The dismissal of a putative stockholder derivative complaint for failure to make pre-suit demand has long been understood to have preclusive effect against attempts by different stockholders to relitigate the demand issue in another court. These decisions recognize that because a stockholder derivative plaintiff sues in the company's name, privity for preclusion purposes exists between the plaintiffs in the first and subsequent actions making similar allegations because in both, the company is the real party in interest. Two recent Court of Chancery decisions have introduced uncertainty in Delaware and potentially elsewhere by urging that this long-standing derivative preclusion rule violates due process. In In re EZCORP Consulting Agreement Deriv. Litig., 130 A.3d 934 (Del. Ch. 2016), the court stated in dictum that the reasoning of the U.S. Supreme Court's Smith v. Bayer, 564 U.S. 299 (2011), which held that absent class members are non-parties who are not bound by any rulings in the case unless and until a class is certified, should mean that stockholders pursuing derivative actions are not in privity with each other until the action has survived a motion to dismiss for failure to adequately plead demand futility under Rule 23.1. Under this approach, due process would foreclose any preclusive effect of a prior demand futility determination on anyone other than the named stockholder plaintiff. Last month, In re Wal-Mart Stores Delaware Deriv. Litig., 2017 WL 3138201 (Del. Ch. July 25, 2017), adopted and amplified EZCORP, recommending that the Delaware Supreme Court adopt a non-preclusion rule that would permit successive derivative litigation.

Pre-Suit Demand and Preclusion

Derivative claims belong to the corporation, which is why a stockholder must make a demand on the company's board or adequately allege demand futility to pursue derivative claims on the company's behalf. To prevent abuse of the derivative form of suit, as a precondition to seeking to enforce a right of a corporation a stockholder must demonstrate that the corporation refused to proceed as requested after suitable demand, unless demand is excused because particularized allegations create reasonable doubt that a majority of the board could impartially consider a demand.

Parallel lawsuits regarding the same allegations are a familiar dynamic in stockholder litigation. In derivative litigation, recent Delaware decisions have sought to curb fast-filed, inadequately-investigated complaints by emphasizing that when stockholders sue in Delaware in a representative capacity, “first-to-file” does not control which plaintiff and their counsel will be granted the leadership role. When suits are filed in more than one forum, a key strategic objective for defendants is avoiding the burden and expense of litigating the same issues in multiple jurisdictions. Once the first final decision on demand-related allegations is rendered, preclusion doctrine protects these interests by prohibiting different stockholders from relitigating the derivative claim.

A request that one court give preclusive effect to a judgment entered in another court invokes constitutional full faith and credit principles. The preclusive effect of a judgment is determined by the law of the forum in which the judgment was rendered. In Delaware and elsewhere, subject to due process, courts give the same preclusive effect to the judgment of another state or federal court as the original court would give. Pyott v. La. Mun. Police Empls.' Ret. Sys., 74 A.3d 612, 615-16 (Del. 2013).

'Wal-Mart'

In response to a Supreme Court remand from a prior dismissal asking the court to address “the complex question” of whether the demand futility preclusion rule violates due process, Chancellor Andre Bouchard reconsidered and changed his prior ruling and recommended that the Supreme Court adopt the rule proposed in EZCORP. In Wal-Mart, allegations of a bribery scheme engendered derivative suits by different stockholders in Arkansas federal court and Delaware. The Arkansas suit was dismissed for failure to plead demand futility while the Delaware plaintiffs were litigating a books and records demand in an effort to bolster their complaint. The Chancellor dismissed the Delaware action based on the issue-preclusive effect of the Arkansas decision. On appeal, the Delaware Supreme Court stated that it was “presently satisfied” that the Chancellor properly applied Arkansas privity law and correctly determined that the stockholders in both suits were in privity because in both, the corporation was the real party in interest. The Supreme Court noted that the Delaware plaintiffs could have intervened in the Arkansas suit, but did not. It ruled, however, that the Chancellor had not sufficiently addressed whether precluding the subsequent suit was consistent with due process, specifically pointing to EZCORP, and remanded for consideration of that question.