Title: Pyott v. Louisiana Municipal Police Employees' Retirement System

State: delaware

Issuer: Delaware Supreme Court

Document:

IN THE SUPREME COURT OF THE STATE OF DELAWARE

DAVID PYOTT, HERBERT W.
BOYER, LOUIS J. LAVIGNE,
GAVIN S. HERBERT, STEPHEN
J.RYAN, LEONARD D.
SCHAEFFER, MICHAEL R.
GALLAGHER, ROBERT
ALEXANDER INGRAM, TREVOR
M. JONES, DAWN E. HUDSON,
RUSSELL T. RAY, DEBORAH
‘DUNSIRE, and ALLERGAN, INC.,

No. 380, 2012
Defendants Below,
Appellants, Court Below:
v Court of Chancery of the
State of Delaware
LOUISIANA MUNICIPAL POLICE
EMPLOYEES’ RETIREMENT C.A. No. 5795

‘SYSTEM and U.F.C.W. LOCAL
1776 & PARTICIPATING
EMPLOYERS PENSION FUND,

Plaintiffs Below,
Appellees.

Submitted: February 5, 2013
Decided: April 4, 2013

Before STEELE, Chief Justice, HOLLAND, BERGER, JACOBS and RIDGELY,
Justices, constituting the Court en Banc.

Upon appeal from the Court of Chancery. REVERSED.

Kenneth J. Nachbar, Esquire and Shannon E. German, Esquire, Morris, Nichols,
Arsht & Tunnell LLP, Wilmington, Delaware for Appellants David Pyott, Herbert
W. Boyer, Louis J. Lavigne., Gavin S. Herbert, Stephen J. Ryan, Leonard D.
‘Schaeffer, Michael R. Gallagher, Robert Alexander Ingram, Trevor M. Jones, Dawn
E. Hudson, Russell T. Ray and Deborah Dunsire.
Of Counsel: Wayne W. Smith, Esquire, Jeffrey H. Reeves, Esquire, Kristopher P.
Diulio, Esquire, Gibson, Dunn & Crutcher LLP, Irvine, California and Mark A. Perry,
Esquire (argued) and Geoffrey C. Weien, Esquire, Gibson, Dun & Crutcher LLP,
Washington, D.C.

Cathy L, Reese, Esquire, Jeremy D. Anderson, Esquire and Joseph B. Warden,
Esquire, Fish & Richardson P.C., Wilmington, Delaware for Appellant Allergan, Inc.

Pamela S. Tikellis, Esquire (argued), Robert J. Kriner, Jr., Esquire and Scott M.
Tucker, Esquire, Chimicles & Tikellis, LLP, Wilmington, Delaware for Appellees.

OfCounsel: Jeffrey W. Golan, Esquire and Lisa M. Lamb, Esquire, Barrack, Rodos
& Bacine, Philadelphia, Pennsylvania.

John L. Reed, Esquire, R. Craig Martin, Esquire and Scott B. Czerwonka, Esquire
DLA Piper LLP (US), Wilmington, Delaware for Amicus Curiae Washington Legal
Foundation.

‘Of Counsel: Richard A. Samp, Esquire, Washington Legal Foundation, Washington,
De.

Danielle Gibbs, Esquire and Nicholas J. Rohrer, Esquire, Young Conaway Stargatt
& Taylor, LLP, Wilmington, Delaware for Amicus Curiae Chamber of Commerce of
the United States of America.

Of Counsel: Jordan Eth, Esquire, Morrison & Foerster LLP, San Francisco,
Califomia; Mark David McPherson, Esquire, Morrison & Foerster LLP, New York,
New York; Deanne E. Maynard, Esquire, Morrison & Foerster LLP, Washington,
D.C.; Robin S. Conrad, Esquire and Rachel Brand, Esquire, National Chamber
Litigation Center, Inc., Washington. D.C.

