In re EZCORP INC. Consulting Agreement Derivative Litigation , 130 A.3d 934 ( 2016 )

IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE
IN RE EZCORP INC. CONSULTING )
AGREEMENT DERIVATIVE ) CA. No. 9962-VCL
LITIGATION )
OPINION
Date Submitted: October 27, 2015
Date Decided: January 15, 2016
Seth. D. Rigrodsky, Brian D. Long, Gina M. Serra, Jeremy J. Reilly, RIGRODSKY &
LONG, P.A., Wilmington, Delaware; Nicholas I. Porritt, Adam M. Apton, LEVI &
KORSINSKY, LLP, Washington, District of Columbia; Counsel for Plaintifl Lawrence
Treppel.
Edward P. Welch, Edward B. Micheletti, Cliff C. Gardner, Lauren N. Rosenello,
SKADDEN, ARPS, SLATE, MEAGHER & FLOM LLP, Wilmington, Delaware;
Counsel for Defendants Phillip Ean Cohen, MS Pawn Corporation, MS Pawn Limited
Partnership, and Madison Park, LLC.
David C. McBride, Elena C. Norman, Nicholas J. Rohrer, Benjamin M. Potts, YOUNG
CONAWAY STARGATT & TAYLOR, LLP, Wilmington, Delaware; Counsel for
Defendant Thomas C. Roberts.
A. Thompson Bayliss, John M. Seaman, ABRAMS & BAYLISS LLP, Wilmington,
Delaware; Randall W. Bodner, Peter L. Welsh, Jesse M. Boodoo, ROPES & GRAY LLP,
Boston, Massachusetts; Counsel for Defendants Joseph J. Beal, William C. Love, and
John Farrell.
Srinivas Raju, Sarah A. Clark, RICHARDS, LAYTON & FINGER, P.A., Wilmington,
Delaware; Counsel for Nominal Defendant EZCORP, Inc.
LASTER, Vice Chancellor.
The complaint in this action named as defendants Joseph J. Beal, William C.
Love, and John Farrell. They were three outside directors of nominal defendant
EZCORP, Inc. (“EZCORP” or the “Company”) who, in varying combinations, approved
transactions challenged in this litigation.
Beal, Love, and Farrell moved to dismiss the complaint, and the motion was fully
briefed. Before it could be argued, the Delaware Supreme Court issued its decision in In
re Cornerstone Therapeutics Inc. Stockholder Litigation, 115 A.3d 1173 (Del. 2015).
After Conerstone, plaintiff’s counsel re—evaluated the strength of their allegations
against Beal, Love, and Farrell. Recognizing that they had not pled a non—exculpated
claim against them, they proposed a dismissal without prejudice.
Beal, Love, and Farrell rejected that idea. They sought a dismissal with prejudice
that would bind all potential plaintiffs. As their counsel agreed at oral argument, they
wanted a dismissal that would be binding “[a]s to the world.” Unable to agree on a form
of dismissal, the outside directors pressed on with their motion.
Rule 15(aaa) defines what should happen. It provides that when a plaintiff chooses
to stand on his complaint and files an answering brief in opposition to a motion to
dismiss, then any dismissal in a class or derivative action is with prejudice as to the
named plaintiff, but without prejudice to other potential plaintiffs. Under an exception to
the general rule, the court can grant a dismissal without prejudice for good cause shown.
In this case, good cause does not exist for a without prejudice dismissal. The claims
against the outside directors are dismissed with prejudice as to the named plaintiff only.
voluntary dismissal of the type contemplated here. Dkt. 72 at 31-33. To reiterate, the full
sentence in Rule 15(aaa) states:
In the event a party fails to timely file an amended complaint or motion to
amend under this subsection (aaa) and the Court thereafter concludes that
the complaint should be dismissed under Rule 12(b)(6) or 23.1, such
dismissal shall be with prejudice (and in the case of complaints brought
pursuant to Rules 23 or 23.1 with prejudice to the named plaintiffs only)
unless the Court, for good cause shown, shall find that dismissal with
prejudice, would not be just under all the circumstances.
Ct. Ch. R. 15(aaa). As Beal, Love, and Farrell read it, the parenthetical identifies bases
for dismissal, not the type of action filed. Thus, if the action were dismissed “pursuant to
Rules 23 or 23.1,” then they would agree that the dismissal would be “with prejudice to
the named plaintiffs only.” Id.; see Dkt. 72 at 35. But because Treppel is dismissing the
action voluntarily, Beal, Love, and Farrell think the parenthetical does not apply.
Beal, Love, and Farrell misread Rule 15(aaa). The parenthetical does not refer to
the basis for dismissal. It refers to the type of action filed. The parenthetical singles out
complaints styled as class actions (Rule 23) or as derivative actions (Rule 23.1). It does
so because they are representative actions where the plaintiff sues not only for itself but
also for others. Rule 15(aaa) contemplates that a dismissal in those types of actions will
be as to the named plaintiff only. Rule 15(aaa) also states that Rule 41(a) “shall be
construed so as to give effect to this subsection (aaa).” Under the plain language of Rule
15(aaa), Treppel’s dismissal is “with prejudice to the named plaintiffs only,” subject to
the court’s ability to grant a dismissal without prejudice for good cause shown. This
outcome matches up with Rule 23.1(c), which otherwise would require notice to
stockholders before Treppel’s complaint could be dismissed. See Ct. Ch. R. 23.1(c)
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(requiring notice “except . . . if the dismissal is to be without prejudice or with prejudice
as to the plaintiff only” and if no compensation has passed to the plaintiff or his counsel).
