In a recent decision by District Court for the District of Delaware, the court dismissed a shareholder derivative action brought by former shareholders of Countrywide Financial Corp. (CFC), which was based primarily on insider trading allegations against the CFC Board of Directors. See In re Countrywide Fin. Corp. Derivative Litig., No. 07-372-SLR, 2008 WL 4488907 (D. Del. Oct. 7, 2008). While plaintiffs were shareholders of CFC when the suit was filed in July 2007, their equity interests were extinguished when Bank of America acquired CFC in a stock-for-stock transaction in July 2008. Based on this development, defendants moved to dismiss, contending that plaintiffs no longer had standing to bring their derivative claims.
The court granted defendants’ motion, holding that under well-established Delaware law, a shareholder in a derivative lawsuit loses standing after a merger where his or her shares are exchanged for those of another company. Id. at *2-*3 (citing Lewis v. Anderson, 477 A.2d 1040 (Del. 1984)). In so holding, the court rejected plaintiffs’ attempt to rely on a Third Circuit opinion, Blasband v. Rales, 971 F.2d 1034, 1044, 1046 (3d Cir. 1992), for the argument that derivative plaintiffs should have “equitable standing” post-merger. The District Court noted that Delaware courts have not followed Blasband and have labeled that decision as “inconsistent with the clear holding of Lewis v. Anderson.” Countrywide, 2008 WL 4488907, at *3 (quoting In re First Interstate Bancorp. Consol. S’holder Litig., 728 A.2d 851, 868 n.18 (Del. Ch. 1998) (internal quotation marks omitted)). Therefore, the court found itself bound to apply well-settled Delaware law and refused plaintiffs’ invitation to “overturn Delaware state law precedent.” Id.
The well-established continuous ownership requirement is based on the principle that a derivative claim is a property right that flows from the nominal corporate defendant to the acquiring corporation by operation of a merger. Lewis, 477 A.2d at 1049. The continuous ownership rule is subject, however, to two limited exceptions. First, continuous ownership will not be required if the merger itself is subject to a claim of fraud. Countrywide, 2008 WL 4488907, at *2 (citing Lewis). Second, the rule is relaxed when the merger is merely a reorganization that does not affect the plaintiff’s ownership in the business enterprise. Id. As the plaintiffs in the Countrywide action could satisfy neither exception, they lacked standing to maintain their claims.