BERGER, Justice:
In this appeal we consider whether the Court of Chancery was required to
dismiss a Delaware derivative complaint after a California federal court entered a
final judgment dismissing essentially the same complaint brought by different
stockholders, The trial court held that it was not required to give preclusive effect to
the California judgment for two reasons. First, the Court of Chancery held, as a

matter of Delaware law, that the stockholder plaintiffs in the two jurisdictions are not

 

in privity with each other. Second, the trial court found that the California
stockholders were not adequate representatives of the defendant corporation. The
Court of Chancery erred in both respects. Under California law, which controls on
this issue, derivative stockholders are in privity with each other because they act on
behalf of the defendant corporation. As to adequacy of representation, the trial court,
adopted a presumption of inadequacy without any record to support the factual
premise on which the presumption was based. Accordingly, the judgment of the
Court of Chancery is reversed

Factu:

  

1d Procedural Background

Allergan, Inc. is a Delaware corporation that develops and markets specialty
pharmaceuticals. One such product is BOTOX, a prescription neurotoxin that has
been approved by the U.S. Food and Drug Administration (FDA) for several
therapeutic and cosmetic uses. The medical community routinely prescribes BOTOX
for therapeutic uses that have not been FDA approved (off-label uses). That practice

3
is well known, and not illegal. It is unlawful, however, for Allergan to market
BOTOX for off-label uses.

In 2007, the Department of Justice began an investigation into Allergan’s
allegedly improper marketing of BOTOX. On September 1, 2010, Allergan
‘announced that it pled guilty to the criminal misdemeanor of misbranding, and that

itagreed to pay a total of $600 million in civil and criminal fines. Several Allergan

 

stockholders responded to the news by filing derivative suits. The Louisiana
Municipal Police Employees’ Retirement System (LAMPERS) filed this action on
September 3%, and other stockholders filed actions in the United States District Court
for the Central District of California during the next three weeks. The California
actions were consolidated on October 24, 2010.

Allergan and ts directors (collectively Allergan) moved to dismiss both actions
for failure to plead demand futility under Rule 23.1. The Court of Chancery
postponed briefing to allow another stockholder, U.F.C.W. Local 1776 &
Participating Employers Pension Fund (UFCW), to inspect books and records relating
to Allergan’s allegedly wrongful Botox activities. After obtaining the books and
records, UFCW intervened in this action. In July 2011, appellees and the California

plaintifs filed essentially the same amended complaint in their respective courts.

 

* Im the California federal action, the motion was based on Fed. R. Civ. P. 23.1. In the Delaware
action, the motion was based on Ch. Ct. R. 23.1. The two rules are substantially the same.

4
Allergan again moved to dismiss, and the parties concluded briefing in the fall.
In January 2012, shortly before the motion was to be argued in the Court of Chancery,
the California Federal Court issued an order dismissing the California action with
prejudice? The parties to this action then filed supplemental briefs addressing the
preclusive effect of the California Judgment. ‘The Court of Chancery held that the
California Judgment did not bar the Delaware action, and denied appellants’ motion
to dismiss. This interlocutory appeal followed.
Discussion
Collateral Estoppel Applies
‘The Court of Chancery recognized that it was required to “give a judgment
[from another jurisdiction] the same force and effect that it would be given by the
rendering court.”* The rationale for that determination originates from the United
States Constitution’s Full Faith and Credit Clause‘ and the Full Faith and Credit Act

CA)! The FFCA “has long been understood to the doctrines of res
encompass

° The California Federal Court denied the stockholder plaintiffs’ motion for reconsideration, and the
matter is now under consideration by the Ninth Circuit Court of Appeals. Ifthe appellate court
reverses, appellants will be able to file a motion for reli from the judgment under Ch. Ct. Rule
6000).

° La, Mun. Police Empls.' Ret. Sys. v, Pyott, 46 A.34 313, 324 (Del. Ch. 2012).

‘Full Faith and Credit shall be given in each State to the public Acts, Records, and judicial
Proceedings of every other State.” U.S. Cons, Art. IV § 1.

S28US.C.§1738.
judicata, or ‘claim preclusion,’ and collateral estoppel, or ‘issue preclusion.”™*

‘The Full Faith and Credit Clause does not explicitly apply when the “rendering
court” is a federal court rather than a state court. Nonetheless, the United States
‘Supreme Court has held that a state court is required to give a federal judgment the
same force and effect as it would be given under the preclusion rules of the state in
which the federal court is sitting. In this case, that state is California.” Accordingly,
federal common law imposes on the state of Delaware a full-faith-and-credit
requirement to give the California Federal Judgment the same force and effect as it
would be entitled to in the California federal or state courts under California's
preclusion rules.* Delaware law, likewise, requires our courts to afford the same
respect to federal court judgments that the Full Faith and Credit Clause requires them
to afford to judgments from other states?