B. The Substantive Law Of Derivative Actions Precludes A With-Prejudice
Dismissal “As To The World.”
Assuming for the sake of argument that Rule 15(aaa) did not provide for this
outcome, the same result would follow as a matter of substantive Delaware law. Treppel
sued derivatively to remedy harm suffered by EZCORP. But when a corporation suffers
harm, the board of directors is the institutional actor legally empowered under Delaware
law to determine what, if any, remedial action the corporation should take, including
pursuing litigation against the individuals involved. See 8 Del. C. § 141(a). “A cardinal
precept of the General Corporation Law of the State of Delaware is that directors, rather
than shareholders, manage the business and affairs of the corporation.”2 “Directors of
Delaware corporations derive their managerial decision making power, which
2 Aronson v. Lewis, 473 A.2d 805, 811 (Del. 1984). In Brehm v. Eisner, 746 A.2d
244, 253-54 (Del. 2000), the Delaware Supreme Court overruled seven precedents,
including Aronson, to the extent those precedents reviewed a Rule 23.1 decision by the
Court of Chancery under an abuse of discretion standard or otherwise suggested
deferential appellate review. See id. at 253 & n.13 (overruling in part on this issue
Scattered Corp. v. Chi. Stock Exch., 701 A.2d 70, 72-73 (Del. 1997); Grimes v. Donald,
673 A.2d 1207, 1217 n.15 (Del. 1996); Heineman v. Datapoint Corp., 611 A.2d 950, 952
(Del. 1992); Levine v. Smith, 591 A.2d 194, 207 (Del. 1991); Grobow v. Perot, 539 A.2d
180, 186 (Del. 1988); Pogostin v. Rice, 480 A.2d 619, 624-25 (Del. 1984); and Aronson,
471 A.2d at 814). The Brehm Court held that going forward, appellate review of a Rule
23.1 determination would be de novo and plenary. Brehm, 746 A.2d at 253-54. The seven
partially overruled precedents otherwise remain good law. In this decision, I do not rely
on any of them for the standard of appellate review. Although the technical rules of legal
citation would require noting that each was reversed on other grounds by Brehm, I have
chosen to omit the cumbersome subsequent history, which creates the misimpression that
Brehm rejected core elements of the Delaware derivative action canon.
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encompasses decisions whether to initiate, or refrain from entering, litigation, from 8 Dela;
C. § 141(a).” Zapata Corp. v. Maldonado, 430 A.2d 779, 782 (Del. 1981) (footnote
omitted). Section 141(a) vests statutory authority in the board of directors to determine
what action the corporation will take with its litigation assets, just as with other corporate
assets. See id.
In a derivative suit, a stockholder plaintiff like Treppel seeks to displace the
board’s authority. Aronson, 473 A.2d at 811. As a matter of Delaware law, a stockholder
whose litigation efforts are opposed by the corporation does not have authority to sue on
behalf of the corporation until there has been a finding of demand excusal or wrongful
refusal};
Because directors are empowered to manage, or direct the management of,
the business and affairs of the corporation, the right of a stockholder to
prosecute a derivative suit is limited to situations where the stockholder has
demanded that the directors pursue the corporate claim and they have
wrongfully refused to do so or where demand is excused because the
directors are incapable of making an impartial decision regarding such
litigation.
Rales v. Blasband, 634 A.2d 927, 932 (Del. 1993) (emphases added; citation omitted).
“The right to bring a derivative action does not come into existence until the plaintiff
shareholder has made a demand on the corporation to institute such an action or until the
shareholder has demonstrated that demand would be futile.” Kaplan v. Peat, Marwick,
Mitchell & C0., 540 A.2d 726, 730 (Del. 1988).3
3 Delaware Court of Chancery decisions have long said the same thing. See, e.g.,
Ainscow v. Sanitary C0. 0fAm., 180 A. 614, 615 (Del. Ch. 1935) (Wolcott, C.) (“[A]
stockholder has no right to file a bill in the corporation’s behalf unless he has first made
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The derivative plaintiff’s lack of authority to sue on behalf of the corporation until
the denial of a Rule 23.1 motion likewise flows from the two-fold nature of the derivative
suit. As the Delaware Supreme Court explained in Aronson, “[t]he nature of the
[derivative] action is two-fold. First, it is the equivalent of a suit by the shareholders to
compel the corporation to sue. Second, it is a suit by the corporation, asserted by the
shareholders on its behalf, against those liable to it.” 473 A.2d at 811. Later Delaware
Supreme Court decisions reaffirmed the two-fold nature of the derivative suit.4 Nor was
this a new concept. One of Delaware’s greatest jurists, Chancellor Josiah Wolcott, wrote
half a century before Aronson that
demand on the corporation that it bring the suit and the demand has been answered by a
refusal, or unless the circumstances are such that because of the relation of the
responsible officers of the corporation to the alleged wrongs, a demand would be
obviously futile . . . .”); accord Maldonado v. Flynn, 413 A.2d 1251, 1262 (Del. Ch.
