Under Delaware law, when a derivative plaintiff loses its stockholder status as the result of a merger, the plaintiff usually also loses its standing to pursue a derivative suit on behalf of the corporation. This rule is subject to only two limited exceptions: (1) when “the merger itself is the subject of a claim of fraud, being perpetrated merely to deprive shareholders of the standing to bring a derivative action,” and (2) when “the merger is in reality merely a reorganization which does not affect plaintiff’s ownership in the business enterprise.” Lewis v. Ward, 852 A.2d 896, 902 (Del. 2004) (clarifying exceptions identified in Lewis v. Anderson, 477 A.2d 1040 (Del. 1984)). In a decision revisiting a 2010 mining tragedy in which dozens of miners were killed, the Delaware Court of Chancery recently concluded that neither exception applied to preserve the standing of stockholders of Massey Energy Company (“Massey”) to bring derivative claims, and that plaintiffs had not brought direct claims for an “inseparable fraud.” In re Massey Energy Co. Derivative & Class Action Litig., Consol. C.A. No. 5430-CB (May 4, 2017).
Backstory: The Court of Chancery Refuses To Enjoin The Massey-Alpha Merger
In 2011, stockholder plaintiffs attempting to enjoin a merger between Massey and Alpha Natural Resources, Inc. (“Alpha”) argued that Massey should be forced to assume and transfer derivative claims against certain Massey fiduciaries to a trust for the benefit of Massey stockholders, rather than allowing the claims to pass to Alpha. While finding “little doubt” that plaintiffs’ derivative claims could survive a motion to dismiss, the Court also concluded that plaintiffs were likely to lose standing to pursue those claims if the merger was consummated.
The Court of Chancery noted that a corporation reasonably may conclude that the risks arising from a lawsuit outweigh the potential risk-weighted recovery, even when the corporation clearly has been harmed. As a practical matter, a corporation with strong claims against former executives may choose not to pursue those claims for valid reasons, including a wish to avoid pleading formal admissions that potentially could be used against the corporation by third parties, such as insurance carriers, government agencies, and employees and other individuals with personal injury and other claims. Delaware courts have declined to hold that these kinds of dilemmas – which arise because the corporation itself is conflicted, and not because the directors suffer a personally disabling conflict of interest – justify excusing a would-be plaintiff from the requirement of a pre-suit demand. In its injunction opinion, the Court in Massey similarly refused to create another exception to the general rule that a merger extinguishes the ability of a former stockholder plaintiff to pursue claims derivatively on behalf of the corporation. In addition, the Court noted that if a potential buyer cannot rely on the fact that a merger will eliminate derivative claims, bids for troubled assets will be reduced, if not deterred completely, because the buyer must discount the value of the assets to reflect the uncertainty.