DOCSLIB.ORG

Litigation Alert >> Double-Derivative Shareholder Actions in the Wake

Total Page：16

File Type：pdf, Size：1020Kb

Download full-text PDF Read full-text
Litigation Alert >> Double-Derivative Shareholder Actions in the Wake FEBRUARY 2011 LITIGATION >> ALERT DOUBLE-DERIVATIVE SHAREHOLDER ACTIONS IN THE WAKE OF STOCK-FOR-STOCK MERGERS Shareholder derivative actions can emerge as an important issue for nearly everyone involved in a company’s activities, including its executives, board members, in-house attorneys, principals and other shareholders. Under certain circumstances, this mechanism can allow a shareholder to redress harm to the corporation by bringing a lawsuit on the corporation’s behalf where the corporation’s management is prevented from doing so due to conflicts of interest. As such, the derivative action can be may bring a derivative action based an important corporate governance on conduct that took place at the THE BOTTOM LINE device to protect shareholders from acquired company before the merger. corporate waste and wrongdoing. Corporate management, in-house In the hands of opportunistic plaintiffs’ CASE BACKGROUND counsel, and stockholders should lawyers, however, the device can This case arose from derivative claims be aware of potential shareholder also be a costly drain on corporate brought in a New York federal court derivative litigation in approaching resources and a source of by former shareholders of Merrill Lynch management distraction. Also, who alleged that Merrill’s senior corporate transactions. The bear in mind that many of the rules management and board members Delaware Supreme Court’s recent that have been developed around breached fiduciary duties in connection pronouncement makes it derivative actions are applicable to with the company’s involvement in particularly important that those companies ranging from the largest underwriting collateralized debt public corporations to closely held obligations, risky mortgage-related involved with acquisitions of LLCs and partnerships. activities, and improper payment troubled or distressed companies of bonuses. When Merrill was The Delaware Supreme Court, a bear in mind any potential leading authority on corporate law, subsequently acquired by Bank of derivative litigation by shareholders has recently spoken definitively on America in a stock-for-stock merger, an issue that will be of particular these derivative claims were of the acquired company in interest to those involved in corporate extinguished based on the rule assessing and planning for the requiring a derivative plaintiff to acquisitions. Specifically, in costs and possible gains of post- Lambrecht v. O’Neal, the court has maintain stock ownership both at the merger litigation, in negotiating addressed the question of whether time of the alleged wrongdoing and and under what circumstances a throughout the course of the litigation. indemnity provisions, and in The purpose of the continuous pre-merger shareholder of an acquired determining the optimal structure company, who has become a current ownership requirement is to ensure and consideration for acquisitions. shareholder of the acquiring company that derivative plaintiffs have a true >> continues on next page by virtue of a stock-for-stock merger, Attorney Advertising FEBRUARY 2011 LITIGATION >> ALERT stake in redressing alleged harm to of whether plaintiffs in fact were CONCLUSION the company and to prevent the required to meet these additional Through its holding, Lambrecht buying and selling of derivative requirements, the federal court in effectively breathed life into the claims through the sale of stock. New York certified this question of double-derivative remedy, particularly law to the Delaware Supreme Court, The court, however, left open in the wake of stock-for-stock which agreed to address the issue. the possibility that the plaintiff mergers. This development may shareholders could re-file the action be particularly significant with regard RULING as a “double-derivative” action in their to the acquisitions of troubled or capacities as new Bank of America The Delaware Supreme Court rejected distressed companies where there shareholders, which they did. the defendants’ contention that are allegations of mismanagement A “double-derivative” action is the plaintiffs would have to show their or wrongdoing by the acquired means through which a shareholder ownership in the acquiring corporation companies’ officers and directors. of a parent corporation can seek and the acquiring corporation’s Lambrecht makes clear that derivative recovery for harm to a subsidiary. ownership of the subsidiary at the time actions by the acquired company’s of the wrongdoing, and overruled prior former shareholders based on these The defendants argued that the caselaw to the extent it held otherwise. allegations will not, as a practical plaintiffs’ double-derivative suit as The court took a practical approach to matter, be extinguished by the merger Bank of America shareholders should the issue, noting that double-derivative so long as those shareholders receive be dismissed because they still could actions are an important mechanism stock of the acquiring company as not meet the continuous ownership for corporate governance and that the part of the acquisition. requirement. Although plaintiffs now defendants’ proposed criteria “would could meet the requirement of holding effectively eviscerate the double stock at the time of the litigation, derivative action as a meaningful FOR MORE INFORMATION defendants contended that plaintiffs remedy.” One of the cornerstones of must also demonstrate that, at the the court’s reasoning was its finding James R. Levine time of the alleged wrongdoing at that, assuming the plaintiffs could Partner the acquired company, satisfy the legal requirements to bring 212.468.4985 [email protected] >> plaintiffs owned stock in the a derivative suit on behalf of Bank of acquiring company, and America, the lawsuit on behalf of Bank or the D&G attorney with whom of America against the Merrill officers you have regular contact. >> the acquiring company owned and directors was not truly a derivative stock in the acquired company. action and thus did not have to meet the continuous share ownership DAVIS & GILBERT LLP The defendants’ argument was requirement. Rather, the court T: 212.468.4800 based in part on prior precedent 1740 Broadway, New York, NY 10019 reasoned that Bank of America could that could be read to support these www.dglaw.com enforce its rights directly in its capacity requirements. Faced with the © 2011 Davis & Gilbert LLP as 100% owner of Merrill. important Delaware law question .
