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In re Wal-Mart Stores, Inc. Delaware Derivative Litigation

Court of Chancery of Delaware

July 25, 2017


          Stuart M. Grant, Michael J. Barry, and Nathan A. Cook, GRANT & EISENHOFER P.A., Wilmington, Delaware; Ned Weinberger, LABATON SUCHAROW LLP, Wilmington, Delaware; Daniel Girard, Dena Sharp, Jordan Elias, and Adam Polk, GIRARD GIBBS LLP, San Francisco, California; Thomas A. Dubbs, Louis Gottlieb, and Jeffrey A. Dubbin, LABATON SUCHAROW LLP, New York, New York; Frederic S. Fox, Hae Sung Nam, Donald R. Hall, and Jeffrey P. Campisi, KAPLAN FOX & KILSHEIMER LLP, New York, New York; David C. Frederick, KELLOGG, HUBER, HANSEN, TODD, EVANS & FIGEL, P.L.L.C., Washington, District of Columbia; Samuel Issacharoff, KELLOGG, HUBER, HANSEN, TODD, EVANS & FIGEL, P.L.L.C., New York, New York; Co-Lead Counsel for the Co-Lead Plaintiffs.

          Donald J. Wolfe, Jr., Stephen C. Norman, and Tyler J. Leavengood, POTTER ANDERSON & CORROON LLP, Wilmington, Delaware; Theodore J. Boutrous, Jr. and Alexander K. Mircheff, GIBSON, DUNN & CRUTCHER LLP, Los Angeles, California; Mark A. Perry, GIBSON, DUNN & CRUTCHER LLP, Washington, District of Columbia; Attorneys for Appearing Defendants.


          BOUCHARD, C.

          This supplemental opinion is submitted in response to the Delaware Supreme Court's order of remand (the "Remand Order") asking this Court to address the following question:

In a situation where dismissal by the federal court in Arkansas of a stockholder plaintiff's derivative action for failure to plead demand futility is held by the Delaware Court of Chancery to preclude subsequent stockholders from pursuing derivative litigation, have the subsequent stockholders' Due Process rights been violated? See Smith v. Bayer Corp., 564 U.S. 299 (2011).[1]

         The first sentence of the Remand Order states: "This is a troubling case."[2] I agree. The trouble arises from a tension in competing policies. On the one hand, Delaware courts have long encouraged stockholders contemplating derivative actions to use the "tools at hand"-in particular to obtain corporate books and records under Section 220 of the Delaware General Corporation Law-before filing derivative litigation so that the issue of demand futility may be decided on a well-developed factual record.[3] On the other hand, as a matter of comity and in the interest of preserving judicial resources, public policy discourages duplicative litigation. The tension between these policies in representative stockholder litigation involving multiple forums is heightened by the "fast-filer" phenomenon, where counsel handling cases on a contingent basis have a significant financial incentive to race to the courthouse in an effort to beat out their competition and seize control of a case, often at the expense of undertaking adequate due diligence.

         Courts that have considered whether a stockholder plaintiff in a second derivative action is barred from re-litigating the issue of demand futility based on the failure of a plaintiff to demonstrate demand futility in a first derivative action- in particular two federal circuit courts-have found that due process is satisfied if the plaintiff in the first action adequately represented other stockholders of the corporation who were not parties to the first action. In doing so, those courts have applied principles from the Restatement (Second) of Judgments (the "Restatement"). This is the approach I followed in concluding in my memorandum opinion dated May 16, 2016 that the earlier Arkansas decision precluded re-litigation of the demand futility issue in Delaware ("Wal-Mart I").[4] In other words, my consideration of due process in Wal-Mart I was embedded in the determination of adequacy of representation.

         Based on the approach used in Wal-Mart I and the federal circuit court decisions it follows, the answer to the question posed in the Remand Order would be "no" unless the representative plaintiff's management of the first derivative action was "so grossly deficient as to be apparent to the opposing party"[5] or failed to satisfy one of the Restatement's other criteria for determining adequacy of representation.[6]But that does not mean that a better approach is not worthy of consideration.