‘The Court of Chancery failed to apply this settled law because it conflated
collateral estoppel with demand futility. It began its analysis with a mistaken

premise, stating that: “[WJhether a stockholder in a Delaware corporation can sue

* San Remo Hotel, L.P. v. City of San Francisco, $45 U.S. 323, 336 (2005).
? Semtek Int'l Inc. v. Lockheed Martin Corp., 531 U.S. 497, 507-08 (2001).
+ lowa-Wisconsin Bridge Cov. Phoenix Finance Corp.,25 A.24383, 391 (Del. 1942) (holding that

“{t)he same sanctity and effect is granted to a judgment of a federal court rendered in alike case and
in similar circumstances, as is conceded to a judgment of a state court”).

 

"Wd.
derivatively after another stockholder attempted to plead demand futility raises a

question of demand futility law.” Once a court of competent jurisdiction has issued

 

a final judgment, however, a successive case is govemed by the principles of
collateral estoppel, under the full faith and credit doctrine, and not by demand futility
Jaw, under the internal affairs doctrine.

‘The Rule 23.1 motion in the California Federal Court implicated the internal
affairs doctrine. The internal affairs doctrine required the California Federal Court
to apply its understanding of Delaware law on the issue of demand futility. The
California Federal Court held, as a matter of Delaware law, that demand was not
futile and dismissed the derivative complaint. It then entered the final California
Federal Judgment on the merits of demand futility.

In the Court of Chancery, the motion to dismiss, based on collateral estoppel,
‘was about federalism, comity, and finality. Itshould have been addressed exclusively
‘on that basis. Under this Court’s precedents, the undisputed interest that Delaware
has in governing the intemal affsirs of its corporations must yield to the stronger
national interests that all state and federal courts have in respecting each other’s

judgments."* The United States Supreme Court has held that the full faith and credit

" La, Mun Police Empls.' Ret. Sys. v. Pyott, 46 A3d at 326.

See lowa-Wisconsin Bridge Co. v. Phoenix Finance Corp.,25 A.24 at 391; Cavalier Oil Corp. .
Harnett, $64 A.24 1137, 1141 Del. 1989).
obligation is “exacting” and that there is “no roving ‘public poli

 

exception’ to the
full faith and credit due judgments.”"

The Court of Chancery should have applied California law or federal common
law to analyze all elements of collateral estoppel. If the Court of Chancery had done
so, rather than invoking the intemal affairs doctrine to apply Delaware law to the
issues of privity and adequacy of representation, the decision in LeBoyer v.
Greenspan" would have compelled it to dismiss the case.

Under California law, collateral estoppel precludes a subsequent action when
the following five factors are satisfied:

First, the issue sought to be precluded . . . must be identical to that

decided in a former proceeding. Second, the issue must have been

actually litigated in the former proceeding. Third, it must have been
necessarily decided in the former proceeding. Fourth, the decision in the
former proceeding must be final and on the merits. Finally, the party
against whom preclusion is sought must be the same as, or in privity

with, the party to the former proceeding."*

‘The dismissal of the California action for failure to adequately plead demand futility
meets each requirement. The issue sought to be precluded is whether, under Rule
23.1, the failure to make demand on the Allergan board is excused because such a

demand would have been futile. The California court addressed that exact question.

" See, eg, Baker v. General Motors Corp., $22 US. 222, 232-33 (1998).

2007 WL 4287646 (C.D. Cal.).

™ LeBoyer v. Greenspan, 2007 WL 4287646 at *1 (C.D. Cal.) (Quotation and citation omitted).
8
 

The issue was actually litigated in that the appellees had “notice, opportunity and
incentive to litigate the issue at the prior proceeding.”"’ The California court entered
a final judgment with prejudice, and that decision was on the merits."* Finally,
because the real plaintiffin a derivative suit is the corporation, “differing groups of
shareholders who can potentially stand in the corporation’ stead are in privity for the
purposes of issue preclusion.”"”

‘The trial court acknowledged that a California court would conclude that the
California decision precludes appellees from pursuing the Delaware action. Indeed,
the trial court noted that numerous other jurisdictions, and at least one Delaware
decision, also hold that stockholders bringing derivative suits are in privity for
purposes of collateral estoppel."® But the trial court stated that because one’s status
as a derivative plaintiff falls within the internal affairs doctrine, derivative status
must be decided as a matter of Delaware law. The court then opined that all the other
Jurisdictions finding privity for purposes of collateral estoppel missed the dual nature

of a Delaware derivative action. According to the Court of Chancery, there is no

id a2,

“Id, at *3, citing Kaplan v. Peat, Marwick, Mitchell & Co., $40 A.24 726, 730 (Del. 1988).

” Ibid.

