On May 4, 2017, Chancellor Andre G. Bouchard of the Delaware Court of Chancery dismissed for lack of post-merger standing an action by former stockholders of Massey Energy Company (“Massey”) against its former officers and directors for their alleged failure to act in good faith to ensure that Massey complied with mine safety regulations. In re Massey Energy Company Derivative and Class Action Litigation, C.A. No. 5430-CB (Del. Ch. May 4, 2017). The plaintiffs, who were divested of their shares in connection with a merger of Massey while the litigation was pending, purported to assert two claims: (i) a breach of fiduciary duty derivative claim and (ii) “inseparable fraud,” styled as a “direct” claim. As to “inseparable fraud,” plaintiffs were relying on what Chancellor Bouchard described as “dictum” in the Delaware Supreme Court’s decision in Arkansas Teacher Retirement System v. Caiafa, 996 A.2d 321, 322-32 (Del. 2010), which stated that “Delaware law recognizes a single, inseparable fraud when directors cover massive wrongdoing with an otherwise permissible merger.” But Chancellor Bouchard found that the misconduct alleged could only constitute a derivative claim, because the allegations “implicated” the directors’ “normal duty” to the corporation to manage its affairs and the allegations of harm—including the “prospect of . . . fines, penalties . . . and the like”—are “prototypical examples of corporate harm that can be pursued only derivatively.” The Court also concluded that plaintiffs’ allegations that the merger was “necessitated” by the misconduct were unavailing, because “inseparable fraud” is not an exception to the “continuous ownership rule for maintaining derivative standing.”
Plaintiffs filed suit following an April 2010 explosion at Massey’s coal mine in West Virginia, which killed 29 miners and was not the first serious accident at a mine owned by the company. Ultimately, the disaster led to various substantial fines and penalties, as well as the criminal conviction of several Massey executives, including at least one of the defendants. While the suit was pending, Massey engaged in a merger, which resulted in Massey becoming a wholly-owned subsidiary of Alpha Natural Resources, Inc. (“Alpha”) and divested plaintiffs of their Massey shares. Plaintiffs had sought a preliminary injunction against the merger, which was rejected by then-Vice Chancellor Leo E. Strine, Jr. The merger closed in June 2011 after approval by a shareholder vote. Until recently, the litigation had been stayed, first at the request of prosecutors because of ongoing criminal investigations and later because Alpha filed for bankruptcy.
Under longstanding Delaware law, “stockholders of Delaware corporations must hold shares not only at the time of the alleged wrong, but continuously thereafter throughout the litigation in order to have standing to maintain derivative claims and will lose standing when their status as stockholders of the company is terminated as a result of a merger.” Here, the Court found that the “gravamen” of plaintiffs’ allegations were that “defendants breached their fiduciary duties by employing ‘a deliberate and systematic business plan of willfully disregarding both internal and external safety regulations’ for several years.” The Court explained that, even though plaintiffs had purported to assert a direct claim—for “inseparable fraud”—in addition to a derivative claim, a “claim is not ‘direct’ simply because it is pled that way, and mentioning a merger does not talismanically create direct action.” The Court thus concluded that plaintiffs’ allegations that the company engaged in a “‘business plan’ to disregard safety regulations” are properly considered derivative, “whether or not . . . styled as a Caremark claim for failing to exercise proper oversight and supervision.”
In dismissing the complaint in its entirety because plaintiffs were no longer shareholders, the Court rejected plaintiffs’ contention that their allegations that the misconduct led to the merger amounted to an “inseparable fraud” that constituted an exception to the “continuous ownership rule” for derivative claims. More specifically, the Court held that there is no such exception. Instead, “in order to state a claim of inseparable fraud, a plaintiff must plead facts from which it would be reasonably conceivable that . . . defendant engaged in serious misconduct before a merger that constitutes a direct claim” (emphasis added). As the Court found, plaintiffs’ allegations here did not constitute a direct claim.
Notably, Chancellor Bouchard mentioned that the stockholder approval of the merger did not serve as an additional basis for dismissal under Corwin v. KKR Financial Holdings, 125 A.3d 304 (Del. 2015). The Vice Chancellor explained, “in order to invoke the cleansing effect of a stockholder vote under Corwin, there logically must be a far more proximate relationship than exists here between the transaction or issue for which stockholder approval is sought and the nature of the claims to be ‘cleansed’ as a result of a fully-informed vote.”
Click here to view the judgement.