Part II Running the Corporation Unit 7 SHAREHOLDER LITIGATION

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Whither we go Shareholder litigation

Types of suits: “Direct” versus “derivative”
Derivative suits
Procedural requirements
Levine on “demand” “Special Litigation Committees” (SLCs)
Zapata and In re Oracle
Policy and recent changesin the litigation landscape
Forum clauses, fee-shifting, settlements

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Introducing Shareholder litigation

General principle. Shareholder litigation is the primary mechanism of enforcing fiduciary duties; the
threat of litigation “disciplines” management

Analysis. Law and practice are motivated by two forces: ¤ (1) Adverse selection (of suits).

Q. How to encourage the meritorious suits and discourage the frivolous suits?
A. “Demand” requirements (for derivative suits)

(2) Collective action failures

Q. How to encourage any suits at all?

A. Attorney’s fees (!)

Direct versus derivative, generally

There are two types of shareholder lawsuits:

Direct - Shareholder sues, directly asserting its own claim. Typically brought as a class action. Not
necessarily of all shareholders
Derivative-Shareholder sues on behalf of the corporation. Shareholder brings a claim that belongs to the
corporation. Thus, the shareholder must additionally show that it should be allowed to bring the claim
“derivatively”

What distinguishes a direct from a derivative claim?

Legal test. Tooleyv. DLJ.
Ask whether it is the shareholder or corporation that:
(1) Suffered harm, and (2) Would receive benefit of recovery

Practically Direct. Shareholder’s rights are at stake: M&A Ex. Smith v. Van Gorkom; Weinberger
Derivative. “Merely” money: executive compensation, oversight liability, self-dealing, waste
Ex. In re Disney; Sinclair Oil v. Levin, Stone v. Ritter

Policy and practice

(Policy.) Does it even make sense to distinguish between “direct” versus “derivative” claims?

Don’t they all hurt shareholders?

The Board supremacy. DGCL § 141
 The board “should” decide when and how to litigate the corporation’s claims, like any other corporate
matter, since it concerns the disposition of a corporate “asset” (the claim)
This argument does not hold when the claim belongs to the shareholder
(Practice.) What if I don’t know which claim to bring? ¤ Plead both (!)

Derivative suits Procedural requirements, no.1

Contemporaneous ownership.
Shareholder must have held stock at the time of alleged wrongdoing; and continue to hold for duration of
action. DGCL § 327

Why have a contemporaneous ownership requirement?

Continued ownership is sound because the incentive to litigate is missing (if not perverse) if the plaintiff
doesn’t hold any interest in the corporation during litigation.

But what about someone who purchases a share after the wrongdoing? Why bar them from suing?
(But) see In re Transkaryotic (2007) and “appraisal arbitrage” See also other questions in AK p.386
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Derivative suits Procedural requirements, no.2

Demand. Under Del. Chancery Ct. Rule 23.1(a), the shareholder-plaintiff must plead either:
(1) it demanded the board bring suit, but board refused (“demand refused”), or
(2) that such demand would be futile and so should be excused (“demand excused”)

In practice, virtually all plaintiffs choose (2).Why? The act of demand concedes that the board is
independent and disinterested. So why would any plaintiff do this?

Levine v. Smith

Facts
Ross Perot is a 0.8% shareholder of GM, a director of GM, and an outspoken critic of GM’s management.
GM buys out Perot (& friends). GM board (excluding Perot) approves a deal: GM gives Perot’s group
$743m for their shares and a promise to not criticize GM

Procedure
Shareholders bring a derivative suit challenging the transaction (in short, because GM paid “too much”)
Chancery dismisses. Supreme Court affirms

Question, no.1

When will a court excuse the demand requirement?

Plaintiff must plead with particularity that a majority of the board . . .

(1) Is interested or lacks independence, OR
(2) Failed to exercise due care
Specifically, that there is a reasonable doubt that the action was a valid exercise of business judgment.
Does this mean rebutting the business judgment rule?
What does it mean to plead with particularity? Pleading specific facts. E.g., which here demonstrate the
director is interested or lacks independence
Question, no.2
According to the court, were a majority of the directors interested or lacking independence? According to you?
Court says No. Court does not revisit question of interest.
Did the directors really have no personal interest in ridding themselves of Perot?
Court rejects dominated directors claim for lack of particularized facts
Why?
Plaintiffs seem to plead the same facts for the dominance claim as for the failure to exercise duty care
claim [(1) and (2) from the last slide]

Moral: If you plead both, don’t just cut-and-paste the argument (!)

Takeaways Levine v. Smith

Test for demand-excused.

To survive dismissal, the shareholder-plaintiff in a derivative suit must plead particularized facts that
show (1) A majority of directors are interested or lacked independence (i.e., dominated); thus, incapable
of exercising judgment over whether to bring the suit, or (2) There is a reasonable doubt that the
transaction was not the product of reasoned business judgment.

If demand is refused(b/c shareholder first asked the board to bring the suit) then shareholder concedes
(1) and so only (2) remains available

Demand excusal
Special litigation committees (“SLCs”)

Recall. Boards have power to convene and delegate decisions to committees.

DGCL § 141(c)(2) In practice, corporations create “Special Litigation Committees” (SLCs) to intervene
when the shareholder skips demand in a derivative suit
Timeline of an SLC
“Demand-excused” derivative suit survives motion to dismiss. Board forms SLC, composed of the most
disinterested directors it can find; SLC hires its own lawyers and investigates claim ¤ SLC (typically)
moves for dismissal on behalf of the corporation Del. court considers motion with some deference.
Exactly how?

Zapata v. Maldonado

Facts.

