Over the years, I’ve bemoaned the lack of “litigation” in “securities litigation.” In this post, I discuss the same problem in “derivative litigation:” why don’t we litigate derivative cases anymore?
Derivative litigation – in which a stockholder asserts claims that belong to the company – takes multiple forms: tag-along cases to securities class actions; stand-alone claims related to other types of alleged legal or business problems; and challenges to mergers and acquisitions. In this post, I focus on tag-along derivative claims.
For the first 15+ or so years after tag-along derivative litigation became ubiquitous, we frequently filed motions to dismiss for failure to make a demand on the board – and won the vast majority of them. But about 10 years ago, most defense counsel started to forego demand motions and, instead, began to negotiate stay agreements with derivative plaintiffs or moved for stays.
Given the high success rate of demand motions, why did this shift happen?
There are several culprits:
- One reason is the perceived lack of a safety net if the demand motion fails. That perception has roots in then-Vice Chancellor Leo Strine’s notorious 2003 decision in In Re Oracle Corp. Derivative Litigation, 824 A.2d 917 (Del. Ch. 2003), in which he held that the Oracle board’s SLC lacked sufficient independence from CEO Larry Ellison – the “too much vivid Stanford Cardinal red” decision. Ever since Oracle, boards have hesitated to form SLCs. The more recent Oracle SLC case, in which the SLC decided to let the shareholders take over the litigation, didn’t help boards’ confidence in SLCs. On top of the perceived substantive risk, SLC investigations are often very expensive.
- Stays seem smart in light of two additional trends: (1) confidence that the defendants will prevail on the securities class action motion to dismiss; and (2) reflexive settlement if the defendants lose the securities motion to dismiss. Why take a risk that you’ll lose the demand motion, the thinking goes, when you’ll win the underlying securities motion to dismiss and will just settle if you don’t. Stays seem more efficient than spending money on a demand motion. As defense costs have consistently risen, companies and carriers have seen this as a place to save money.
- Delaware forum bylaws have split apart the forums for securities class actions and derivative actions. Before Delaware forum bylaws, federal derivative cases were frequently filed in or transferred to the securities class action forum, coordinated, and handled by the same judge. And state court derivative cases were handled by judges in the same city as the federal judge, which tended to create sufficient coordination and cohesion. We thus could make sure that if we made a demand motion, it would lag behind the securities class action motion to dismiss. Now, that’s more difficult to accomplish – creating the risk that the demand motion could be decided (and denied) before the securities class action motion to dismiss is decided.
Failure to make demand motions has consequences. Most significantly, the number of derivative cases overall and in individual cases continues to rise – if you’re a derivative plaintiffs’ lawyer, there’s little downside to filing a case or making a board demand if you find a client. While there is only one derivative claim no matter how many plaintiffs’ lawyers file a case (or make a board demand), as a practical matter, the more derivative plaintiffs there are, the more difficult it is to obtain voluntarily dismissals if the securities motion to dismiss is granted or to settle if it is denied.
What should we do about it? I don’t think we should go back to routine demand motions. There are good reasons, in particular cases and overall, to stay derivative cases. Instead, I think we need to start at least making a deliberate, strategic decision whether to make a demand motion or agree to or move to stay based on the circumstances.
But we definitely should not sell demand motions short. They are a high-percentage motion, and they can (and usually should) be straightforward and utilize the already-developed securities class action arguments when arguing against a substantial likelihood of director liability. The risk that a Delaware court could decide the demand motion first is a significant factor that needs to be weighed, but with good case management and communication with the court, it’s a manageable risk in many cases. And even if a demand motion fails, an SLC is an effective procedure and doesn’t need to break the bank, as I’ve written.
The key, as in so many areas of securities and derivative litigation, is improved strategic analysis and collegiality among the defendants, defense counsel, the insurers, and the broker. Together, we can make good judgment calls and improve outcomes.