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In re EZCORP INC. Consulting Agreement Derivative Litigation

Court of Chancery of Delaware
130 A.3d 934 (2016)
ELI5:

Rule of Law:

A dismissal with prejudice under Delaware Court of Chancery Rule 15(aaa) in a stockholder derivative action, entered before the plaintiff has been granted authority to represent the corporation, binds only the named plaintiff. Such a dismissal does not have a preclusive effect on the corporation or other stockholders due to the plain language of the rule, the substantive nature of derivative actions, and constitutional due process principles.


Facts:

  • EZCORP, Inc., a publicly traded Delaware corporation, was controlled by its stockholder Phillip Ean Cohen.
  • Beginning in 2004, EZCORP entered into a series of services agreements with Madison Park, LLC, an entity affiliated with Cohen.
  • Under these agreements, EZCORP paid Madison Park monthly fees for consulting services, with the fees increasing substantially over time, from $100,000 per month in 2004 to $600,000 per month by 2013.
  • Defendants Joseph J. Beal, William C. Love, and John Farrell were outside directors of EZCORP.
  • Love and Farrell served on the audit committee that approved the agreements with Madison Park for 2012 and 2013.
  • Beal, Love, and Farrell all served on the audit committee that approved the agreement with Madison Park for 2014.
  • Lawrence Treppel, an EZCORP stockholder, made a demand to inspect corporate books and records related to these agreements.
  • EZCORP refused Treppel's demand, claiming he had not shown a credible basis to infer wrongdoing.

Procedural Posture:

  • Lawrence Treppel filed a stockholder derivative action against directors Beal, Love, and Farrell, among others, in the Delaware Court of Chancery.
  • The complaint asserted claims for breach of fiduciary duty and waste of corporate assets.
  • Beal, Love, and Farrell filed a motion to dismiss the complaint under Court of Chancery Rules 12(b)(6) and 23.1.
  • Treppel filed an answering brief in opposition to the motion to dismiss.
  • Before oral argument on the motion, the Delaware Supreme Court issued its decision in In re Cornerstone Therapeutics Inc. Stockholder Litigation, which clarified pleading standards for claims against directors.
  • Following the Cornerstone decision, Treppel's counsel acknowledged his complaint was likely insufficient and offered to voluntarily dismiss the claims without prejudice.
  • The defendant directors rejected this offer, insisting on a dismissal with prejudice that would be binding on all potential plaintiffs, or 'as to the world.'

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Issue:

In a stockholder derivative action, does a dismissal with prejudice under Court of Chancery Rule 15(aaa), entered before the plaintiff has survived a Rule 23.1 motion to dismiss, bind all potential plaintiffs and the corporation ('as to the world')?


Opinions:

Majority - Laster, Vice Chancellor

No. A dismissal with prejudice under Rule 15(aaa) in a derivative action binds only the named plaintiff, not the corporation or other stockholders. The court's reasoning is threefold. First, the plain language of Rule 15(aaa) explicitly states that in a derivative action brought pursuant to Rule 23.1, a dismissal 'shall be with prejudice to the named plaintiffs only.' Second, the substantive law of derivative actions dictates this result; a derivative suit has two phases, and a plaintiff does not gain authority to sue on behalf of the corporation until they survive a Rule 23.1 motion by showing demand was excused or wrongfully refused. Until that point, the plaintiff only represents themself and can only bind themself. Third, due process prevents a judgment from binding non-parties who have not had their day in court. Just as a judgment in a proposed class action does not bind absent class members until the class is certified, a judgment in a derivative suit cannot bind the corporation or other stockholders until the plaintiff's authority to represent them has been judicially established.



Analysis:

This decision provides critical clarity on the scope of pre-merits dismissals in derivative litigation under Delaware's Rule 15(aaa). It reinforces the two-step nature of derivative actions, strongly emphasizing that a plaintiff lacks authority to bind the corporation until demand futility is established. By grounding its reasoning in fundamental due process principles articulated by the U.S. Supreme Court in Smith v. Bayer Corp., the court ensures that procedural rules do not override constitutional protections for non-parties. This precedent prevents defendants from using an early dismissal against a single, potentially weak plaintiff to obtain a global release and immunize themselves from future, potentially stronger claims by other stockholders.

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