1980) (“The stockholder’s individual right to bring the action does not ripen, however,
until he has made a demand on the corporation which has been met with a refusal by the
corporation to assert its cause of action or unless he can show a demand to be futile”),
rev ’d on other grounds sub nom, Zapata, 430 A.2d at 784 (“[W]here demand is properly
excused, the stockholder does possess the ability to initiate the action on his corporation’s
behalf”).
4 See Schoon v. Smith, 953 A.2d 196, 201-02 (Del. 2008) (tracing history of
derivative action and explaining its dual nature); Spiegel v. Buntrock, 571 A.2d 767, 773
(Del. 1990) (quoting Aronson for the “two—fold” nature of the derivative action);
Sternberg v. O’Neil, 550 A.2d 1105, 1124 n.41 (Del. 1988) (“The normal derivative suit
was ‘two suits in one: (1) The plaintiff brought a suit in equity against the corporation
seeking an order against it; (2) to bring a suit for damages or other legal injury for
damages or other relief against some third person who had caused legal injury to the
corporation.”’ (quoting Robert C. Clark, Corporate Law 639-40 (1986))); Peat, Marwick,
540 A.2d at 730 (quoting Aronson in describing the “two-fold” nature of the derivative
action); Zapata, 430 A.2d at 784 (citing “the ‘two phases’ of a derivative suit, the
stockholder’s suit to compel the corporation to sue and the corporation’s suit”).
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[t]he complainants’ case, being asserted by them in their derivative right as
stockholders, has a double aspect. Its nature is dual. It asserts as the
principal cause of action a claim belonging to the corporation to have an
accounting from the defendants and a decree against them for payment to
the corporation of the sum found due on such accounting. In this aspect, the
cause of action is the corporation’s. It does not belong to the complainants.
Inasmuch however as the corporation will not sue because of the
domination over it by the alleged wrongdoers who are its directors, the
complainants as stockholders have a right in equity to compel the assertion
of the corporation’s rights to redress. This is their individual right. A bill
filed by stockholders in their derivative right therefore has two phases—one
is the equivalent of a suit to compel the corporation to sue, and the other is
the suit by the corporation, asserted by the stockholders in its behalf,
against those liable to it. The former belongs to the complaining
stockholders; the latter to the corporation.5
A Rule 23.1 motion addresses the first phase of the derivative action in which the
stockholder sues individually to obtain authority to assert the corporation’s 'claim.
Under these controlling Delaware precedents, until the derivative action passes the
Rule 23.1 stage, the named plaintiff does not have authority to sue on behalf of the
corporation or anyone else. The stockholder plaintiff is only suing in the plaintiff’s own
name to “compel the corporation to sue.” Aronson, 473 A.2d at 811. The only plaintiff
legitimately in the case at that point is the stockholder plaintiff.
Because of the substantive law that governs a derivative action, the named
plaintiff is the only party who could be bound by a dismissal with prejudice entered
5 Cantor v. Sachs, 162 A. 73, 76 (Del. Ch. 1932) (citations omitted); accord Harfi‘
v. Kerkorian, 324 A.2d 215, 218 (Del. Ch. 1974) (“The nature of the derivative suit is
two-fold: first, it is the equivalent of a suit by the stockholders to compel the corporation
to sue; and second, it is a suit by the corporation, asserted by the stockholders in its
behalf, against those liable to it.”), afi'd in part, rev ’d in part on other grounds, 347 A.2d
133 (Del. 1975).
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before the denial of a Rule 23.1 motion or before the board or a duly empowered
committee permits the stockholder to sue. Here, the only plaintiff validly in the case, and
the only plaintiff to whom the with-prejudice dismissal would apply, is Treppel.
The stage of the case differentiates a with-prejudice dismissal under Rule 15(aaa)
from later, post-Rule 23.1 judgments in derivative actions that do bind the corporation
and all of its stockholders.6 A judgment in a stockholder derivative action certainly binds
the corporation and its stockholders when the plaintiff has authority to assert the
corporation’s claims. Examples include when (i) the corporation has brought the case or
taken it over through the special litigation committee process, (ii) the derivative plaintiff
has survived a Rule 23.1 motion, thereby gained authority to sue, and obtained a decision
6 For cases explaining the general rule, see, for example, Cramer v. Gen. Tel. &
Elecs. Corp, 582 F.2d 259, 269 (3d Cir. 1978) (“Nonparty shareholders are usually
bound by a judgment in a derivative suit on the theory that the named plaintiff
represented their interests in the case”); Dana v. Morgan, 232 F. 85, 89 (2d Cir. 1916)
(explaining that a stockholder derivative “action is really the action of all the
stockholders, as it is necessarily commenced in their behalf and for their benefit. And as
in such suits the wrong to be redressed is the wrong done to the corporation and as the
corporation is a necessary part to the suit, it inevitably follows that there can be but one
adjudication on the rights of the corporation. And it is undoubted law that the judgment in
the state court is an estoppel and a finality not only as to all matters actually litigated in
the suit but also as to all matters which were not but might have been presented to the
court and passed upon therein”); Ratner v. Paramount Pictures, Inc., 6 F.R.D. 618, 619
(S.D.N.Y. 1942) (“A judgment in the stockholders’ derivative action is res judicata both
as to the corporation and as to all of its stockholders, including stockholders who were
not parties to the original action in subsequent actions based upon the same subject
matter.”); Parkofi v. Gen. Tel. & Elecs. Corp., 425 N.E.2d 820, 824 (NY. 1981)
(“Because the claim asserted in a stockholder’s derivative action is a claim belonging to
and on behalf of the corporation, a judgment rendered in such an action brought on behalf
of the corporation by one shareholder will generally be effective to preclude other actions
predicated on the same wrong brought by other shareholders”).
