In re Massey Energy Co. Derivative and Class Action Litigation
160 A.3d 484, 2017 Del. Ch. LEXIS 74, 2017 WL 1739201 (2017)
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Rule of Law:
Under Delaware law, shareholders lose standing to maintain derivative claims when they cease to be shareholders due to a merger. The theory of 'inseparable fraud' does not create a third exception to this continuous ownership rule; rather, to survive a merger, a claim must qualify as a direct claim under the Tooley test by showing harm to the shareholders individually, independent of any harm to the corporation.
Facts:
- Massey Energy Company, under its CEO Don Blankenship, developed a corporate culture that prioritized coal production over mine safety, leading to a long history of safety violations and fatalities.
- In 2008, Massey pleaded guilty to criminal charges for willful safety violations resulting in death at its Aracoma mine and, in a separate settlement, formed a new Safety Committee, yet violations continued to escalate.
- On April 5, 2010, a major explosion at Massey’s Upper Big Branch (UBB) mine killed 29 miners, an event later attributed by multiple investigations to the company's systemic and willful disregard for safety regulations.
- In the wake of the UBB disaster, Massey's stock price fell significantly, and its board began exploring strategic alternatives.
- Following a lengthy sale process and the forced retirement of CEO Don Blankenship, Massey's board unanimously approved a merger agreement with Alpha Natural Resources, Inc. on January 27, 2011.
- The merger, which represented a significant premium over Massey's post-disaster stock price, closed in June 2011, making Massey a wholly-owned subsidiary of Alpha.
Procedural Posture:
- In April 2010, following the Upper Big Branch mine disaster, Massey Energy Company stockholders filed several derivative actions against the company's directors and officers in the Delaware Court of Chancery.
- The actions were consolidated on October 21, 2010.
- After the merger with Alpha Natural Resources was announced, plaintiffs moved for a preliminary injunction to block the merger unless the derivative claims were placed in a litigation trust for the benefit of Massey stockholders.
- On May 31, 2011, the Court of Chancery denied the motion for a preliminary injunction.
- The merger closed on June 1, 2011, and the case was subsequently stayed for several years due to a federal criminal investigation and Alpha's bankruptcy.
- After the stay was lifted, plaintiffs filed a fourth amended complaint asserting a direct claim for 'inseparable fraud' (Count I) and, alternatively, a derivative claim (Count II).
- The defendants, former Massey directors and officers, then filed motions to dismiss the complaint for lack of standing and failure to state a claim.
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Issue:
Does pre-merger corporate mismanagement that allegedly necessitates a subsequent merger give rise to a direct claim for 'inseparable fraud' on behalf of former shareholders, or is it a derivative claim for which standing is lost upon the merger?
Opinions:
Majority - Bouchard, C.
No, such a claim is derivative, not direct. The court held that the plaintiffs' putative direct claim for 'inseparable fraud' is, in reality, a derivative claim that was extinguished by the merger. First, the court dismissed the explicit derivative claim (Count II) because the plaintiffs lost standing under the continuous ownership rule once their Massey shares were converted in the merger, and neither of the two narrow exceptions to this rule applied. Second, addressing the direct claim (Count I), the court clarified that 'inseparable fraud' is not a third exception to the continuous ownership rule. Instead, the underlying pre-merger misconduct must itself constitute a direct claim. Applying the Tooley test, the court determined the harm alleged—corporate fines, reputational damage, and a depressed stock price—was an injury to the corporation, Massey, not to the shareholders individually. Because the duty breached was the duty to manage the corporation, and the harm was corporate in nature, the claim is derivative and fails for lack of standing.
Analysis:
This decision provides a crucial clarification of the 'inseparable fraud' theory mentioned in the Countrywide cases, firmly establishing that it is not a standalone cause of action or an exception to the continuous ownership rule for derivative claims. The ruling reinforces the primacy of the Tooley test in distinguishing between direct and derivative actions, preventing plaintiffs from repackaging classic corporate mismanagement claims as direct 'fraud' claims to survive a merger. The case solidifies the principle that derivative claims are corporate assets that transfer to the acquirer in a merger, ensuring that the new corporate owner, which bears the liabilities of the acquired company, also controls the right to seek recovery for past misconduct on the company's behalf.
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