In Lambrecht v. O'Neal, No. 135, 2010, 2010 WL 3397451 (Del. Aug. 27, 2010), the Supreme Court of Delaware answered a certified question of Delaware law from the United States District Court for the Southern District of New York regarding the standing of a plaintiff-shareholder of a parent corporation to bring a "double derivative" action following a merger. The Court held that plaintiffs who were pre-merger shareholders in an acquired company and who, by virtue of a stock-for-stock merger, are current shareholders of a post-merger parent company need not demonstrate for purposes of standing that, at the time of the alleged wrongdoing at the acquired company, (1) they owned stock in the acquiring company, and (2) the acquiring company owned stock in the acquired company. In so holding, the Court clarified the law allowing for the possibility of double derivative claims where standard derivative claims are extinguished by an intervening merger.
The certified question of law arose out of two double derivative
actions asserted on behalf of Bank of America
("BofA") and its wholly-owned subsidiary, Merrill
Lynch & Co. ("Merrill Lynch").
Originally, plaintiffs in those actions filed standard derivative
actions on behalf of Merrill Lynch to recover losses Merrill Lynch
suffered in transactions that occurred before BofA acquired Merrill
Lynch in the wake of the 2008 financial crisis in a stock-for-stock
merger. Plaintiffs alleged that Merrill Lynch's senior
management and directors breached their fiduciary duties by
involving Merrill Lynch in underwriting collateralized debt
obligations and by disregarding warnings about risks concerning its
mortgage-related activities, thereby causing Merrill Lynch to lose
billions of dollars. In addition, plaintiffs also alleged that on
the eve of the merger, Merrill Lynch, with the assent of BofA,
improperly paid bonuses totaling $3.6 billion to various Merrill
Lynch employees.
In the merger, Merrill Lynch became a wholly-owned subsidiary of
BofA, and plaintiffs' Merrill Lynch shares were converted
to shares of BofA. After the merger, the complaints were amended to
take the form of "double derivative" actions in
which the plaintiffs sought the same relief. A "double
derivative" action is a suit brought by a shareholder of a
parent corporation on behalf of the parent to enforce a claim
belonging to a subsidiary that is either wholly owned or majority
controlled by the parent.
Defendants then moved to dismiss the double derivative actions for
lack of standing. Defendants argued that plaintiffs were required
to show that (1) plaintiffs were BofA stockholders both post-merger
and at the time of the pre-merger wrongdoing complained of, and (2)
BofA was a Merrill Lynch stockholder at the time of such pre-merger
conduct. The Supreme Court assumed, for purposes of its analysis,
that at least one plaintiff's ownership of BofA stock was
not contemporaneous with the conduct complained of, and that BofA
was not a Merrill Lynch stockholder during the time of the
wrongdoing alleged by plaintiffs.
In determining whether the procedural requirements proposed by
defendants were mandated under Delaware law, the Delaware Supreme
Court first examined defendants' conceptual model, whereby
a double derivative action represents "two separate
derivative lawsuits, one stacked on top of the other,"
consisting of both a standard derivative action by BofA (through
plaintiffs), asserting a claim on Merrill Lynch's behalf,
and a "superimposed" action asserting the same
claim derivatively on BofA's behalf as the new owner. Under
such a model, the Court noted, the procedural requirements for
bringing each derivative claim would independently need to be
satisfied.
The Court then noted four flaws in defendants' proposed
conceptual model. First, it explained that the procedural
requirements posed by defendants would render double derivative
lawsuits "virtually impossible to bring except in
bizarrely happenstance circumstances" where, for example,
plaintiff-shareholders of the acquired corporation at the time of
the pre-merger wrongdoing also simultaneously (and coincidentally)
held stock of the acquiring corporation at the time of the
pre-merger wrongdoing complained of and the acquiring
corporation held stock of the acquired corporation at the time of
the pre-merger wrongdoing. Thus, because "the
defendants' argued-for double derivative model . . . would
effectively eviscerate the double derivative action as a meaningful
remedy," the Court found that rejection of the
defendants' position was warranted even "on that
basis alone."
Second, the Court held that defendants' argument that BofA
must have owned Merrill Lynch stock at the time of the pre-merger
wrongdoing incorrectly presupposes that to be legally capable of
enforcing Merrill Lunch's pre-merger claim, BofA must
proceed derivatively against the persons who were Merrill
Lynch directors at the time of the alleged wrongdoing. The Court
held that defendants misinterpreted Delaware case law, which holds
that BofA may enforce such a claim directly, by virtue of
its 100 percent ownership interest in Merrill Lynch. Indeed,
BofA's sole ownership of Merrill Lynch "empowers
and entitles" the company to "use its
direct control to cause its wholly owned subsidiary,
Merrill Lynch, to do what is necessary to enforce Merrill
Lynch's pre-merger claim" (emphasis added).
Third, the Supreme Court also held as "fatally
flawed" defendants' assertion that plaintiffs must
have owned BofA stock at the time of the alleged misconduct at
Merrill Lynch. The Court explained held that this notion misapplied
the contemporaneous ownership requirement in double derivative
actions. It explained that in double derivative actions,
"the plaintiffs stand in the shoes of [the acquiring
company]; that is, they are enforcing [the acquiring
company's] post-merger right, as 100 percent owner, to
prosecute [the acquired company's] pre-merger
claim." Thus, it suffices that the plaintiffs
"own shares of [the acquiring company] at the time they
seek to proceed double derivatively on its behalf."
Finally, in response to the defendants' policy argument
that "allowing the plaintiffs' post-merger double
derivative action to proceed would "disrespect the
corporate separateness of [BofA] and Merrill Lynch" and
run afoul of Delaware precedent on the impact of a merger on a
pending derivative action, the Court determined that a double
derivative action is not a de facto continuation of a
pre-merger derivative action, but instead represents a
"new, distinct action" in which the
plaintiffs' standing to sue rests upon "a
different temporal and factual basis," namely, a failure
by the BofA board, post-merger, to prosecute plaintiffs'
pre-merger claim against Merrill Lynch. Furthermore, because of
this "quite different structure, the policies favoring
both the preservation of the corporate separateness of the parent
and subsidiary and the prevention of abusive derivative suits are
fully respected."
Finally, the Supreme Court rejected defendants' argument
that the Delaware Court of Chancery's
2004 decision in Saito v. McCall, 2004 WL 3029876 (Del.
Ch. Dec. 20, 2004) ("Saito"), provided
legal support for defendants' proposed procedural
requirements, finding that Saito addressed the
requirements for a double derivative claim in a
"conclusory" fashion as a result of the
procedural posture of the case. The Court explicitly overruled
Saito as a "misappli[cation] [of] Delaware
law," noting that no reasoning is articulated to support
Saito's holding. Furthermore, the Supreme Court
also concluded that to the extent Saito is inconsistent
with the Supreme Court's reasoning and conclusions in the
instant case, it is overruled.
This decision demonstrates the Delaware Supreme Court's
emphasis that state precedents not only validate, but also
encourage, the bringing of double derivative actions in cases where
standing to maintain a standard derivative action is extinguished
as a result of an intervening merger. See, e.g.,
Lewis v. Ward, 852 A. 2d 896, 906 (Del. 2004). More
importantly, prior to this decision, the main case that had touched
on the requirements for bringing double derivative actions
following a merger was the Chancery Court's decision in
Saito, which the Supreme Court held did so in a
"conclusory" manner and which was not
representative of "sound Delaware law." Thus,
this decision provides the clear guidance on when a
plaintiff-shareholder may bring a post-merger double derivative
action.
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