In a case which is significant for all Delaware corporations, the Delaware Supreme Court, in an en banc decision issued on Friday, January 28, 2011, entitled Charles R. King v. Verifone Holdings, Inc., 2011 Del. LEXIS 60 (January 28, 2011)("King"), held that the prior filing of a shareholder derivative action against a Delaware corporation does not, in itself, necessarily bar a shareholder derivative plaintiff from later pursuing an action in the Delaware Chancery Court under 8 Delaware Code § 220 ("Section 220") seeking to compel production of corporate records relating to his or her dismissed shareholder derivative claims. If this decision stands (i.e. is not withdrawn or overturned by the Delaware legislature), Delaware corporations may now have to deal with a larger number of Section 220 actions from dismissed shareholder derivative plaintiffs seeking corporate records relating to their claims.
In King, the Delaware Chancery Court had dismissed a shareholder's Section 220 action against Verifone Holdings, Inc. (the "Company") on grounds that the shareholder lacked a "proper purpose" for seeking the relevant records, which included a report on an internal investigation of certain matters conducted at the direction of the Company's audit committee, because the shareholder had already filed a shareholder derivative action in a California federal court concerning the same matters. In so holding, the Chancery Court had reasoned that "stockholders who seek books and records in order to determine whether to bring a derivative suit should do so before filing the derivative suit," and that "[o]nce a plaintiff has chosen to file a derivative suit, it has chosen its course and may not reverse course." 994 A.2d 354, 356-57 (Del. Ch. 2010).
In reversing this decision, the Delaware Supreme Court noted that prior Delaware Chancery Court decisions had allowed shareholder derivative plaintiffs whose complaints had been dismissed without prejudice and with leave to amend to subsequently pursue Section 220 actions seeking records pertaining to the issues raised in those complaints, and that a "bright line" rule prohibiting the prosecution of Section 220 actions under those circumstances would be "overbroad and unsupported by the text of, and the policy underlying, Section 220." King, 2011 Del. LEXIS 60 (January 28, 2011) at *30.
At the same time, however, the Delaware Supreme Court noted in its decision that it was "sensitive to the policy concerns" underlying the Chancery Court's dismissal order, and agreed that it was "wasteful of the court's and the litigants' resources to have a regime that could require a corporation to litigate repeatedly the issue of demand futility" as a result of the premature filing of shareholder derivative actions by plaintiffs who had not used the tools provided under Section 220 to properly investigate the facts pertaining to their claims of demand futility before commencing those actions. Id. at **29-30. To deal with this problem, it cited a number of alternative remedies that could properly be imposed by the courts in which premature "demand futility" derivative actions were filed, such as dismissing those actions with prejudice, or conditioning any leave to amend the complaints in those actions on the payment of the attorneys fees incurred by the defendants on the initial motion to dismiss. Id. at **29-34.
Henceforward, this new decision will likely be the subject of considerable discussion and debate in any shareholder derivative action in which the plaintiff claims that demand on a Delaware corporation's Board of Directors' would have been futile, but has not first used the tools provided by Section 220 to obtain the facts necessary to plead such "demand futility" with the particularity that Delaware law requires. In some ways, King shifts the responsibility for dealing with this problem back to the courts in which such shareholder derivative actions are filed, relying on them to fashion dismissal orders that will effectively address the problem of premature filing of "demand futility" shareholder derivative actions that are not based on adequately particularized factual claims.