Plaintiff-Maldonado is a shareholder of Zapata

Procedure

Maldonado brings a derivative claim against the directors of Zapata; pleads demand futility. By the time
the case is before the court, four director defendants have left Zapata; two new outside directors are
appointed.

Board convenes an SLC (the “Independent Investigation Committee”) composed of those two new
directors. Committee concludes that pursuing the claims is not in the corporation’s interest.
Thus, the SLC causes the corporation, Zapata, to move for dismissal.

Question, no.1
What’s the tradeoff between
(1) Giving BJR deference to a properly convened SLC’s motion to dismiss a derivative suit, versus:
(2) Ignoring it?

According to the court: (1) Strips the derivative suit of its enforcement power, while (2) increases the risk
of meritless suits

The tradeoff is b/t two extremes of screening derivative suits ¤ Thus, the Del. court chooses a balance ¤
What’s wrong with BJR deference?

Takeaways Zapata v. Maldonado

What’s the court’s solution to this tradeoff?

I.e., how does the court review an SLC’s motion to dismiss derivative litigation?
Two steps:
(1) Corporation has burden of demonstrating that the SLC is convened and its investigation conducted in
good faith; and further that the SLC is composed of independent directors; plaintiff gets limited discovery
to refute this
(2) “The Court should determine, applying its own independent business judgment, whether the motion
should be granted.” [Meaning? See In re Oracle . . . ]

In re Oracle Corp. Deriv. Litig.

Facts:

Defendant-CEO-Chairman-Ellison is the largest shareholder of Oracle

Procedure:

Shareholders bring a derivative suit against Ellison and other directors for “breaching their duty of
loyalty by misappropriating inside information and using it as the basis for trading decisions”. Oracle’s
Board recruits two new directors to constitute a special litigation committee; both are Stanford professors.
The SLC’s report concludes the derivative litigation is not in Oracle’s interest; SLC moves to dismiss. Del.
Chancery denies the motion

Question, no.1

Chancery granted limited discovery to do what? And why?

To investigate three things:

(1) “the independence of the SLC”
(2) “the good faith of its investigative efforts”
(3) “the reasonableness of the bases for its conclusion that the lawsuit should be terminated”

Why these three? It’s straight from Zapata’s standard for reviewing SLC motions. What about Zapata’s second
step?

Question, no.2
Did the SLC show independence? Why or why not independent? And how was this argued?
Not independent; SLC did not satisfy the burden
Why?

Because of the SLC members’ many connections with the defendant-directors: Former professor (Boskin),
generous benefactor (Lucas, Ellison)
How?
“It is critical to note I do not infer that [the SLC member] would be tougher on someone with whom he
did not have connections . . . [but instead] that a person in his position would find it difficult [to not
consider his association]

Tactic: Abstract away from the SLC member; focus on the associations; the direction of bias is immaterial

Shareholder litigation Attorney’s fees

General principle (attorney’s fees). Delaware courts typically award the prevailing plaintiff attorney’s
fees; contra the “American rule”

Why? To overcome the collective action problem: The incentive to bring a case is diluted by ones
ownership share.
Awards are typically 15% - 30% of recovery, which is considerable motivation for the plaintiffs’ bar to
find cases.
Pros and cons of awarding fees?

How does it promote or underminethe screening goals of litigation policy (separating the good from bad
cases)?

Attorney’s fees Common fund doctrine

General principle (common fund doctrine). Authority for fee awards comes from the common fund
doctrine “A litigant or a lawyer who recovers a common fund for the benefit of persons other than
himself or his client is entitled to a reasonable attorney's fee from the fund as a whole.” Americas Mining
Corp. Court rewards an attorney’s results, not efforts .

Awards also reflect risk of losing (and thus not getting paid anything)
Empirics. “Typical” fees between $250k – $750k (for “minimal” work; quick settlements)

Shareholder litigation Recent changes

Three recent changes in shareholder litigation policy have significantly changed the litigation landscape:

(1) Against “disclosure-only” settlements

Delaware courts are increasingly wary of rubber-stamping “disclosure-only” settlements in M&A
litigation. In a “disclosure-only” settlement, the shareholders drop the suit in exchange for additional
(and sometimes trivial) disclosures by the company . . . And hefty plaintiff’s attorney’s fees.
In re Trulia (2016) rejected such a settlement and requires future disclosure-only settlements to include
“plainly material” disclosures. Will that “fix” the problem?

(2) Exclusive forum provision is OK

Bylaws or charter may include an “exclusive forum provision” requiring that “internal corporate claims”
be brought in a single forum.
However, the provision cannot exclude the Delaware court. DGCL § 115. Is this a necessary limitation?
(3) No fee-shifting to shareholders.
The charter or bylaws may not hold a shareholder liable for the corporation’s attorney’s fees ¤ E.g., even
if shareholder loses on all claims. DGCL § 102(f)
Whither we’ve been Shareholder litigation

Derivative suits (brought “on behalf of” the corporation)

Additional procedural requirements, notably demand
Special Litigation Committees are an attempt by the corporation to wrest derivative litigation from
shareholders
Zapata is the “classic” case, but In re Oracle is (probably?) a clearer statement on current practice.

What’s the difference?

Recent policy changes in shareholder litigation
Tactic: Analyze all of these by asking the two basic questions of shareholder litigation policy:
(1) How do they screen good from bad cases and (2) How do they incentivize enforcement of fiduciary
duties?

Cases:

Levine v. Smith – Ross Perot criticizes GM

Zapata Corp. v. Maldonado – SLC two-step
In re Oracle Corp. Derivative Litigation – Derivative Litigation (Stanford SLC)