Load more

Recommended publications
  • II. the Onset of Insolvency Or Financial Distress
    Reproduced with permission from Corporate Practice Series, "Corporate Governance of Insolvent and Troubled Entities," Portfolio 109 (109 CPS II). Copyright 2017 by The Bureau of National Affairs, Inc. (800-372-1033) http://www.bna.com II. The Onset of Insolvency or Financial Distress A. Introduction Because a Chapter 11 reorganization can be expensive and time consuming, a troubled corporation may seek to right itself through an out-of-court transaction—such as a recapitalization, merger or asset sale. These transactions and the directors' decisions concerning them are analyzed under state corporation law. Corporation law also provides a state law alternative to a Chapter 7 liquidation through procedures for voluntary and forced dissolution as well as ancillary remedies such as the appointment of a receiver to marshal a corporation's assets, sell those assets, distribute the proceeds to creditors, and take other steps to wind down a corporation. That said, as discussed below, state law insolvency proceedings have limitations that often make them an unsuitable alternative to federal bankruptcy proceedings. B. Director Duties in the `Zone of Insolvency' and Insolvency As discussed in Chapter I, § 141(a) of the DGCL gives directors the authority and power to manage a corporation, and in exercising that authority directors are subject to the fiduciary duties of care and loyalty. Under ordinary circumstances, these fiduciary duties require that directors maximize the value of the corporation for the benefit of its stockholders, who are the beneficiaries of any increase in the value of the corporation. When a corporation is insolvent, however, the value of the corporation's equity may be zero.
    [Show full text]
  • Direct Versus Derivative and the Law of Limited Liability Companies Daniel S
    Mitchell Hamline School of Law Mitchell Hamline Open Access Faculty Scholarship 2006 Direct Versus Derivative and the Law of Limited Liability Companies Daniel S. Kleinberger Mitchell Hamline School of Law, [email protected] Publication Information 58 Baylor Law Review 63 (2006) Repository Citation Kleinberger, Daniel S., "Direct Versus Derivative and the Law of Limited Liability Companies" (2006). Faculty Scholarship. Paper 233. http://open.mitchellhamline.edu/facsch/233 This Article is brought to you for free and open access by Mitchell Hamline Open Access. It has been accepted for inclusion in Faculty Scholarship by an authorized administrator of Mitchell Hamline Open Access. For more information, please contact [email protected]. Direct Versus Derivative and the Law of Limited Liability Companies Abstract The yh brid nature of limited liability companies causes us to re-invent, or at least re-examine, many doctrinal wheels. This Article will reexamine one of the most practical of those wheels-the distinction between direct and derivative claims in the context of a closely-held limited liability company. Case law concerning the direct/derivative distinction is still overwhelmingly from the law of corporations, although LLC cases are now being reported with some frequency. LLC cases routinely analogize to, or borrow from, the corporate law. This Article encompasses that law, analyzes LLC developments, and argues that courts should (i) avoid the "special injury" rule, (ii) embrace the "direct harm" approach, and (iii) engraft ot the direct harm approach an exception applicable when those in control of a limited liability company harm the company with the "purpose and effect" of injuring a particular member.
