“Filing Olympics” Discouraged in Delaware Derivative Litigation
July 26, 2010
In two recent significant decisions, the Delaware Chancery Court has sent a clear message to would-be plaintiffs racing to be the first to file a derivative class action to do their homework first. In both cases, the lead plaintiffs filed derivative actions and subsequently made Section 220 books-and-records demands under Delaware General Corporation Law to obtain information from the company to bolster their claims in the actions. While it is perfectly appropriate to make a Section 220 demand to gather the necessary facts to plead demand futility and other derivative claims, derivate plaintiffs must seek books-and-records and conduct an adequate investigation into demand futility prior to filing a derivative action. To do so after filing the complaint constitutes an improper purpose for making a Section 220 demand, and both courts viewed the demand as an attempt to circumvent Chancery Court’s Rule 23.1 heightened pleading standard. As one Court noted, Rule 23.1 exists to prevent a corporation from having “to expend money and resources in discovery and trial in the stockholder’s quixotic pursuit of a purported claim based solely on conclusions, opinions or speculations.” To allow shareholders to use Section 220 to bolster derivative complaints would only “[exacerbate] the perverse incentives motivating too many representative plaintiffs’ unseemingly and inefficient race to the courthouse.”
Unable to adequately plead demand futility without the information from their improper Section 220 books-and-records demands, both actions were dismissed with prejudice. As aptly summed up by the Court, “Section 220 should be used before filing a derivative complaint, not after … [the plaintiff] did not conduct a proper pre-filing investigation. He cannot attempt to remedy that failure through post-filing procedural contortions.”
http://www.delawarebusinesslitigation.com/uploads/file/King%20v%20VeriFone.pdf
http://www.delawarebusinesslitigation.com/uploads/file/Baca%20v%20Insight.pdf
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