Court of Chancery, Applying Arkansas Law, Precludes Re-Litigation of Demand Futility Issue in the Context of a Derivative Suit Brought by Different Stockholder Plaintiffs
By Josh Gaul and H. Corinne Smith
In In re Wal-Mart Stores, Inc., C.A. No. 7455-CB (Del Ch. May 13, 2016), the Court of Chancery, applying Arkansas law, held that issue preclusion applies to different stockholder plaintiffs in the context of a derivative suit and, therefore, that the Arkansas district court’s holding that demand was not futile precludes re-litigation of the issue in the Delaware court system.
Stockholders of Wal-Mart Stores, Inc. (“Wal-Mart”) filed fifteen lawsuits in Arkansas and Delaware asserting derivative claims on behalf of Wal-Mart against Wal-Mart’s directors and executives for alleged breach of fiduciary duty and for contribution and indemnity. These lawsuits were consolidated in two actions: one in Arkansas (the “Arkansas Action”) and one in Delaware (the “Delaware Action”). Stockholder plaintiffs in the Delaware Action (“Delaware Plaintiffs”) pursued Section 220 books-and-records litigation, which took years to resolve. Meanwhile, stockholder plaintiffs in the Arkansas Action (“Arkansas Plaintiffs”) did not seek Wal-Mart’s records or wait for the outcome of the Delaware Section 220 case. Before Delaware Plaintiffs had completed the Section 220 litigation and filed their amended complaint, the district court in Arkansas granted defendants’ motion to dismiss, concluding that the Arkansas Action complaint failed to adequately allege demand futility. Defendants then moved to dismiss the Delaware Action, arguing that (1) “the Arkansas decision collaterally estopped Delaware Plaintiffs from alleging demand futility” (i.e. that issue preclusion applied); and (2) “even if they were not collaterally estopped, Delaware Plaintiffs failed to adequately plead demand futility under Court of Chancery Rule 23.1.” Because the court held that issue preclusion applied, it did not look at the underlying issue of demand futility.
As stated by the court, issue preclusion “prevents a party who litigated an issue in one forum from later re-litigating the issue in another forum.” In determining if an issue is precluded, a court takes judicial notice of the prior adjudication and resulting opinions, but only as to the elements of issue preclusion and not to the merits of the underlying issue. For issue preclusion to apply under Arkansas law (which law the court had determined governed the question): “(1) the issue sought to be precluded must be the same as the issue in the prior litigation; (2) the issue must have been actually litigated; (3) the issue must have been determined by a valid and final judgment; and (4) the determination must have been essential to the judgment.” In addition, under Arkansas law, the parties precluded must have been parties in the prior litigation or been in privity with those parties and the precluded party must have been adequately represented in the previous litigation. The Delaware Plaintiffs did not dispute that the third and fourth elements of the issue preclusion test had been satisfied, so the court only addressed whether (a) the issue was the same; (b) the issue was actually litigated in the Arkansas Action; (c) privity existed; and (d) the representation was adequate.
The court first determined that, although certain factual details were present in one complaint and not the other, the core demand futility issue in the Arkansas Action and the Delaware Action were the same. In so finding, the court rejected the plaintiff’s argument that the two complaints were not the same in that the Delaware complaint contained additional details and was more extensive. The court then held that the issue of demand futility was actually litigated. Under Arkansas law, an issue is “actually litigated” if it is raised in pleadings; if the defendant had a full and fair opportunity to be heard; and if a decision was rendered on the issue. The court was not persuaded by the plaintiff’s argument that the Arkansas district court had applied the wrong standard in analyzing demand futility and that the issue had not been fully litigated.
Under Arkansas law, for issue preclusion to apply, the precluded parties must either be the same or be in privity. Because Arkansas courts have not explicitly addressed privity in the context of derivative actions involving distinct stockholder plaintiffs, the Court of Chancery examined the status of Arkansas law to determine what rule Arkansas courts would likely follow. In evaluating unsettled matters of issue preclusion, Arkansas courts look to decisions in other jurisdictions, the Restatement of Judgments, and principles of public policy. The Court of Chancery concluded that courts in other jurisdictions (including federal appellate courts and courts in Delaware) generally have concluded that privity exists between different stockholder plaintiffs who file separate derivative actions since the corporation is the real party in interest in the suits. Although the Court of Chancery reached a different decision in Pyott I (holding that the stockholder does not yet represent the corporation at the time demand futility is challenged by the defendants), the court in this case was not persuaded that an Arkansas court would apply the Pyott I reasoning given the clear weight of contrary authority. The court next concluded that the multiple plausible readings of the Restatement of Judgments made it inconclusive as a predictor of how an Arkansas court would answer the privity question. Finally, considering public policy, the court concluded that Arkansas takes a “practical approach” regarding privity that favors preventing re-litigation so long as the derivative plaintiff is an adequate representative. In sum, the court concluded that Arkansas courts would likely follow the “clear weight of authority” and find the privity requirement satisfied.
Finally, the court concluded that the Arkansas Plaintiffs were adequate representatives of the Delaware Plaintiffs. In analyzing the adequacy of the representation, the court used two questions derived from the Restatement of Judgments: first, whether the interests of the representative and the represented person align and, second, whether the representation was grossly deficient. Here, the court concluded that the Arkansas Plaintiffs’ interests were sufficiently aligned with the interests of the Delaware Plaintiffs. While the Delaware Plaintiffs argued that counsel for the Arkansas Plaintiffs had personal economic interests in maintaining the Arkansas Action, the court concluded that this did not render the interests misaligned between the two plaintiff groups. While the court did acknowledge that the Arkansas Plaintiffs may have pursued an imperfect litigation strategy, there was no indication that they were grossly deficient representatives of the Delaware Plaintiffs. In its analysis, the court declined to address the substance of the documents eventually obtained by the Delaware Plaintiffs in their Section 220 action, noting that such consideration would encourage inappropriate hindsight review of conduct that should be judged based on the circumstances as they exist in real time. In doing so, the court noted that “defendants have made legitimate arguments that the Section 220 materials, including some of the best documents (as identified by plaintiffs) supporting the allegations of demand futility, would not have affected the outcome of the demand futility analysis.”
The Court of Chancery found that all four elements required under Arkansas law for issue preclusion had been established and that an Arkansas court would likely conclude both that privity exists between the two sets of plaintiffs and that the Arkansas Plaintiffs were not grossly inadequate representatives. As a result, issue preclusion applies to different stockholder plaintiffs in the context of a derivative suit and the Arkansas court’s holding that demand was not futile precludes re-litigation of the issue in Delaware.