         In In re EZCORP, Inc. Consulting Agreement Derivative Litigation, Vice Chancellor Laster stated in dictum that, both as a matter of Delaware law and as a matter of due process, 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."[7] EZCORP thus endorses a bright-line rule drawing a distinction between the pre- and post-demand futility phases of derivative litigation. In doing so, the Court analogized derivative actions to class actions, relying on the United States Supreme Court's adoption of a similar bright-line rule in Smith v. Bayer, which distinguished between pre- and post-certification in the class action context, although Bayer explicitly was not decided on due process grounds.[8]

         Considering afresh the question presented in the Remand Order, I recommend that the Supreme Court adopt the rule proposed in EZCORP. Although no court has done so to date, and although the Supreme Court previously declined to embrace such a rule in the context of considering the question of privity in derivative litigation, [9] it is my opinion for the reasons explained below that this rule will better safeguard the due process rights of stockholder plaintiffs and should go a long way to addressing fast-filer problems currently inherent in multi-forum derivative litigation.

         I. BACKGROUND

         A detailed description of the factual background giving rise to this action is set forth in Wal-Mart I.[10] This supplemental opinion assumes general familiarity with Wal-Mart I and sets forth below only certain facts relevant to addressing the issue on remand.

         A. The Arkansas Litigation

         In April 2012, The New York Times published an article detailing an alleged bribery scheme at Wal-Mart de Mexico, a subsidiary of Wal-Mart Stores, Inc. ("Wal-Mart"), and the related cover-up. Shortly after the article was published, Wal-Mart stockholders filed multiple derivative suits in Delaware and Arkansas.

         The United States District Court for the Western District of Arkansas consolidated the federal actions in Arkansas, and the Arkansas plaintiffs filed a consolidated complaint on May 31, 2012. The Arkansas complaint asserted claims against certain of Wal-Mart's current and former directors and officers for breach of fiduciary duty and for violations of Sections 14(a) and 29(b) of the Securities Exchange Act.[11] On March 31, 2015, the district court granted defendants' motion to dismiss the Arkansas complaint under Federal Rule of Civil Procedure 23.1 for failing to adequately allege demand futility (the "Arkansas Decision").[12] On July 22, 2016, the Eighth Circuit affirmed the Arkansas Decision.[13]

         B. The Delaware Litigation

         Around the same time the Arkansas litigation was beginning, seven derivative actions were filed in this Court. On June 6, 2012, plaintiff Indiana Electrical Workers Pension Trust Fund IBEW sent Wal-Mart a demand for books and records under 8 Del. C. § 220. On August 13, 2012, after Wal-Mart produced certain documents, IBEW filed a Section 220 complaint alleging deficiencies in Wal-Mart's document production.[14] On September 5, 2012, the Court of Chancery consolidated the seven derivative actions, appointed co-lead plaintiffs and co-lead counsel, and ordered plaintiffs to file a consolidated amended complaint after completion of the Section 220 action.[15]

         After a trial on the papers, an appeal to the Delaware Supreme Court, [16] and a subsequent motion for contempt, [17] the Section 220 action eventually reached a final resolution on May 7, 2015.[18] In the meantime, on May 1, 2015, about one month after the district court's dismissal of the Arkansas complaint, the Delaware plaintiffs filed the Verified Consolidated Amended Stockholder Derivative Complaint in this action, asserting a single claim against certain of Wal-Mart's current and former directors and officers for breach of fiduciary duty.

         On June 1, 2015, defendants in the Delaware action moved to dismiss, arguing that the Arkansas Decision collaterally estopped plaintiffs from alleging demand futility, and that even if they were not collaterally estopped, plaintiffs had failed to adequately plead demand futility under Court of Chancery Rule 23.1.

         I granted defendants' motion to dismiss on May 13, 2016, finding that the Arkansas Decision precluded the Delaware plaintiffs from re-litigating the issue of demand futility.[19] Specifically, I held that "[s]ubject to Constitutional standards of due process, Arkansas law governs the question of issue preclusion in this case."[20] Under Arkansas law, issue preclusion applies when the following requirements are satisfied:

(1) the issue sought to be precluded must be the same as the issue in the prior litigation; (2) the issue must have been actually litigated; (3) the issue must have been determined by a valid and final judgment; and (4) the determination must have been essential to the judgment. In addition, the parties to be precluded must have been parties in the prior litigation or been in privity with those parties. Finally, the precluded party must have been adequately represented in the previous litigation.[21]

         Although Arkansas courts have not addressed issue preclusion in the context of stockholder derivative suits, which involves unique issues of "privity" and "adequate representation, " I concluded, based on the clear weight of authority from other jurisdictions and guidance from the Restatement, that an Arkansas court likely would find the test for issue preclusion satisfied in this case.