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on summary judgment or at trial, or (iii) a court has approved a derivative action
settlement and made the determinations required by Rule 23.1. But the general rule does
not apply before the stockholder plaintiff has gained authority to sue on behalf of the
corporation;.
C. Due Process Precludes A With-Prejudice Dismissal “As T0 The World.”
Beyond the Delaware substantive law of derivative actions, there is even a more
fundamental doctrine that prevents Beal, Love, and Farrell from obtaining a with-
prejudice dismissal “as to the world”: due process of law. A foundational principle of
American law is that “[a] person who is not a party to an action is not bound by the
judgment in that action.” Restatement (Second) of Judgments § 62 cmt. a (1982)
[hereinafter Judgments]. This “basic principle of law” is subject to three exceptions. Id.
One applies “where a non-party has a specific type ofpre-existing legal relationship with
a named party, such as bailor and bailee, predecessor and successor or indemnitor and
indemnitee.” Kohls v. Kenetech Corp., 791 A.2d 763, 769 (Del. Ch. 2000), afl’d, 794
A.2d 1160 (Del. 2002). “Being fellow stockholders is plainly not the type of legal
relationship that fits [this] exception . . . . An individual stockholder is not, solely because
of potentially aligned interests, presumed to act in the place of (and with the power to
bind) the other stockholders.” Id.
A second exception applies when “a person who is not a party to an action . . . is
involved with it in a way that falls short of becoming a party but which justly should
result in his being denied opportunity to relitigate the matters previously in issue.”
Judgments § 62 cmt. a. “Several kinds of conduct by a non-party are recognized as
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having this effect. These include allowing the use of one’s name as a party when the
effect is to mislead an opposing litigant; assuming control of litigation being maintained
by another; and agreeing to be bound by an adjudication between others.” Id. (citations
omitted). Concrete, case-specific actions by a stockholder plaintiff or its counsel might
well trigger this exception, such as, for example, if the same counsel represented both
stockholders or the plaintiffs otherwise collaborated. Cf. Beiser v. PMC—Sierra, Inc., 2009
WL 483321, at *3 (Del. Ch. Feb. 26, 2009); Cohen v. El Paso Corp., 2004 WL 2340046,
at *2 (Del. Ch. Oct. 18, 2004). But the general scenario of parallel, overlapping, or
seriatim efforts by unaffiliated stockholders to assert or prompt the assertion of corporate
claims does not implicate this exception.
The third and most pertinent exception is a properly commenced and maintained
representative action. Kohls, 791 A.2d at 769. Stockholder class and derivative actions
qualify, but even here, the authority to represent others is not conferred automatically by
filing a complaint. “A representative party must be granted . . . authority, either by the
represented party itself (in accordance with agency principles) or, in the class action
context, by the court.” Id. It is “self-evident that if a litigant never seeks to and is never
compelled to act in a representative capacity, the class of people that theoretically could
have been represented by that-litigant is in no way precluded from asserting their own
claims in a subsequent proceeding.”7
7 Id. at 769-70; see Judgments § 41 (identifying categories of persons who can
bind non—parties as including “[t]he representative of a class of persons similarly situated,
designated as such with the approval of the court, of which the person is a member”
17
When a stockholder representative pursues claims on a class basis, authority is
conferred by a class certification ruling.8 When a stockholder representative pursues
claims in a derivative action, authority can be conferred in two ways. First, the board of
directors or a duly empowered committee can approve the litigation expressly or by
failing to oppose it. See Peat, Marwick, 540 A.2d at 730. Second, and more commonly, a
court can determine that the stockholder plaintiff has authority to proceed by denying a
Rule 23.1 motion because the complaint adequately pleads either that demand should be
excused as futile or that demand was made and wrongfully refused. Until authority is
conferred, the representative plaintiff only represents himself.
The limitations that due process places on the scope of a judgment find support in
more august authority than common law doctrine. They are embodied in the Due Process
Clause of the United States Constitution. The United States Supreme Court has held that
— _— _—___ _-='_
(emphasis added»; id. § 59 cmt. c (“The stockholder’s or member’s derivative action is
usually though not invariably in the form of a suit by some of the stockholders or
members as representatives of all of them. Whether the judgment in such a representative
suit is binding upon all stockholders or members is determined by the rules stated in §§
41 and 42.”).
8 See Ct. Ch. R. 23; Standard Fire Ins. Co. v. Knowles, 133 S. Ct. 1345, 1349
(2013) (“[A] plaintiff who files a proposed class action cannot legally bind members of
the proposed class before the class is certified”); Schwarzschild v. Tse, 69 F.3d 293, 297
(9th Cir. 1995) (“[W]hen defendants obtain summary judgment before the class has been
properly certified or before notice has been sent, . . . [the summary judgment] decision
binds only the named plaintiffs”); 3 Alba Conte & Herbert B. Newberg, Newberg on
Class Actions § 7.12, at 63-64 (5th ed. 2013) (“[I]f a court rules on a dispositive motion
prior to certification and the defendant prevails[,] . . . the resulting order would not bind
putative absent class members since no class was certified, and they remained complete
nonparties.”).
l8
to bind other litigants to an adjudication in a case where they were not parties “deprive[s]
them of the due process of law guaranteed by the Fourteenth Amendment.” Richards v.