    [Show full text]
  • Overview of Shareholder Derivative Litigation
    CHAPTER 1 Overview of Shareholder Derivative Litigation Chapter Contents § 1.01 The Shareholder of the Modern Corporation § 1.02 The Shareholder Derivative Action: Definition [1] A Working Example of Shareholder Litigation [2] Defining the Derivative Suit and Distinguishing It from the Direct Action § 1.03 History [1] Early History [2] Derivative Suits Today § 1.04 Statutes Affecting Derivative Lawsuits [1] The Private Securities Litigation Reform Act [a] Purposes of the Reform Act [b] Provisions of the Reform Act [i] Reduction of Abusive Litigation [ii] Reduction of Coercive Settlements [iii] Auditor Disclosure of Corporate Fraud [2] Securities Litigation Uniform Standard Act (SLUSA) of 1998 [3] Evaluating the Impact of the PSLRA [4] The Sarbanes-Oxley Act of 2002 [5] The Dodd-Frank Wall Street Reform and Consumer Protection Act § 1.05 Nature of the Derivative Suit § 1.01 The Shareholder of the Modern Corporation It is beyond debate that the corporate form has emerged as one of the most frequently employed mechanisms through which to engage in business. This is driven largely by the fact that a corporation offers lim - ited liability, perpetual existence, and easy transferability of interests. 1-1 (Rel. 35) § 1.01 SHAREHOLDER DERIVATIVE LITIGATION 1-2 Given its current status, it is perhaps surprising that the corporation was once regarded with hostility and fear. As Justice Brandeis recog - nized in his dissent in Louis K. Liggett Co. v. Lee : “Although the value of this instrumentality [the corporation] in commerce and industry was fully recognized, incorporation for busi - ness was commonly denied long after it had been freely granted for religious, educational, and charitable purposes.
    [Show full text]
  • The Lost Lessons of Shareholder Derivative Suits
    Washington and Lee Law Review Volume 77 Issue 3 Article 5 Summer 2020 The Lost Lessons of Shareholder Derivative Suits Jessica Erickson University of Richmond School of Law, [email protected] Follow this and additional works at: https://scholarlycommons.law.wlu.edu/wlulr Part of the Business Organizations Law Commons, and the Litigation Commons Recommended Citation Jessica Erickson, The Lost Lessons of Shareholder Derivative Suits, 77 Wash. & Lee L. Rev. 1131 (2020), https://scholarlycommons.law.wlu.edu/wlulr/vol77/iss3/5 This Article is brought to you for free and open access by the Washington and Lee Law Review at Washington & Lee University School of Law Scholarly Commons. It has been accepted for inclusion in Washington and Lee Law Review by an authorized editor of Washington & Lee University School of Law Scholarly Commons. For more information, please contact [email protected]. The Lost Lessons of Shareholder Derivative Suits Jessica Erickson* Abstract Merger litigation has changed dramatically. Today, nearly every announcement of a significant merger sparks litigation, and these cases look quite different from merger cases in the past. These cases are now filed primarily outside of Delaware, they typically settle without shareholders receiving any financial consideration, and corporate boards now have far more ex ante power to shape these cases. Although these changes are often heralded as unprecedented, they are not. Over the past several decades, derivative suits experienced many of the same changes. This Article explores the similarities between the recent changes in merger litigation and the longer history of derivative suits. The trajectories of these lawsuits are not identical, but they nonetheless suggest larger lessons about shareholder litigation, including the predictable ways in which agency costs play out in the courtroom and at the settlement table.