         In reaching my conclusion on the "privity" issue, I looked to "decisions from courts in other jurisdictions, the Restatement, and principles of public policy."[22] I noted that "[a]pplying the privity requirement to derivative actions involving two different stockholder plaintiffs raises the question whether the required privity is between the two stockholders, or between each stockholder and the corporation."[23] After reviewing an extensive body of case law from other jurisdictions, I found that:

The vast majority of other jurisdictions that have decided the issue have concluded that privity exists between different stockholder plaintiffs who file separate derivative actions. The common theme in the opinions where privity has been found is that the corporation is the real party in interest in both the first derivative action and the subsequent suit. Viewed in this fashion, the first stockholder plaintiff does not represent the second stockholder plaintiff. Instead, both plaintiffs sue on behalf of the corporation and are essentially interchangeable.[24]

         I also found that "the Restatement is ambiguous on the privity question in the derivative context, "[25] and that "public policy arguments exist on both sides of the privity question, " but concerns about fast-filers "may be balanced by requiring that a derivative plaintiff be an adequate representative in order for a judgment to have a preclusive effect on subsequent actions."[26] As a result, I determined that Arkansas courts likely would find the privity requirement satisfied.

         In the last part of my issue preclusion analysis, I considered whether the Arkansas plaintiffs were adequate representatives, and in doing so, addressed the issue of due process that is embedded in the adequate representation requirement.[27] More specifically, as explained in the opinion, I looked, as other courts have done, to the Restatement for an analytical framework to determine compliance with due process "because Constitutional principles of due process are embedded in the pertinent provisions of the Restatement."[28] Applying Section 42 of the Restatement, I concluded that the Arkansas plaintiffs were adequate representatives because their interests were not misaligned, and because their representation was not "grossly deficient, " which is a key standard for determining inadequacy under the Restatement:

The failure of a representative to invoke all possible legal theories or to develop all possible resources of proof does not make his representation legally ineffective, any more than such circumstances overcome the binding effect of a judgment on a party himself. . . . Where the representative's management of the litigation is so grossly deficient as to be apparent to the opposing party, it likewise creates no justifiable reliance interest in the adjudication on the part of the opposing party. Tactical mistakes or negligence on the part of the representative are not as such sufficient to render the judgment vulnerable.[29]

         In assessing whether the Arkansas plaintiffs' representation was grossly deficient, I relied on guidance from the Delaware Supreme Court in Pyott v. Louisiana Municipal Police Employees' Retirement System ("Pyott II"), which rejected a presumption of inadequacy for stockholders who fail to pursue books and records before filing derivative actions.[30] In this case, as in Pyott II, there was no basis on which to conclude that the Arkansas plaintiffs were inadequate representatives absent such a presumption.[31] For these reasons, I determined that a court in Arkansas would accord preclusive effect to the Arkansas Decision and, impliedly, that the Delaware plaintiffs' constitutional right to due process had not been violated.

         C. The Remand Order

         Plaintiffs appealed from Wal-Mart I. On January 18, 2017, the Delaware Supreme Court issued the Remand Order, asking this Court to address the following question:

In a situation where dismissal by the federal court in Arkansas of a stockholder plaintiff's derivative action for failure to plead demand futility is held by the Delaware Court of Chancery to preclude subsequent stockholders from pursuing derivative litigation, have the subsequent stockholders' Due Process rights been violated? See Smith v. Bayer Corp., 564 U.S. 299 (2011).[32]

         Following remand, the Court received supplemental briefing from the parties.

         II. ANALYSIS

         A. Nonparty Preclusion in General

         In Richards v. Jefferson County, Alabama, the United States Supreme Court stated that:

State courts are generally free to develop their own rules for protecting against the relitigation of common issues or the piecemeal resolution of disputes. We have long held, however, that extreme applications of the doctrine of res judicata may be inconsistent with a federal right that is "fundamental in character."[33]

         As I read the Remand Order, the Delaware Supreme Court appears to agree with the issue preclusion analysis set forth in Wal-Mart I as a matter of Arkansas state law, [34]which follows the approach most jurisdictions have taken. Thus, frankly stated, the issue presented on remand is whether the predominant approach on issue preclusion in the derivative action context constitutes such an "extreme application[] of the doctrine of res judicata" as to affront due process.