Jeflerson Cty., Ala., 517 US. 793, 797 (1996); accord S. Cent. Bell Tel. Co. v. Ala., 526
US. 160, 168 (1999),;
For present purposes, the most analogous decision is Smith v. Bayer Corp., 564
US. 299, 131 S. Ct. 2368 (2011), where the United States Supreme Court applied this
principle to a putative class action. The Bayer litigation began in 2001, when a different
plaintiff—George McCollins—sued Bayer Corporation in West Virginia state court. His
complaint asserted various state-law claims relating to Baycol, a drug sold by Bayer_;.;_
McCollins sought to represent a class comprising all West Virginia residents who
purchased Baycol. A month later, another West Virginia resident, Keith Smith, filed a
similar action in a different county court. Neither ,knew about the other’s suit. Bayer
removed McCollins’ case to federal court based on diversity jurisdiction, but Smith’s
case remained in state court for lack of complete diversity. Six years later, with both
cases moving at roughly the same pace, the federal court denied class certification in
McCollins’ action. Bayer than moved to have the federal court enjoin the state court from
certifying a class in Smith’s action, arguing that “the proposed class in Smith’s case was
identical to the one the federal court had just rejected.” Id. at 2374. The federal court
issued the injunction, and the Court of Appeals for the Eighth Circuit affirmed.
The Supreme Court reversed, holding that “[n]either a proposed class action nor a
rejected class action may bind nonparties.” Id. at 2380. In reaching this conclusion, the
Court rejected Bayer’s argument that “Smith—an unnamed member of a proposed but
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I. FACTUAL BACKGROUND
The relevant facts are few. They are drawn from the currently operative pleading,
which is the Verified Amended Stockholder Derivative Complaint (the “Complaint”).
A. The Company And The Services Agreements
EZCORP is a publicly traded Delaware corporation headquartered in Austin,
Texas. Its controlling stockholder is Phillip Ean Cohen...
In 2004, EZCORP entered into a services agreement with defendant Madison
Park, LLC, an entity affiliated with Cohen. The agreement called for EZCORP to pay
Madison Park $100,000 per month for a period of three years. Beginning in September
2007, when the initial agreement expired, EZCORP and Madison Park entered into
annual renewals. In 2008, the monthly fee increased to $150,000. In each of the ensuing
five years, the monthly fee increased again: in 2009 to $200,000, in 2010 to $300,000, in
2011 to $400,000, in 2012 to $500,000, and in 2013 to $600,000. In 2014 it remained at
$600,000. In return for these payments, Madison Park agreed to consult with EZCORP as
needed about mergers, acquisitions, divestitures, strategic planning, corporate
development, investor relations, and other matters.
A special committee of the board of directors approved the services agreements
for 2007, 2008, and 2009. The board’s audit committee approved the later agreements-r.
When the audit committee approved the agreement with Madison Park for 2012 and
2013, its members included Love and Farrell. When the audit committee approved the
agreement with Madison Park for 2014, its members were Beal, Love, and Farrell.
uncertified class—qualifies as a party to the McCollins litigation.” Id. at 2379. The Court
explained that this argument “ill-comports with any proper understanding of what a
‘party’ is,” and that while an unnamed member of a certified class can be considered a
party for limited purposes, no one would “advance the novel and surely erroneous
argument that a nonnamed class member is a party to the class-action litigation before
that class is certified.” Id. (internal quotation omitted).
The Court found the non-binding nature of the district court’s determination all the
more clear because class certification was denied. Id. at 2379 (“Still less does [Bayer’s]
argument make sense once certification is denied”). The Court held that “[t]he definition
of the term ‘party’ can on no account be stretched so far as to cover a person . . . whom __
the plaintiff in a lawsuit was denied leave to represent.” Id.
If we know one thing about the McCollins suit, we know that it was not a
class action. Indeed, the very ruling that Bayer argues ought to be given
preclusive effect is the District Court’s decision that a class could not
properly be certified. So Bayer wants to bind Smith as a member of a class
action (because it is only as such that a nonparty in Smith’s situation can be
bound) to a determination that there could not be a class action.
Id. at 2380. The Court held that a decision properly authorizing the plaintiff to represent a
class was a precondition for binding unnamed class members. Id.
In reaching this conclusion, the Court rejected the defendant’s policy-based
arguments. Bayer contended that without a broad judgment that would bind all unnamed
class members, multiple plaintiffs could file seriatim lawsuits, forcing the “serial
relitigation of class certification.” Id. at 2381. The Court responded that “[t]his form of
argument flies in the face of the rule against nonparty preclusion. . . . [O]ur legal system
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generally relies on principles of stare decisis and comity among courts to mitigate the
sometimes substantial costs of similar litigation brought by different plaintiffs.” Id. See
generally Taylor v. Sturgell, 553 US. 880, 898—901 (2008) (rejecting on similar grounds
the theory of preclusion by “virtual representation”).