    [Show full text]
  • SHAREHOLDER DERIVATIVE LITIGATION a Primer for Insurance Coverage Counsel
    SHAREHOLDER DERIVATIVE LITIGATION A Primer for Insurance Coverage Counsel By John D. Hughes, Gregory D. Pendleton and Jonathan Toren I. Introduction The recent spate of mergers, acquisitions, leveraged dividends and regulatory investigations has led to a much higher frequency of shareholder derivative actions. Shareholder derivative actions have unique and complicated procedural requirements which this article discusses in detail. Two other corporate procedures, books and records demands and special litigation committees, are frequent companions to shareholder derivative litigation. Accordingly, this article discusses these as well, and the important roles they play in the context of shareholder derivative litigation. Finally, the article also contains a discussion of the types of indemnification permitted under Delaware law, as well as how directors’ and officers’ insurance interacts with these indemnification provisions. II. Purpose of a Derivative Suit: Policing Behavior of Corporate Directors and Officers Corporate directors and officers owe the corporations they serve the fiduciary duties of loyalty and due care. When shareholders believe that either of these duties has been breached to the detriment of the corporation, the available remedy is a shareholder derivative suit. In other words, the purpose of a derivative suit is to redress damage done to the corporation by wayward directors and officers. See, e.g., La. Mun. Police Emples. Ret. Sys. v. Pyott, 46 A.3d 313, 340 (Del. Ch. 2012) (“A breach of fiduciary duty claim that seeks to hold directors accountable for the consequences of a corporate trauma is known colloquially as a Caremark claim [after]…In re Caremark Int’l Inc. Deriv. Litig., 698 A.2d 959 (Del.
    [Show full text]
  • Still Standing
    MCLE ARTICLE AND SELF-ASSESSMENT TEST By reading this article and answering the accompanying test questions, you can earn one MCLE credit. To apply for credit, please follow the instructions on the test answer sheet on page 29. by Peter Zablotsky and Sa’id Vakili Still ST ANDING Defendants in shareholder derivative lawsuits are unlikely to disqualify plaintiffs who can meet ownership and demand requirements UNDER CALIFORNIA LAW, to qualify as separate direct and derivative claims and may An exception exists when the interests of a derivative plaintiff and institute an action maintain a direct action and a derivative the plaintiff in the direct action are so adverse on behalf of a corporation, the plaintiff must action.2 Nothing prevents shareholders from or in such conflict with the interests of the show: 1) status as a shareholder of record, enforcing their personal rights against the other shareholders that the plaintiff cannot holder of a beneficial interest, or holder or a corporation while simultaneously enforcing adequately represent the other shareholders. voting trust certificate, 2) shareholder status the rights of the corporation in a derivative For example, in Hornreich v. Plant Indus- at the time of the wrong to the corporation action. As the court held in Denevi v. LGCC, tries,6 which was prosecuted under the pro- giving rise to the action (the contemporane- one who has “suffered injury both as an visions of Rule 23.1,7 the plaintiff and his ous-ownership rule), and 3) that reasonable owner of a corporate entity and in an indi- brother sold their company to an independent effort was made to inform the corporate vidual capacity is entitled to pursue remedies corporation in exchange for shares of the directors about the action and induce them to in both capacities.”3 Typically, the personal latter’s corporate stock.
    [Show full text]
  • Indemnity and Infidelity: Advancement of Defence Costs in Actions "By
    INDEMNITY AND INFIDELITY: ADVANCEMENT OF DEFENCE COSTS IN ACTIONS "BY . THE CORPORATION" Pamela D. Pengelley* I. INTRODUCTION Indemnification of corporate directors refers to the financial protection provided by the corporation to its directors.1 It shields directors from expenses and liability of legal proceedings alleging breaches of their duty to the corporation.2 This is of concern for directors because, in addition to the potential liability they face if found blameworthy, the cost of funding an adequate defence can be staggering. To illustrate, since 2003, the Sun-Times Media Group Inc. (formerly Hollinger International Inc.) has paid U.S. $107.7 million in legal fees alone to defend Conrad Black and other former officers in the criminal lawsuit launched by the U.S. government, as well as a bevy of civil suits in Canada and the United States.3 Corporate pundits rightly regard liberal indemnification provisions as necessary to recruit capable management4 and to encourage directors to act on behalf of the corporation in a manner * Associate, Cozen O'Connor, Toronto, Ontario. The author would like to thank both Lawrence T. Bowman of Cozen O'Connor, Dallas, Texas and the anonymous reviewer for their helpful comments with earlier drafts of this article. Any errors are solely those of the author. 1. Committee on Corporate Laws, ªChanges in the Model Business Corporations Act Ð Amendments Pertaining to Indemnification and Advance for Expensesº (1994), 49 Bus. Law. 749 at p. 749. Although this article refers to ªdirectorsº, the Canada Business Corporations Act, R.S.C. 1985, c. C-44 (CBCA) provisions respecting indemnity include ªofficersº as well, thus much of this article is applicable to the indemnification of corporate management generally.
