Opinion ID: 2442966
Heading Depth: 1
Heading Rank: 5

Heading: Nature of a Double Derivative Action

Text: Any discussion of a double derivative action must be with reference to the baseline standard derivative action. To illustrate, in a standard derivative action, a shareholder brings a lawsuit asserting a claim belonging to a corporate entity in which the shareholder owns shares (corporation A). A double derivative action, in contrast, involves two entities: corporation A (the corporation whose claim is being asserted), and corporation B, which owns or controls corporation A. We have previously observed that: The stockholder derivative suit is an important and unique feature of corporate governance. In such a suit, a stockholder asserts a cause of action belonging to the corporation.... In a double derivative suit, such as the present case, a stockholder of a parent corporation seeks recovery for a cause of action belonging to a subsidiary corporation.... Because directors are empowered to manage, or direct the management of, the business and affairs of the corporation, 8 Del. C. § 141(a), the right of a stockholder to prosecute a derivative suit is limited to situations where the stockholder has demanded that the directors pursue the corporate claim and they have wrongfully refused to do so or where demand is excused because the directors are incapable of making an impartial decision regarding such litigation. [9] Thus, by its nature a double derivative suit is one brought by a shareholder of a parent corporation to enforce a claim belonging to a subsidiary that is either wholly owned or majority controlled. Normally, such a claim is one that only the parent corporation, acting through its board of directors, is empowered to enforce. Cases may arise, however, where the parent corporation's board is shown to be incapable of making an impartial business judgment regarding whether to assert the subsidiary's claim. In those cases a shareholder of the parent will be permitted to enforce that claim on the parent corporation's behalf, that is, double derivatively. [10] Double derivative actions generally fall into two distinct categories. The first are lawsuits that are brought originally as double-derivative actions on behalf of a parent corporation that has a pre-existing, wholly owned subsidiary at the time of the alleged wrongful conduct at the subsidiary level. In this category, no intervening merger takes place. The second category involves cases, such as this, where the action is brought originally as a standard derivative action on behalf of a corporation that thereafter is acquired by another corporation in an intervening stock-for-stock merger. We distinguish these two categories because they create different standing (and pre-suit demand) issues. In the first categorycases where the wholly-owned subsidiary pre-existed the alleged wrongdoing and where no intervening merger took placecorporation A is already a subsidiary of corporation B at the time of the alleged wrongdoing at corporation A. In those cases, only the parent corporation owns the subsidiary's stock at the time of the alleged wrongdoing, and the plaintiff owns stock only in the parent. Therefore, a Rule 23.1 demand could only be madeand a derivative action could only be broughtat the parent, not the subsidiary, level. [11] Sternberg v. O'Neil [12] exemplifies this type of case. In Sternberg, the subsidiary (a Delaware corporation) was acquired by the parent (an Ohio corporation) thirty years before the alleged wrongdoing occurred. The plaintiff, who owned stock in the parent corporation, brought a double derivative action as a shareholder of the parent, claiming (among other things) mismanagement and breaches of fiduciary duty by the directors of the subsidiary that resulted in harm to the subsidiary and, consequently, to the parent as the subsidiary's only shareholder. [13] In these circumstances, our law recognizes a right to proceed double derivatively. Otherwise, there would be no procedural vehicle to remedy the claimed wrongdoing in cases where the parent company board's decision not to enforce the subsidiary's claim is unprotected by the business judgment rule. [14] Because the first category does not include the case before us, we set that category aside and do not discuss it again in this Opinion. The second category involves actions brought derivatively on behalf of a corporation that was originally a stand-alone entity but where, as a result of being acquired in a later stock-for-stock merger, (1) the acquired corporation became a wholly-owned subsidiary of the acquiring corporation and (2) the shareholders of the (pre-merger) entity became shareholders of the acquiring corporation. Lewis v. Ward [15] and this case are two examples. What materially differentiates the second category from the first is that in this second category, as a matter of law the merger operates to divest the original shareholder plaintiff of standing to maintain the standard derivative action brought originally on behalf of the acquired corporation. That result, in turn, creates issues relating to whetherand, if so, in what circumstancesthe original stockholder plaintiff, as a newly incarnated shareholder of the acquirer-parent corporation can have standing to assert the (now wholly-owned) subsidiary's claim double-derivatively. That brings us to the second subject of this preliminary sketch of the current legal roadmap: standing.