Corporate Governance

Plaintiffs and Prolixity: Wood v. Baum and The Use of Unnecesary Procedural Barriers (Part 4)

By J. Robert Brown

We are discussing Wood v. Baum, a recent Delaware Supreme Court upholding the dismissal of a derivative claim. Plaintiff alleged demand excusal because the directors signed false reports, authorized certain self interested transactions, served on the audit committee and ignored certain red flags.

Delaware courts impose excessive pleading standards, as we have noted often on this blog.  As a result, they ignore evidence and decline to allow potentially meritorious cases to go to discovery.  But in so doing, they often blame the plaintiffs for the state of affairs.  This case was no different.  After ignoring or recasting most of plaintiff's argument, the Court chided the plaintiff for not seeking to inspect the corporate records.  As the Court noted:

• This case is but another replay of other similar cases where the plaintiff failed to allege with particularity any facts from which it could be inferred that particular directors knew or should have been on notice of alleged accounting improprieties, and any facts suggesting that the board knowingly allowed or participated in a violation of law. In such cases, the failure to allege particularized facts is frequently compounded by a failure to make a statutory “books and records” request concerning the matters alleged and the Board’s consideration of such matters. Here, plaintiff could have, but chose not to, make a books and records request pursuant to the LLCA.

But as we have noted, this is nothing more than a requirement that plaintiffs add cost and delay to their action, sometimes without gaining access to the required documents and with little chance that the effort will turn up anything useful.  Even the Delaware judges, in a frank moment, have admitted this.  See Khanna v. McMinn, 2006 Del. Ch. LEXIS 86 (May 9, 2006)("Indeed, even after using the "tools at hand" to develop particularized facts (e.g., public filings and Sec. 220), certain information may be restricted due to the fact that it is held by entities with no public disclosure obligations. Although the burdens presented by such obstacles have been recognized, . . .  the pleading standard under which the Court examines allegations for requisite particularity remains unaltered, even for plaintiffs who employed the "tools at hand."). 

Our criticism of the excessive standards used in these cases drew the umbrage of the Delaware Chancery Court.   The reliance in inspections rights is a rationalization.  Courts confronted with evidence on a motion to dismiss sufficient to allow the case to go to discovery can nonetheless ignore it and blame any dismissal on plaintiffs.   

Primary materials from the Chancery Court can be found at the DU Corporate Governance web site.

Full post as published by The Race to the Bottom on July 17, 2008 (boomark / email).