In my View, just as the Due Process Clause prevents a judgment from binding
absent class members before a class has been certified, the Due Process Clause likewise
prevents a judgment from binding the corporation or other stockholders in a derivative
action until the action has survived a Rule 23.1 motion to dismiss, or the board of
directors has given the plaintiff authority to proceed by declining to oppose the suit. Cf.
Parfi Hldg. AB v. Mirror Image Internet, 954 A.2d 911, 940 (Del. Ch. 2008) (Strine,
V.C.) (“Although it is too often overlooked, derivative suits are a form of representative
action. Indeed, they should be seen for what they are, a form of class action”). In this
case, a dismissal order that would be binding “as to the world” would parallel the anti-
suit injunction that the district court issued in Bayer. Like the order in Bayer, it would
purport to bind persons who are not parties to the suit and whose interests Treppel has
never been given authority to represent. Under the logic of Bayer, the Due Process Clause
forecloses a judgment in a derivative action that is entered before the stockholder plaintiff
acquires authority to litigate on behalf of the corporation from binding anyone other than
the named stockholder plaintiff, just as Rule 15(aaa) provides.
D. Treppel’s Request For A Without-Prejudice Dismissal
For the reasons described in the previous sections, Beal, Love, and Farrell cannot
obtain a with-prejudice dismissal “as to the world.” Treppel takes the polar opposite
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view, arguing that any dismissal should be without prejudice. To reiterate, Treppel posits
that if his counsel had the benefit of Cornerstone, he would not have sued Beal, Love,
and Farrell. He then would not be in the position of facing a dismissal with prejudice as
to himself under Rule 15(aaa) that would limit his ability to name Beal, Love, and Farrell
if discovery uncovers a basis for suit.
In my view, Treppel has not established good cause for a without-prejudice
dismissal. A similar situation arose in Quadrant Structured Products Co., Ltd. v. Vertin,
2014 WL 5465535 (Del. Ch. Oct. 28, 2014). That decision granted a motion to dismiss in
part, dismissing derivative claims for breach of fiduciary duty against certain directors
due to the absence of allegations that would have called into question the defendants’
loyalty or good faith. Under Rule 15(aaa), the dismissal was with prejudice as to the
named plaintiff. The plaintiff moved for reargument, positing that as discovery went
forward on other claims, it might yield evidence that would permit the plaintiff to plead a
viable claim against the directors. The plaintiff claimed that this possibility supported a
without—prejudice dismissal, because only then could the plaintiff name the directors
later. I disagreed, noting that the dismissal was an interlocutory ruling. Id. at *5.
Consequently, subject to the law of the case doctrine, the dismissal could be “revisited
should future developments, including evidence generated by the discovery process,
provide a compelling reason for doing so.” Id; accord Siegman v. Columbia Pictures
Entni’t, Inc., 1993 WL 10969, at *3 (Del. Ch. Jan. 15, 1993). This meant there was no
prejudice from a with-prejudice dismissal, and good cause for a without-prejudice
dismissal did not exist.
22
The same reasoning applies here. As in Quadrant, the with-prejudice dismissal of I
Beal, Love, and Farrell can be revisited if a “compelling reason to do so appears.” Zirn v. ;
VLI Corp, 1994 WL 548938, at *2 (Del. Ch. Sept. 23, 1994) (Allen, C.). That possibility
alleviates any need to grant a without-prejudice dismissal now, and good cause does not E
exist for departing from the default rule established by Rule 15(aaa).
III. CONCLUSION
Beal, Love, and Farrell’s motion to dismiss is granted. The dismissal is with
prejudice only as to Treppel,
23
B. This Litigation
On July 9, 2014, plaintiff Lawrence Treppel sent EZCORP a demand for books
and records pursuant to 8 Del. C. § 220. Treppel sought to examine the services
agreements between EZCORP and Madison Park and related documents. EZCORP
refused to provide any of the requested documentation, claiming that the demand failed to
set forth a credible basis to infer any wrongdoing.
On July 28, 2014, Treppel filed this action. On September 23, 2014, he filed the
Complaint. It contains four counts:
0 Count I asserts a claim for breach of fiduciary duty against Love, Beal, Farrell,
and other director defendants.
0 Count II asserts a claim for waste of corporate assets against the same defendants
as Count I.
0 Count III asserts a claim against Cohen and two of his affiliates for aiding and
abetting the directors in breaching their fiduciary duties.
0 Count IV asserts a claim against Cohen and Madison Park for unjust enrichment.
C. The Motion To Dismiss
On October 13, 2014, the defendants filed proforma motions to dismiss pursuant
to Court of Chancery Rules 12(b)(6) and 23.1. On November 12, 2014, they filed their
opening briefs. On January 9, 2015, Treppel filed his answering brief, and on February 6,
2015, the defendants filed their reply briefs. Vice Chancellor Parsons, to whom the case
was then assigned, scheduled oral argument for July 7, 2015.
On May 14, 2015, the Delaware Supreme Court issued its decision in
Cornerstone, which addressed what a plaintiff must plead against outside director
defendants to overcome a motion to dismiss based on the existence of an exculpatory
charter provision in a setting where the transaction under challenge is governed by the
entire fairness standard of review.
