brought a derivative claim against executive for unjust enrichment, and against the present directors of the corporation for breach of fiduciary duty and waste. Defendants moved to dismiss under Court of Chancery Rule 23.1.

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Court of Chancery Partially Grants Motion For Summary Judgment Based Upon Plaintiffs' Lack Of Standing To Bring Derivative Claims As Result Of Merger

Gentile v. Rossette, C.A. No. 20213-NC, 2005 WL 2810683 (Del. Ch. Oct. 20, 2005).

Plaintiffs, former shareholders of SinglePoint Financial, Inc. which merged into a subsidiary of Cofiniti, Inc., alleged that two former directors of SinglePoint breached their fiduciary duties in connection with the issuance of a large number of shares to one of the defendants and the merger. Defendants moved for summary judgment.

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Court of Chancery Finds LLC Member Had Standing To Bring Derivative Claims On Behalf Of LLC, But That Her Claims Were Subject To Arbitration

Ishimaru v. Fung, C.A. No. 929, 2005 WL 2899680 (Del. Ch. Oct. 26, 2005).

Plaintiff, a member of Paradigm Financial Products International LLC, sought to assert a cause of action on behalf of Paradigm against Defendant Ivy Asset Management Corp. for breach of contract. Ivy Asset moved to dismiss for lack of subject matter jurisdiction.

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Court of Chancery Grants Plaintiff's Motion To Amend Derivative Complaint Against Director-Defendants For Insider Trading

Zimmerman v. Braddock, C.A. No. 18473-NC, 2005 WL 2266566 (Del. Ch. Sept. 8, 2005).

Plaintiff, a shareholder of priceline.com, Inc., moved for leave to amend his derivative complaint against directors of Priceline based upon three defendants' alleged insider trading and misappropriation of confidential information. Defendants argued amendment would be futile.

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District Court Holds that Price Adjustment for Conversion of Preferred Stock was not "Purchase" of Corporation's Common Stock

Morrison v. Madison Dearborn Capital Partners III, LP, 389 F. Supp. 2d 596 (D.Del. 2005).

A shareholder brough a derivative action to recover profits from short-swing insider trading of stock. The defendants moved to dismiss under Federal Rule 12(b)(6).

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Court of Chancery Denies Motion For Continued Sealing Of Portions Of Derivative Complaint

Stone v. Ritter, C.A. No. 1570-N, 2005 WL 2416365 (Del. Ch. Sept. 26, 2005).

Defendants sought continued sealing of portions of derivative complaint.

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Court of Chancery Dismisses Stockholders' Claims Because Claims were Derivative and Demand was Not Excused

In re J.P. Morgan Chase & Co. S'holder Litig., 2005 WL 1076069 (Del. Ch. April 29, 2005), aff'd, 2006 WL 585606 (Del. Mar. 8, 2006).

J.P. Morgan Chase & Co. ("JPMC") and Bank One agreed to a business combination that was expected to create the second largest financial institution in the country. JMPC paid a premium over the market share price for Bank One, effectively making JPMC the acquirer and the Bank One the target. After the merger was completed, the stockholders of the acquirer sued its directors, alleging breaches of fiduciary duty with regard to the acquisition. Their claims stemmed from the allegation that the directors paid too much for the acquired bank. The defendants moved to dismiss the complaint on the basis that the claims were derivative, not direct, and that demand was not excused. The court granted defendants motion to dismiss.

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Court Of Chancery Ropes In Florida Corporation On Conspiracy Theory For Jurisdictional Nexus

Benihana of Tokyo, Inc. v. Benihana, Inc., et al., C.A. No. 550-N (Del. Ch. Feb. 28, 2005).

This case deals with several motions to dismiss on several grounds, the upholding of personal jurisdiction under a conspiracy or aiding/abetting theory and plaintiff's request for a declaratory judgment.

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Defendant Fails To Rebut Presumption Of Beneficial Causation For Merger Fee Award

In re Plains Resources Inc. Shareholders Litigation, C.A. No. 071-N, 2005 WL 332811 (Del. Ch. Feb. 04, 2005).

This is an action for plaintiff's attorney fees following settlement of fiduciary duty-based shareholder class actions.

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Court of Chancery Stays Discovery Applying The "Special Circumstances" Test

George D. Orloff, et al. v. Lloyd J. Shulman, et al., C.A. No. 852-N, 2005 WL 333240 (Del. Ch. Feb. 02, 2005).

Minority shareholders of LLC brought a derivative suit for corporate waste and breach of fiduciary duties. Defendants filed a motion to stay discovery pending the resolution of a motion to dismiss. The court granted it.

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Court of Chancery Denies Answer Amendment On Public Policy Grounds

Oliver, et al. v. Boston University., et al., C.A. No. 16570-NC (Del. Ch. Jan. 28, 2005).

Plaintiff filed a motion to amend its answer to limit its liability exposure to its shareholders in a publicly traded corporation, by asserting an affirmative defense under the law of Massachusetts.

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