         In 2008, in Taylor v. Sturgell, the United States Supreme Court struck down, on due process grounds, a "virtual representation" theory that was purportedly based on some Supreme Court decisions "recognizing that a nonparty may be bound by a judgment if she was adequately represented by a party to the earlier suit."[35] The Court began its analysis by citing the general rule stated in Hansberry v. Lee that "one is not bound by a judgment in personam in a litigation in which he is not designated as a party or to which he has not been made a party by service of process."[36] The Court then delineated six categories of recognized exceptions to the general rule against nonparty preclusion:[37]

First, a person who agrees to be bound by the determination of issues in an action between others is bound in accordance with the terms of his agreement.
** * * *
Second, nonparty preclusion may be justified based on a variety of preexisting substantive legal relationships between the person to be bound and a party to the judgment.
** * * *
Third, . . . in certain limited circumstances, a nonparty may be bound by a judgment because she was adequately represented by someone with the same interests who was a party to the suit. Representative suits with preclusive effect on nonparties include properly conducted class actions, and suits brought by trustees, guardians, and other fiduciaries.
** * * *
Fourth, a nonparty is bound by a judgment if she assumed control over the litigation in which that judgment was rendered.
Fifth, a party bound by a judgment may not avoid its preclusive force by relitigating through a proxy.
* * * * *
Sixth, in certain circumstances a special statutory scheme may expressly foreclose successive litigation by nonlitigants . . . if the scheme is otherwise consistent with due process.[38]

         In the lower court opinion in Sturgell, the D.C. Circuit purported to ground its virtual representation doctrine in the third exception that, "in some circumstances, a person may be bound by a judgment if she was adequately represented by a party to the proceeding yielding that judgment."[39] The Supreme Court, however, found that the D.C. Circuit had misapprehended the constitutional standard of "adequate representation, " which required, at a minimum, "either special procedures to protect the nonparties' interests or an understanding by the concerned parties that the first suit was brought in a representative capacity."[40]

         The Sturgell Court's focus on the adequacy of representation in its due process analysis of the application of the third exception suggests that the "adequate representation" requirement provides the core constitutional check on when a nonparty may be bound by a judgment against someone with the same interests who was a party in a prior suit. In addition, although not many cases have addressed the issue of due process in the context of precluding relitigation of demand futility in stockholder derivative actions, those that have done so-in particular two federal circuit courts-also focused their due process inquiries on the adequacy of representation.

         B. Nonparty Preclusion in Derivative Actions: Arduini and Sonus

         In 2014, in Arduini v. Hart, the Ninth Circuit affirmed a district court's dismissal of a derivative action filed by plaintiff Lawrence Arduini.[41] Arduini had filed his action in federal court in Nevada against International Gaming Technology and its board of directors, alleging that certain officers of the company made intentionally misleading statements about the company's financial prospects.[42]Before Arduini filed his lawsuit, however, the same court had dismissed another derivative action (the Fosbre action) asserting substantially similar claims for failure to make a demand on the company's board or to sufficiently allege demand futility.[43]Applying the doctrine of issue preclusion, the district court held that Arduini was barred from relitigating demand futility based on the dismissal of the Fosbre action. In an opinion post-dating Sturgell, the Ninth Circuit affirmed.[44]

         Arduini contended on appeal that issue preclusion should not apply because, among other things, "he is not in privity with the Fosbre plaintiffs for the purposes of issue preclusion, " and "the equities and due process weigh against applying issue preclusion here."[45] On the privity issue, Arduini advanced the same argument as the plaintiffs in Wal-Mart I, namely, that "there is no privity because shareholders who fail to establish their representative capacity can only act on their own behalf and are not in privity with other shareholders."[46] Significantly, the Ninth Circuit followed the majority rule from other jurisdictions to find privity, despite its stated concern about due process rights:

The fact that Arduini was not a party to the Fosbre case does potentially raise concerns. The Nevada Supreme Court has stated that issue preclusion can only be used against a party whose due process rights have been met by virtue of that party having been a party or in privity with a party in the prior litigation.[47]

         Thus, in holding the way it did, the Ninth Circuit implicitly rejected the notion that finding privity between Arduini and his fellow stockholders violated due process even though the earlier stockholder plaintiffs failed to establish demand futility.

         The Ninth Circuit also expressly considered due process in connection with its discussion of adequate representation.[48] It noted that "precluding the suit of a litigant who has not been adequately represented in the earlier suit would raise serious due process concerns."[49] Although the Court left "for another day the precise contours of what conduct constitutes inadequate representation, " the authorities it cited were consistent with the "grossly deficient" standard in the Restatement. In particular, the Court cited In re Sonus Networks, Inc., Shareholder Derivative Litigation, a First Circuit decision (discussed below) that adopted the "grossly deficient" standard, [50] and it looked to Section 42(1) of the Restatement, which, as noted above, utilizes a "grossly deficient" standard for ...

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