Corporate Governance

Derivative Suits, Delaware and the Race to the Bottom: Schoon v. Smith (Part 3)

By J. Robert Brown

We are discussing Schoon v. Smith, an entirely predictable opinion in which the Delaware Supreme Court declined to allow a single director to bring a derivative suit.

We know that the Delaware courts have a pro-management bias that has little to do with the protection of shareholders.  But the courts are supposed to pretend to be neutral.  Sometimes, however, the biases leak out into the decisions, giving a true glimpse of judicial motivation. 

In determining whether a director had the right the bring a derivative suit, the Court discussed Section 327 of the Delaware General Corporation Law, which imposed on shareholders an obligation to own shares at the time of the transaction challenged in the derivative suit.  In discussing the provision, the Court noted that "[o]ver time, the stockholder derivative action became stigmatized as a 'refuge of strike suit artists specializing in corporate extortion.'" 

Really?  While everyone knows there are strike suits in the area, it came as a surprise to discover that there was apparently general agreement that litigation in this area was in fact a refuge for strike suits.  No doubt the Court had impeccable authority for such a broad and pejorative characterization. 

In fact, the Court cited only one source, a law review article that in turn contained the quoted language.  In other words, the Court did not go to the original source for the quote but relied on a secondary rendition.  Moreover, the use of the quote was taken entirely out of context.  The article, Juggling Shareholder Rights and Strike Suits in Derivative Litigation, 77 Minn. L. Rev. 1339, 1348 (1993), discussed the benefits and costs of derivative suits.  After noting that "courts and commentators have advocated derivative suits as a way to curb managerial misconduct" the article went on to provide the other side of the issue.  

• In contrast to these potentially substantial benefits, courts and commentators have also long stigmatized derivative litigation as the "refuge of strike suit artists specializing in corporate extortion." Thus, courts rather grudgingly recognize the benefit of derivative suits while often reciting their dangers. Opinions often also recite the judicial inclination to permit the derivative remedy only under extraordinary circumstances where a plaintiff has no other means of redress.

In other words, the article was not trying to characterize derivative suits.  Instead, it was noting that some viewed them as beneficial and some did not.  Moreover, it noted that the attitude was a judicial one, something the Supreme Court in Schoon omitted.  And in any event, the authority for the proposition?  The quote noted above and a Columbia Law Review note written in 1934.

It is the Delaware Supreme Court that does not like derivative suits and views them as a refuge for strike suit artists, a view that can be seen from the analysis in Schoon.  As we have noted in the past, the Delaware courts often lack an appropriate judicial temperament.  The characterization of derivative suits in this manner was gratuitous and unnecessary to the disposition of the case.  It could only take place from a Court not interested in even the pretence of a balanced approach. 

We have posted the opinion and redacted briefs on the DU Corporate Governance web site. 

Full post as published by The Race to the Bottom on February 22, 2008 (boomark / email).