™ See, eg.: In re Somus Networks, Inc. S'holder Deriv. Lit, 499 F.34 47 (I* Cir. 2007); Henik ex
rel. LaBranche & Co. v. LaBranche, 433 F. Supp. 24372 (S.D.N.Y.2006);Arduln x rel. u'I Game
Tech. v. Hart2012 WL 893874 (D. Nev.; Inre Career Educ. Corp. Deri Litig.,2007 WL2875203
(Del. Ch); Inre Bed Bath & Beyond Inc. Deriy, Litig., 2007 WL 4165389 (D.N.J).

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privity between derivative stockholders because, until a stockholder survives a

motion to dismiss based on failure to make demand, the stockholder is not acting for

 

the corporation. Rather, the stockholder is asserting an “individual claim to obtain
‘equitable authority to sue.”"? Thus, a final judgment denying that individual claim
has no preclusive effect on other stockholders’ derivative claims.

We will not address this analysis because, as discussed, the Court of Chancery
should not have applied Delaware law in deciding whether the California Federal
Court Judgment must be given preclusive effect. We note, however, as did the Court
‘of Chancery, that numerous other jurisdictions have held that there is privity between
derivative stockholders. Although the Court of Chancery is divided on the privity
issue as a matter of Delaware law,” we cannot address the merits of that issue in this
case,

The adequacy of the California plaintiffs’ representation remains to be
considered. If they were inadequate representatives, collateral estoppel will not bar

4 second, identical claim." The trial court held that the California plaintifis were

 

La, Mun. Police Empls.' Rt. Sys. v. Pyott, 46 4.34313, 330 (Del. Ch. 2012).
» See: In re Career Educ. Corp. Deriv.Litig, 2007 WL2875203 (Del. Ch).

See, e.., Restatement (Second) Judgments § 42(1) (“A person is not bound by a judgment for or
against a party who purports to represent him if... (c) [the representative failed to prosecute or
defend the action with due diligence and reasonable prudence .. ..”); Career Educ, 2007 WL
2875203, at *10 (Del. Ch.); Sonus Networks, 499 F. 34 at 64; Prezant v. De Angelis, 636 A24 915,
924 (Del. 1994); see also Matsushita Elec. Indus. Co, Ltd v. Epstein, 516 US. 367, 395-96 (1996)
Ginsburg, J, concurring in par, dissenting in part) (finding final judgments can be attacked

10

 
inadequate representatives. It found that, “[rJather than representing the best interests
of the corporation, the California plaintiffS sought to maximize the potential returns
of the specialized law firms who filed suit on their behalf.” In doing so, the Court
of Chancery sua sponte announced and applied an irrebutable presumption that
derivative plaintiffs who file their complaints without seeking books and records,
very shortly after the announcement of a “corporate trauma,” are inadequate
representatives.

Unlike the issue of privity, we address the inadequate representation issue
because the Court of Chancery addressed it both as a matter of Delaware law and as
‘a matter of California Law. We reject the “fast filer” irrebuttable presumption of
inadequacy. Undoubtedly there will be cases where a fast filing stockholder also is
‘an inadequate representative. But, there is no record support for the trial court's
premise that stockholders who file quickly, without bringing a § 220 books and
records action,” are a priori acting on behalf of their law firms instead of the
corporation. This Court understands the trial court’s concems about fast filers. But

remedies for the problems they create should be directed at the lawyers, not the

collaterally on due process grounds for fsilure to satisfy the adequate representation requirement).
® La, Mun. Police Empls.' Ret. Sys. v. Pyot, 46 A.34 at 350-51.

® 8 Del. C. §220 provides that stockholders have the right to inspect corporate books and records
fora proper purpose.

n
stockholder plaintiffs or their complaints.

Absent the presumption, there was no basis on which to conclude that the
California plaintiffs were inadequate. The two complaints are so similar that the
California complaint could not be “grossly deficient” when, according to the Court
of Chancery, the Delaware complaint adequately states a claim for relief*

Conclusion
Based on the foregoing, the Court of Chancery’s judgment denying appellee’s

motion to dismiss is reversed. Jurisdiction is not retained.

 

» See: King. Verifone Holdings, Inc, 12 A.34 1140, 1152 (Del. 2011); White . Panic, 783 A24
'543, 549-50 (Del. 2001).

* In re Somus Networks, Inc. S’holder Deriv. Lit, 499 F.3d at 66.(Quoting Restatement (Second)
Judgments, § 42(1(¢) Comment £)

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