Delaware Update: Impact Of Derivative Action Dismissals On Absent Shareholders

Concerned that absent shareholders would be unfairly prejudiced, courts have been reluctant to dismiss with prejudice inadequately pleaded derivative actions. In a recent decision, however, Vice Chancellor Travis Laster elaborated on a doctrinal basis for such dismissals that, in appropriate cases, preserves the right of absent shareholders to pursue the same derivative claim. South v. Baker, C.A. No. 7294-VCL (Del. Ch. Sept. 25, 2012). The South decision should therefore make preclusive derivative pleading dismissals more prevalent.

Background

In 2011, the Hecla Mining Company experienced serious accidents at its "Lucky Friday" mine. These incidents resulted in federal safety citations and lowered production. Thereafter, in what Vice Chancellor Laster described as a typical "race to the courthouse," two federal securities and seven stockholder derivative actions were filed in several jurisdictions. One of these was the South derivative action in Delaware Chancery Court. South at 11. None of the derivative cases had been preceded by the pre-litigation "books and records" inspection available under the Delaware Code. 8 Del. C. §220. Two other prospective shareholder representatives, however, had initiated pre-litigation Section 220 inspection requests. South at 12. In South, named plaintiffs Steven and Linda South brought a so-called Caremark claim, alleging that the Board of Directors should have prevented the accidents. The Souths also pleaded "demand futility," claiming that any demand for remedial Board action pursuant to Rule 23.1 of the Chancery Rules would have been futile. In re Caremark International Inc. Derivative Litigation, 698 A.2d 959 (Del. Ch. 1996). In order to prosecute a Caremark action, a derivative plaintiff must plead facts indicating that the directors "knowingly caus[ed] or consciously permitt[ed] the corporation to violate positive law, or ... fail[ed] utterly to attempt to establish a reporting system or other oversight mechanism to monitor the corporation's legal compliance." South at 1; accord, id. at 16 ("A Caremark claim contends that the directors set in motion or allowed a situation to develop and continue which exposed the corporation to enormous legal liability and that in doing so they violated a duty to be active monitors of corporate performance.") To plead "demand futility," a derivative complaint must allege specific "facts establishing a sufficient connection between the corporate trauma and the board...