United States: Ninth Circuit Holds that Under Nevada Law, a Prior Stockholder’s Litigation of Demand Futility Precludes Another Stockholder From Litigating Demand Futility In a Subsequent Derivative Action

In Arduini v. Hart, 2014 WL 7156764 (9th Cir. Dec. 17, 2014), the United States Court of Appeals for the Ninth Circuit considered whether the doctrine of issue preclusion prevents a stockholder from relitigating a prior adverse determination concerning demand futility in derivative action brought by a different stockholder.  Applying Nevada law, the Court held that a subsequent stockholder cannot again litigate the issue of demand futility after prior adverse determination of the issue in an earlier derivative action concerning the same alleged wrongful conduct.

International Game Technology ("IGT" or the "Company") is Nevada corporation that makes and services electronic gaming systems.  Plaintiff-appellant, Lawrence Arduini, was a stockholder of IGT and alleged that certain IGT senior officers made misleading statements about the financial prospects of IGT when, in fact, they supposedly knew that IGT's financial prospects were dim.  Mr. Arduini also alleged that the board of directors failed to oversee adequately the officers and the Company.  Mr. Arduini did not make a presuit demand on IGT's board of directors.  Instead he filed a derivative action alleging that a demand on the board to pursue litigation would be futile.

Prior to the date Mr. Arduini filed his action, four other stockholders of IGT filed derivative complaints containing allegations similar to those of Mr. Arduini's.  The prior derivative actions were consolidated (the "Consolidated Action") into a single action.  The United States District Court for the District of Nevada dismissed the Consolidated Action, holding that the demand futility allegations in the consolidated complaint were insufficient to confer standing upon the stockholder plaintiffs to sue on behalf of the Company.  In response, the plaintiffs in the Consolidated Action appealed to the Ninth Circuit.  The Ninth Circuit, however, affirmed the district court's ruling regarding the plaintiffs' failure to plead sufficient facts to support a finding of demand futility and dismissed the Consolidated Action.  See Israni v. Bittman, 473 F. App'x 548 (9th Cir. 2012) (unpublished disposition).

At the same time as the Consolidated Action was pending in the district court, the district court also was presiding over a securities class action based upon similar allegations.  In the securities class action, the district court denied the defendants' motion to dismiss, holding that the class action plaintiffs' claims alleged facts giving rise to a sufficient inference that IGT misled investors with scienter.  Thereafter, the class action plaintiffs settled and the case was dismissed with prejudice.

Shortly after the district court denied the defendants' motion to dismiss in the securities class action, Mr. Arduini filed his duplicative derivative action.  In response, the defendants filed a motion arguing that the action should be dismissed under the doctrine of issue preclusion because demand futility was previously litigated in favor of IGT in the Consolidated Action.  The district court agreed and dismissed Mr. Arduini's action.  Mr. Arduini appealed.

On appeal, Mr. Arduini argued that issue preclusion did not apply because (i) the issues in the Consolidated Action in his action were not identical; (ii) he was not in privity with the plaintiffs in the Consolidated Action; and (iii) that the equities and due process weighed against applying the doctrine of issue preclusion.  After determining that Nevada law applied to the action, the Ninth Circuit rejected each of Mr. Arduini's arguments.

With respect to the "identity of issues," Mr. Arduini contended that issue preclusion did not apply because he asserted new allegations regarding demand futility that were absent from the allegations in the Consolidated Action.  Mr. Arduini argued that in order for collateral estoppel to apply, each allegation regarding demand futility in his action must have been included in the complaint filed in the Consolidated Action.  The Ninth Circuit rejected this argument.  "Under Nevada law, the underlying demand futility allegations need not be identical before issue preclusion applies.  . . .  The question is . . . whether the 'same ultimate' issue was decided in the prior case."  Mr. Arduini's additional allegations to support his contention that a demand was futile did not create a different issue.  "To hold otherwise would mean that issue preclusion would almost never apply — subsequent plaintiffs could simply add more allegations . . . and then claim there was no identity of issues."

In addition, Mr. Arduini was unable to show that the "new" issues raised in his complaint were different from those raised by the Consolidated Action.  With the exception of the allegations concerning the denial of the motion to dismiss in the related securities fraud class action, all of Mr. Arduini's allegations were raised or could have bene raised in the Consolidated Action.  Regardless, Mr. Arduini's additional demand futility allegations could not affect the analysis because he failed to show that the current board was incapable of considering his demand  Only two of the eight board members formed part of IGT's board during the time the alleged wrongful conduct occurred.  Accordingly, a majority of IGT's current board did not face a "substantial likelihood of liability" sufficient to render a demand on the board futile.

The Ninth Circuit also concluded that Mr. Arduini was in privity with the plaintiffs in the Consolidated Action.  Mr. Arduini claimed there was no privity because the plaintiffs in the Consolidated Action had failed to establish derivative standing and did not adequately represent IGT.  The Ninth Circuit rejected this argument as well.  "[D]erivative stockholders are in privity with each other because they act on behalf of the defendant corporation."  Moreover, although "inadequate representation by the first shareholders may prevent issue preclusion because a shareholder may not bind a corporation unless he adequately represents the interest of the corporation," the Ninth Circuit held that Mr. Arduini failed to show that the plaintiffs in the Consolidated Action were inadequate representatives.

Finally, the Ninth Circuit rejected Mr. Arduini's claim that his "due process" rights were violated because he was not provided with notice of the dismissal of the Consolidated Action.  NRS Rule 23.1 requires court approval and notice to the stockholders when a derivative action is settled and dismissed.  There is no provision, however, requiring notice of an involuntary dismissal.  "Even assuming that Arduini was the true party in interest (rather than IGT), the [Consolidated Action] plaintiffs were in essence representing all IGT shareholders when they filed their derivative suit, thus binding subsequent derivative plaintiffs even if they personally did not have notice of the dismissal [of the Consolidated Action]."

Arduini confirms that stockholders of Nevada corporations will not normally be entitled to a second "bite at the apple" to plead demand futility after a court has resolved that issue in an earlier case.

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