Before Cornerstone, the Delaware Supreme Court had referred to the effect of an
exculpatory charter provision as being “in the nature of an affirmative defense.” Emerald
P’rs v. Berlin (Emerald I), 726 A.2d 1215, 1223 (Del. 1999). The Emerald I decision and
other opinions from the high court could be read to distinguish between the application of
Section 102(b)(7) at the pleading stage in a case governed by the business judgment rule
versus in a case governed by the entire fairness standard.1 In Cornerstone, however, the
high court squarely held that “[a] plaintiff seeking only monetary damages must plead
non-exculpated claims against a director who is protected by an exculpatory charter
provision to survive a motion to dismiss, regardless of the underlying standard of review
1 Compare Emerald I, 726 A.2d at 1223 (holding that in a challenge to a
transaction involving a controlling stockholder to which entire fairness applied, court
could not apply Section 102(b)(7) on motion for summary judgment because factual
conflicts required a trial to determine nature of the duty breached), with Malpiede v.
Townson, 780 A.2d 1075, 1094-96 (Del. 2001) (holding that in a challenge to third-party,
arms’ length merger that was approved by a fully informed stockholder vote and to which
the business judgment rule applied, the court could apply Section 102(b)(7) at the
pleadings stage unless plaintiff pled facts sufficient to show that a majority of the board
was not disinterested or independent), with Emerald P’rs 12. Berlin (Emerald II), 787
A.2d 85, 90, 92-94 (Del. 2001) (holding that in a challenge to a transaction with a
majority stockholder to which entire fairness applied, court could not apply Section
102(b)(7) without first analyzing transaction under entire fairness standard to determine
nature of the fiduciary breach and distinguishing Malpiede as a case involving the
business judgment standard of review). Cf. Corwin v. KKR Fin. Hldgs. LLC, 125 A.3d
304, 308 (Del. 2015) (holding explicitly, as Malpiede indicated implicitly, that a fully
informed stockholder vote lowers the standard of review from enhanced scrutiny to
business judgment review). See generally 1 David A. Drexler et al., 111, Delaware
Corporation Law and Practice, § 6.02 [7] at 6-17 (2015).
for the board’s conduct—be it Revlon, Unocal, the entire fairness standard, or the
business judgment rule.” Cornerstone, 115 A.3d at 1175-76 (footnotes omitted). So
applied, the existence of an exculpatory provision operates more in the nature of an
immunity, comparable to. the extent to which sovereign immunity typically protects
government employees from suit, rather than as an affirmative defense.
Treppel’s counsel had named Beal, Love, and Farrel as defendants based on a
more plaintiff-friendly understanding of the law, which the Delaware Supreme Court
recognized in Cornerstone was at least an arguable reading of its earlier precedent. See
id. at 1185. Treppel’s Delaware counsel in fact represented the plaintiffs in Cornerstone,
where they advanced their interpretation.
With Cornerstone having clarified matters, Treppel’s counsel re—examined their
pleading. Recognizing the paucity of factual allegations against defendants Beal, Love,
and Farrell, they offered to stipulate to a dismissal of those defendants without prejudice
pursuant to Court of Chancery Rule 41(a)(1). Treppel’s counsel proposed a without—
prejudice dismissal because, assuming they had the benefit of Cornerstone before filing
the Complaint, they would not have named Beal, Love, and Farrell as defendants. In turn,
they would not have faced the prospect of a with-prejudice dismissal and would have
retained the freedom to name those individuals as defendants later.
Beal, Love, and Farrell rejected that proposal. They insisted that any dismissal
should be with prejudice, not only as to Treppel but as to all other potential plaintiffs. As
their counsel conceded at oral argument, Beal, Love, and Farrell wanted a dismissal with
prejudice “[a]s to the world.” Dkt. 72 at 31.
Unable to agree on a stipulated order, Beal, Love, and Farrell pressed forward with
argument on their motion to dismiss. Treppel’s counsel agreed that dismissal was
warranted, but argued that good cause existed for it to be without prejudice.
Due to Vice Chancellor Parson’s retirement, the case was re-assigned to me.
11. LEGAL ANALYSIS
Rule 41(a)(1) generally permits a plaintiff to dismiss a claim against a defendant
unilaterally as long as the defendant has not yet answered or moved for summary
judgment. It statesaa
Subject to payment of costs and the provisions of Rule 23(e) and Rule 23.1
an action may be dismissed by the plaintiff without order of court (i) by
filing a notice of dismissal at any time before service by the adverse party
of an answer or of a motion for summary judgment, whichever first
occurs . . . . However, no such dismissal pursuant to subpart (i) above shall
be effective where the complaint is subject to a motion to dismiss and the
plaintiff has chosen to file an answering brief rather than seeking to
amend. . .. Unless otherwise stated in the notice of dismissal . . . , the
dismissal is without prejudice, except that a notice of dismissal operates as
an adjudication upon the merits when filed by a plaintiff who has once
dismissed in any court of the United States or of any state an action based
on or including the same claim.
Ct. Ch. R. 41(a)(l).
As indicated by the rule’s introductory phrase, when the complaint asserts a
derivative claim, a Rule 41(a)(1) dismissal is “[s]ubject to . . . the provisions of . . . Rule
23.1.” Rule 23.1(0) generally requires judicial approval and notice to stockholders before
any derivative action can be dismissed. At the same time, Rule 23.1(c) contemplates the
ability to forego notice when the dismissal does not present any risk of a surreptitious
buyoff of the named plaintiff or its counsel and when the order will not foreclose other
plaintiffs from litigating the same claims. The pertinent part states:
[A derivative] action shall not be dismissed or compromised without the
approval of the Court, and notice by mail, publication or otherwise of the
proposed dismissal or compromise shall be given to shareholders or
members in such manner as the Court directs; except that if the dismissal is
to be without prejudice or with prejudice to the plaintifi‘ only, then such
dismissal shall be ordered without notice thereof if there is a showing that
no compensation in any form has passed directly or indirectly from any of
the defendants to the plaintifi or plaintifi’s attorney and that no promise to
give any such compensation has been made.
