A Tale of Two Derivative Suits: Issue Preclusion and Comity Prevail

The Delaware Supreme Court declined to adopt a new standard governing issue preclusion of derivative actions, creating a tension with Delaware courts' forceful encouragement that stockholders fully investigate their claims before pursuing such actions on behalf of a company. On Jan. 25, the court issued its decision in California State Teachers Retirement System v. Alvarez fully dismissing a shareholder action against Walmart Inc. and its board and concluding years of deliberation at both the Delaware Court of Chancery and Supreme Court levels over whether a hastily pursued derivative suit should have a preclusive effect against more diligent plaintiffs.

Background

In early 2016, the Delaware Court of Chancery dismissed a derivative action involving Walmart on the ground that dispositive issues had already been litigated and resolved in the U.S. District Court for the Western District of Arkansas. The earlier Arkansas action was dismissed for failure to adequately plead demand futility—a prerequisite to bringing a derivative action without first requesting that a company's board of directors institute the action themselves. Because similar (though not identical) demand futility arguments were raised in the Delaware action, Chancellor Andre G. Bouchard determined that the dismissal of the Arkansas action was dispositive in the Delaware case on the basis of collateral estoppel, or issue preclusion.

Plaintiffs disputed the Chancery Court's mechanical application of the issue preclusion doctrine on a number of grounds. Most significantly, however, plaintiffs argued that the Arkansas action was only filed and resolved prior to the Delaware action because the Arkansas plaintiffs rushed their case while the Delaware plaintiffs performed a more thorough investigation, including by making a books and records request under Section 220 of the Delaware General Corporation Law. The Delaware plaintiffs argued such diligence—which was undertaken after heeding the blunt warnings from then-Chancellor Leo Strine to do so—should be credited rather than punished.

First Appeal and Partial Remand

On appeal in mid-2017, the Delaware Supreme Court declined to affirm or deny the Chancery Court's decision and instead remanded the case asking the Chancery Court to address whether the facts in that case implicated due process concerns for stockholders. On remand, Bouchard issued a supplemental opinion agreeing with the Delaware Supreme Court's statement that the facts presented “a troubling case.” Specifically, the chancellor noted the tension between two well-established and now competing principles: the encouragement that stockholders fully investigate their claims—including via books and records requests—before pursuing derivative actions, and the widely recognized principles of comity and judicial efficiency in recognizing the decisions of other courts that concern the same issues.

In an attempt to reconcile this tension, Bouchard recommended that the Delaware Supreme Court adopt a standard previously endorsed only in dicta that “a judgment cannot bind the corporation or other stockholders in a derivative action until the action has survived a Rule 23.1 motion to dismiss, or the board of directors has given the plaintiff authority to proceed by declining to oppose the suit.” However, recognizing that the Delaware Supreme Court would need to adopt such a standard before it could be applied, Bouchard conditionally reaffirmed that dismissal was appropriate and that plaintiffs' due process rights had not been violated.

Final Decision

After considering the supplemental opinion, the Delaware Supreme Court declined to adopt Bouchard's proposed new standard and affirmed dismissal of the Delaware action. Recognizing once again that “this dispute implicates complex questions of law and policy,” the Delaware Supreme Court ultimately held that “our state's interest in governing the internal affairs of Delaware corporations must yield to the 'stronger national interests that all state and federal courts have in respecting each other's judgments.'”