    [Show full text]
  • Security for Expense Statutes: Easing Shareholder Hopelessness? Miriam R
    Maurice A. Deane School of Law at Hofstra University Scholarly Commons at Hofstra Law Hofstra Law Faculty Scholarship 2018 Security for Expense Statutes: Easing Shareholder Hopelessness? Miriam R. Albert Maurice A. Deane School of Law at Hofstra University Follow this and additional works at: https://scholarlycommons.law.hofstra.edu/faculty_scholarship Part of the Law Commons Recommended Citation Miriam R. Albert, Security for Expense Statutes: Easing Shareholder Hopelessness?, 24 Fordham J. Corp. & Fin. L. 33 (2018) Available at: https://scholarlycommons.law.hofstra.edu/faculty_scholarship/1222 This Article is brought to you for free and open access by Scholarly Commons at Hofstra Law. It has been accepted for inclusion in Hofstra Law Faculty Scholarship by an authorized administrator of Scholarly Commons at Hofstra Law. For more information, please contact [email protected]. SECURITY FOR EXPENSE STATUTES: EASING SHAREHOLDER HOPELESSNESS? Miriam R. Albert* ABSTRACT The quintessential derivative suit is a suit by a shareholder to force the corporation to sue a manager for fraud, which is admittedly an awkward and likely unpleasant endeavor and, according to the Supreme Court, a “remedy born of stockholder helplessness.”1 Where ownership and control of an enterprise are vested in the same population, the need for a corrective mechanism like a derivative suit is greatly lessened because the owner/managers’ self-interests will arguably guide managerial conduct. But where ownership and control are in separate hands, the incentives change, and managerial conduct may not conform to the owners’ views of the best course of action. This may lead to what the owners consider to be director misconduct.
    [Show full text]
  • The Role of Liability Rules and the Derivative Suit in Corporate Law: a Theoretical and Empirical Anaylsis
    University of Chicago Law School Chicago Unbound Journal Articles Faculty Scholarship 1986 The Role of Liability Rules and the Derivative Suit in Corporate Law: A Theoretical and Empirical Anaylsis Daniel R. Fischel Michael Bradley Follow this and additional works at: https://chicagounbound.uchicago.edu/journal_articles Part of the Law Commons Recommended Citation Daniel R. Fischel & Michael Bradley, "The Role of Liability Rules and the Derivative Suit in Corporate Law: A Theoretical and Empirical Anaylsis," 71 Cornell Law Review 261 (1986). This Article is brought to you for free and open access by the Faculty Scholarship at Chicago Unbound. It has been accepted for inclusion in Journal Articles by an authorized administrator of Chicago Unbound. For more information, please contact [email protected]. SYMPOSIUM THE ROLE OF LIABILITY RULES AND THE DERIVATIVE SUIT IN CORPORATE LAW: A THEORETICAL AND EMPIRICAL ANAYLSIS Daniel R. Fischelt and Michael Bradley 1 I INTRODUCTION Liability rules create incentives to engage in socially desirable conduct. Tort rules, for example, are beneficial because they create incentives for automobile drivers to drive more carefully than they otherwise would. This characteristic of liability rules has led many to argue that such rules should be more frequently utilized in the publicly-held corporation to minimize divergences of interest be- tween managers and investors.' Proposals have included expanding both the duty of care and the duty of loyalty; these proposals would expand the potential legal liability which corporate managers face. t Professor of Law, University of Chicago. B.A. 1972, Cornell University; M.A. 1974, Brown University; J.D. 1977, University of Chicago.