Ct. Ch. R. 23.1(c) (emphasis added).
Yet another rule, Rule 15(aaa), identifies circumstances when a court will dismiss
a complaint with prejudice, thereby limiting a plaintiff’s ability to file seriatim
complaints. Under Rule 15(aaa),
a party that wishes to respond to a motion to dismiss under Rules 12(b)(6)
or 23.1 by amending its pleading must file an amended complaint, or a
motion to amend in conformity with this Rule, no later than the time such
party’s answering brief in response to either of the foregoing motions is due
to be filed. In the event a party fails to timely file an amended complaint or
motion to amend under this subsection (aaa) and the Court thereafter
concludes that the complaint should be dismissed under Rule 12(b)(6) or
23.1, such dismissal shall be with prejudice (and in the case of complaints
brought pursuant to Rules 23 or 23.1 with prejudice to the named plaintiffs
only) unless the Court, for good cause shown, shall find that dismissal with
prejudice would not be just under all the circumstances. Rules 41(a), 23(e)
and 23.1 shall be construed so as to give effect to this subsection (aaa).
Ct. Ch. R. 15(aaa). The upshot of Rule 15(aaa) is that “[w]hen a court dismisses a
complaint after full briefing in the absence of a timely motion to amend, the dismissal
shall be with prejudice unless the plaintiff can show ‘good cause [why] dismissal with
prejudice would not be just under all the circumstances.’” E. Sussex Assocs. LLC v. W.
Sussex Assocs. LLC, 2013 WL 2389868, at *1 (Del. Ch. June 3, 2013) (alteration in
original). The purpose of this rule is “to conserve litigants’ and judicial resources by
discouraging a party from briefing a dispositive motion before filing an amended
complaint.” Id.
When originally adopted in 2001, Rule 15(aaa) did not apply literally to a
sequence in which the plaintiff filed an answering brief in opposition to a motion to
dismiss, then sought to dismiss its complaint without prejudice pursuant to Rule 41(a)(1).
This court nevertheless held that the principles underlying Rule 15(aaa) governed, such
that the Rule 41(a)(1) dismissal would be with prejudice absent good cause shown. Stern
v. LF Capital P’rs, LLC, 820 A.2d 1143, 1147 (Del. Ch. 2003). Effective February 1,
2006, Rule 15(aaa) was amended to provide that “Rule[] 41(a) . . . shall be construed so
as to give effect to this subsection (aaa),” thereby codifying Stern. Rule 15(aaa) now
literally applies to notices and motions for voluntary dismissal. See E. Sussex, 2013 WL
2389868, at *1.
In this case, Beal, Love, and Farrell filed their opening brief in support of their
motion to dismiss, Treppel filed a combined answering brief in opposition to their motion
and similar motions filed by other defendants, and Beal, Love, and Farrell filed a reply
brief. Treppel then proposed to dismiss his claims against Beal, Love, and Farrell.
Given this sequence, Rule 15(aaa) calls for a dismissal with prejudice as to
Treppel only. The plain language of Rule 15(aaa) generates this result because the
complaint was brought and filed derivatively and is governed by Rule 23.1. The
parenthetical describing the effect of a dismissal states that “in the case of complaints
brought pursuant to Rules 23 or 23.1” the dismissal shall be “with prejudice to the named
plaintiffs only.”
A. Rule 15(aaa) Does Not Contemplate A With-Prejudice Dismissal “As To The
World.”
Beal, Love, and Farrell reject the prospect of a dismissal that only would be with
prejudice as to Treppel. They insist that they are “entitled to under Rule 15(aaa)” a
dismissal with prejudice “[a]s to the world.” Dkt. 72 at 31-32. The difference between a
dismissal with prejudice and without prejudice is consequential. “In general, a dismissal
with prejudice constitutes a final decree for res judicata purposes.” RBC Capital Mkts.,
LLC v. Educ. Loan Tr. IV, 87 A.3d 632, 643 (Del. 2014). By contrast, “the phrase
‘without prejudice’ will mean only that the otherwise final judgment does not operate as a
res judicata bar to preclude a subsequent lawsuit on the same cause of action.” Braddock
v. Zimmerman, 906 A.2d 776, 784 (Del. 2006). A with-prejudice dismissal that applies
only to Treppel permits other plaintiffs, including EZCORP and other stockholders, to
litigate in the future against Beal, Love, and Farrell about the issues raised in the
Complaint. Any future plaintiffs still would need to plead facts sufficient to state a claim,
but they would not be barred at the gate by res judicata. By contrast, a with-prejudice
dismissal “as to the world” would bar anyone else, including EZCORP and other
stockholders, from litigating against Beal, Love, and Farrell, no matter what the future
might reveal about their conduct.
The three directors base their claimed entitlement to a dismissal with prejudice “as
to the world” on the absence of any reference in Rule 15(aaa)’s parenthetical to a