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In Multi-jurisdictional Derivative Suits, Del. Courts Stress Safeguarding State Law, Managing Dockets

By Stephen B. Brauerman

Frustrated with the proposed settlement of weak, disclosure-based derivative claims that raised “meaningful, litigable process” concerns, Vice Chancellor J. Travis Laster took the extraordinary step of appointing special counsel to advise the court on collusive forum shopping and the proper role the court should play in policing multi-jurisdictional derivative litigation in Scully v. Nighthawk Radiology Holdings Inc.

The brief of special counsel, filed last month, is important both for the conclusions it reaches and its illustration of the sincerity with which the Court of Chancery takes its supervisory role in approving derivative settlements and monitoring its docket. The Nighthawk case, and a recent letter opinion by Vice Chancellor Leo E. Strine Jr. dismissing a placeholder suit in In re Dynergy Inc. Shareholders Litigation, provide important lessons for corporate defendants managing multi-jurisdictional deal litigation.

In Nighthawk, Laster took the unusual step of appointing special counsel to consider the question of collusive forum shopping after receiving notice of the parties’ intent to submit their disclosure based settlement to the state courts of Arizona for approval in pending companion litigation. While the court recognized that numerous suits are frequently filed in multiple jurisdictions almost immediately after the announcement of a major deal and that eventually only one court can approve the derivative settlement the parties negotiate, Laster took issue with the parties’ decision to submit a disclosure based settlement for approval by another jurisdiction after he had considered plaintiffs’ disclosure based claims on a motion to expedite and found them wanting. Compounding the vice chancellor’s frustration was his observation that actionable substantive problems plagued the deal.

The court expressed concern that the parties chose Arizona specifically to avoid questions from a skeptical judge (himself) who already reached a conclusion about the merits of the case: “This is a case that involved issues of Delaware law on the internal affairs doctrine, yet here the parties were running to a different court not familiar with Delaware law to seek approval from a court that hadn’t done anything to look at the case yet. … So I had serious concerns when I got that [settlement agreement] that what was going on here was collusive forum shopping.”

Though Nighthawk had indicia of collusive forum shopping — for example multiple jurisdictions with competing plaintiffs lawyers and a favored jurisdiction that became disfavored after a preliminary ruling on the merits against the defendant — Laster acknowledged that collusive forum shopping may be necessary and even a permissible evil of multi-jurisdictional litigation and sought briefing from the parties as well as appointed special counsel to consider the issue.

In a comprehensive brief, special counsel first reviewed forum shopping in the context of multi-jurisdictional class action litigation, explained the “reverse auction phenomenon” where defendants induce competing sets of plaintiffs’ counsel to bid against the class in different jurisdictions to earn a larger fee award, and discussed the risks from delaying class certification until after approval of the settlement. Then special counsel addressed the court’s questions about the evils of collusive forum shopping and what role, if any, the court should play in preventing it. After observing that “forum shopping often carries with it a negative connotation,” the special counsel emphasized that evaluating the virtues of each jurisdiction in which litigation is filed is not only ethically permissible but also expected of zealous advocates. Although plaintiffs initially have the upper hand in forum selection, that advantage quickly shifts to defendants in multi-jurisdictional cases, who can cooperate with discovery, agree to expedition, or negotiate with counsel in a favored jurisdiction. This leverage, of course, gives rise to the potential for abuse and the case law is rife with examples of collusion — resulting in disapproved settlements, reduced or non-existent fee awards, and in extreme cases removal and replacement of class counsel.

Although most of the traditional remedies for collusive forum shopping disproportionately penalize plaintiffs’ counsel, the special counsel observed that a court’s disapproval of a settlement causes reputational and relational difficulties for defense counsel as well. Special counsel explained that this imbalance is appropriate because, under the Rules of the Court of Chancery, defense counsel are not subjected to the same scrutiny as class counsel who act as fiduciaries for absent principals. In contrast, defense counsel must respond to the needs of an active, engaged and often sophisticated client. In extreme circumstances, however, defense counsel could face sanctions (including revocation of pro hac vice admission or disciplinary proceedings) or aiding and abetting claims stemming from class counsel’s breach of fiduciary duty if the parties engage in collusive forum shopping.

Reconciling the remedial imbalance and acknowledging the Court of Chancery’s concern that the parties may not choose to share the Court of Chancery’s assessment of the disclosure based claims with the Arizona court, special counsel recommended that the disfavored forum impose enhanced informational and disclosure requirements on the defendant in the favored forum. Since each venue would have jurisdiction over the common corporate defendant, enhanced disclosure would minimize the risk of outcome based forum shopping. It would also provide the favored jurisdiction, at least in Nighthawk, with an assessment on the merits by a jurist from another state, applying its own law, to a weak disclosure-based settlement that could influence the Arizona court’s approval of the settlement or award of attorney fees.

Ultimately, the special counsel found that under the facts of Nighthawk, no collusive forum shopping occurred and recommended against the imposition of sanctions. Of course, the Court of Chancery will have the last word and may or may not share special counsel’s view of the parties’ strategic choices. Regardless of the court’s ultimate conclusion, Nighthawk should remind defense and class counsel of the risks of even the appearance of collusive forum shopping.

A similar lesson in a different context is found in Strine’s three-page letter opinion in Dynergy, which was issued on March 16. Dynergy involved the plaintiffs’ effort to avoid dismissal of a derivative suit in the Court of Chancery that had been tabled in favor of litigation in Texas. Though plaintiffs conceded that the Delaware litigation was inactive, they nevertheless opposed dismissal until the final resolution of the Texas litigation. The only open issue in Texas, as the court learned from defendants’ reply, was plaintiffs’ application for an award of fees and expenses as the substantive claims had earlier been settled. Unpersuaded by plaintiffs’ argument that inactive litigation does not impose costs or burdens on the disfavored jurisdiction, the court explained that “so long as a case remains open, the parties and the court must attend to it. There are costs to the public of maintaining files and of taking staff and judicial time in ensuring that an action is eventually resolved.” The court ultimately granted the motion to dismiss, finding that “plaintiffs are not entitled to file placeholder actions, choose not to prosecute them at all, and to keep them on file because they perceive that gives them some leverage in litigation elsewhere. This is an undue burden on the defendants, to the stockholders … and to the public, which is entitled to have scarce judicial resources focused on actual cases.”

Nighthawk and Dynergy provide a number of lessons for counsel and clients managing multi-jurisdictional derivative litigation. First, litigations should expect active oversight from the Court of Chancery, even when the primary suit challenging the transaction is pending in another jurisdiction. Second, counsel should take care to avoid even the appearance of collusive forum shopping. Third, counsel should know that the Court of Chancery may find unacceptable efforts to avoid its jurisdiction after the parties ask the court to engage substantively with the merits of the case. Finally, parties should not seek to use the Delaware courts simply to increase costs or gain leverage in companion litigation pending in other jurisdictions. Even where the Delaware action is not the driving force behind the litigation, Delaware courts will continue to play an active role in safeguarding Delaware law and managing their dockets.

Update (added April 17): On April 12, Laster issued a two-page letter opinion in Nighthawk, wherein he adopted the findings of the special counsel and expressed confidence that, after reviewing all of the facts of the case, the parties had not engaged in misconduct or collusive forum shopping. The court noted that all of its initial concerns had been allayed by the submissions of counsel for the parties and the special counsel. It then stayed the Delaware matter to allow the fully informed Arizona court to assess the parties’ settlement.

Reprinted with permission from the April 13, 2011 issue of Delaware Business Court Insider. (c) 2011 ALM Media Properties, LLC. Further duplication without permission is prohibited.

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