    [Show full text]
  • Removing Nevada Derivative Litigation to Federal Court
    Portfolio Media. Inc. | 111 West 19th Street, 5th Floor | New York, NY 10011 | www.law360.com Phone: +1 646 783 7100 | Fax: +1 646 783 7161 | [email protected] Removing Nevada Derivative Litigation To Federal Court Law360, New York (March 3, 2017, 11:25 AM EST) -- In a case noteworthy for companies incorporated in Nevada, a recent decision by the U.S. District Court for the District of Nevada paved the way for defendants in shareholder derivative lawsuits, brought in Nevada state court and asserting state law claims, to remove the litigation to federal court. The Nevada district court in Gartner ruled, for the first time in the Ninth Circuit, that a company in a shareholder derivative lawsuit — although considered a nominal defendant — can be aligned with, and effectively deemed, a plaintiff for purposes of, and thus easing, removal to federal court.[1] The advantages of litigating in a federal forum can include, for example, greater amenability to a stay of discovery pending a motion to dismiss or a bench with wider exposure to corporate governance matters. We discuss the Sameer Rastogi Gartner decision and its implications in this article. Companies incorporated in foreign states — for example, Delaware[2] and, increasingly, Nevada — face steep legal hurdles in removing shareholder derivative lawsuits, which typically only assert state-based claims and are commenced in the state of incorporation, to the appropriate federal forum. Upon defendants’ removal on diversity grounds, plaintiffs often move to remand on the basis of the “forum defendant rule.” This rule prevents defendants from removing a case to federal court if at least one defendant is a citizen of the forum state.
    [Show full text]
  • Los Angeles Lawyer April 2015
    Exper Guide to THE MAGAZINE OF THE LOS ANGELES COUNTY BAR ASSOCIATION t W PAGE it ne 38 sse s APRIL 2015 / $4 EARN MCLE CREDIT PLUS 2014 Ethics Prosecuting Roundup Elder Financial page 23 Abuse page 30 Lender Liability after Foley page 12 Inverse Condemnation for Water Damage page 14 Secrecy in Doubling Mediation page 68 Down Los Angeles lawyer Robert M. Heller argues that double derivative indemnity litigation may come to California page 16 by Robert M. Heller Doubling Down Doubling Down California has yet to follow Delaware and other jurisdictions and allow double derivative standing ALTHOUGH DOUBLE DERIVATIVE corporation is controlled by the wrongdoers who wished to reduce or eliminate the risk of standing has been adopted in many jurisdic- who may be expected to refuse to file suit breach of fiduciary duty and other actions tions outside California to address the mod- against themselves.3 On the other hand, when against themselves could simply form and ern corporate form,1 California courts have an individual owns an interest in a parent operate through a corporate subsidiary while yet to rule on whether it will be allowed in this company, and its subsidiary is the target of also controlling the parent.5 For this reason, state. Application of the double derivative wrongdoing, the individual does not directly numerous jurisdictions have kept stride with principle permits a shareholder of a parent own shares in the subsidiary.4 Classic single “the realities of the changing techniques and company to sue for harm to its subsidiary and derivative standing does not convey a right to structures of the modern corporation.”6 Courts prevents corporate fiduciaries from using the sue on behalf of the subsidiary, because the in other states have recognized and steadily parent-subsidiary form to circumvent share- individual only owns an interest in the par- expanded the double derivative category of holder derivative litigation.
    [Show full text]
  • Conflicts Inherent in Shareholder Derivative Actions
    March2012_ Master.qxp 2/13/12 1:58 PM Page 20 by SA’ID VAKILI CORPORATIONSIN CONFLICT The potential for conflicts of interest in shareholder derivative lawsuits is high, leading to complex issue for courts and attorneys to resolve SHAREHOLDER DERIVATIVE LAWSUITS the most important are the potential con- and its shareholders and with such care, have not diminished. Indeed, in industries flicts between the shareholder and the cor- including reasonable inquiry, as an ordinar- such as finance and technology, the number poration, between the plaintiff shareholder ily prudent person in a like position would use of these lawsuits is growing.1 A shareholder and other shareholders, and between the cor- under similar circumstances.”4 In addition to derivative suit is typically an action by one or poration and its counsel. Some of these poten- the duty of care, directors also owe a fiduciary more shareholders against some or all of the tial conflicts may also pose ethical challenges duty of loyalty to the corporation they serve. officers or directors of a corporation to redress to the attorneys involved. “Loyalty” means placing corporate and share- corporate mismanagement. While the cor- Although myriad acts can underlie a claim, holder interests ahead of any other business poration itself is usually named as a defen- shareholder derivative actions usually emerge or personal interests.5 dant, its status as defendant is nominal. In as a result of breaches of fiduciary duties by Discharging these obligations requires the practice, the interests of the shareholder and officers or directors. These duties, long rec- exercise of sound business judgment.
    [Show full text]