Louisiana Municipal Police Employees' Retirement System v. Pyott

Court of Chancery of Delaware
46 A.3d 313, 2012 WL 2087205, 2012 Del. Ch. LEXIS 130 (2012)

ELI5:

Rule of Law:

A Rule 23.1 dismissal of a derivative action for failure to plead demand futility does not automatically preclude a subsequent derivative action by a different stockholder, as the initial plaintiff lacks authority to sue on the corporation's behalf until demand futility is granted. Furthermore, a derivative complaint adequately pleads demand futility for a Caremark claim when it presents particularized allegations supporting a reasonable inference that the board knowingly approved a business plan that involved illegal activity.

Facts:

Allergan, a Delaware corporation, manufactures Botox, a drug initially approved by the FDA for limited therapeutic uses (strabismus, blepharospasm, cervical dystonia, axillary hyperhidrosis) starting in 1989.
While physicians could legally prescribe approved pharmaceutical products like Botox for 'off-label' (unapproved) uses, it was illegal for a manufacturer like Allergan to market or promote drugs for uses that the FDA had not approved.
From at least 1997, Allergan's Board of Directors (the "Board") discussed and approved a series of annual strategic plans that sought to dramatically expand Botox sales, identifying unapproved uses (e.g., spasticity, migraine, pain) as 'Top Corporate Priorities' and sources of 'immediate growth' for North America.
Allergan strongly advocated expanded uses for Botox and supported off-label sales through various initiatives, including sponsoring seminars, funding organizations that advocated off-label uses, providing reimbursement assistance for physicians, and offering temporary price allowances to incentivize off-label prescriptions.
Allergan received multiple warning letters from the FDA, including one in August 2001 regarding misleading promotional activities and another in September 2006 concerning off-label marketing by an Allergan-sponsored speaker, Dr. Jack Schim.
Between 2000 and 2004, Allergan's net sales of Botox grew rapidly (25% to 42% annually), with off-label sales for spasticity, headache, and pain skyrocketing; by 2007, 70-80% of annual therapeutic Botox sales (nearly $600 million) were generated by off-label use.
In October 2006, Allergan's General Counsel, Douglas S. Ingram, advised the Board by email about the FDA inquiry into the Dr. Schim incident, noting that Allergan was responsible for the content of its 'directly funded, hosted, and controlled' dinner programs and that the non-compliance was due to a 'perceived lack of responsibility within the sales and marketing organization,' warning of a 'potentially serious matter.'
Despite the FDA warnings and the Schim incident, the Board continued to authorize aggressive efforts to increase Botox sales, approving the 2007-2011 Strategic Plan which explicitly linked the number of sales representatives to increased off-label sales, and continued to receive detailed reports on Botox sales and revenue mix, including the high percentage derived from off-label use.
On September 1, 2010, Allergan entered into a settlement with the United States Department of Justice, pleading guilty to criminal misdemeanor misbranding for the period from 2000 through 2005 and agreeing to pay a total of $600 million in civil and criminal fines for its off-label marketing practices.

Procedural Posture:

On September 1, 2010, Allergan, Inc. entered into a settlement with the United States Department of Justice, pleading guilty to criminal misdemeanor misbranding and paying a total of $600 million in civil and criminal fines.
On September 3, 2010, Louisiana Municipal Police Employees' Retirement System (LAMPERS) filed a derivative action in the Delaware Court of Chancery.
Between September 9 and 24, 2010, other specialized stockholder plaintiffs' firms filed similar derivative actions in the United States District Court for the Central District of California (the "California Federal Court").
On October 25, 2010, the California Federal Court consolidated these cases, creating the "California Action."
On October 11, 2010, LAMPERS filed its first amended complaint in the Delaware Court of Chancery action.
Defendants (Allergan and individual directors) moved to dismiss LAMPERS' amended complaint in Delaware pursuant to Rules 23.1 and 12(b)(6).
On November 3, 2010, U.F.C.W. Local 1776 & Participating Employers Pension Fund (UFCW) sent Allergan a Section 220 demand for books and records.
On November 30, 2010, UFCW moved to intervene in the Delaware Chancery action.
On January 21, 2011, the Delaware Court of Chancery denied UFCW's motion to intervene without prejudice but postponed any hearing on the defendants' motions to dismiss "until after the 220 process is over."
UFCW subsequently obtained documents through its Section 220 demand.
On April 12, 2011, the California Federal Court dismissed the California plaintiffs' first complaint without prejudice.
Allergan shared the Section 220 production (obtained by UFCW) with the California plaintiffs.
The California plaintiffs subsequently filed an amended complaint incorporating the documents Allergan provided.
The California defendants again moved to dismiss the amended California complaint.
On July 8, 2011, LAMPERS and UFCW, having reached an accommodation to serve as co-plaintiffs, jointly filed an 84-page, 241-paragraph Verified Second Amended Derivative Complaint in the Delaware action.
On July 15, 2011, the defendants (Allergan and individual directors) moved to dismiss the Delaware Complaint.
On January 17, 2012, the California Federal Court issued a five-page order (the "California Judgment") dismissing the California Action with prejudice for failure to plead demand futility pursuant to Rule 23.1.
On February 22, 2012, the California Federal Court denied the California plaintiffs' motion for reargument.
Defendants in the Delaware action then supplemented their motions to dismiss to invoke collateral estoppel based on the California Judgment.

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Issue:

1. Does a Delaware federal court's Rule 23.1 dismissal of a derivative action for failure to plead demand futility, brought by one group of stockholders, preclude a subsequent derivative action in Delaware Chancery Court by a different group of stockholders concerning the same underlying conduct? 2. Does the derivative complaint in the Delaware Chancery Court action adequately plead demand futility under Rule 23.1 by alleging particularized facts that support a reasonable inference that Allergan's board knowingly approved a business plan that contemplated illegal off-label marketing?

Opinions:

Majority - Laster, Vice Chancellor

No, the California Judgment does not have preclusive effect on this Delaware derivative action. Under Delaware law, which governs the internal affairs of Delaware corporations, a stockholder pursuing a derivative action does not have the authority to sue on behalf of the corporation until a Rule 23.1 motion for demand futility has been denied. Prior to that point, the stockholder is only asserting an individual claim to obtain equitable authority to sue, not representing the corporation's claims. Therefore, other stockholders are not in 'privity' with the plaintiff in a derivative action dismissed at the demand futility stage, and such a dismissal cannot bind them through collateral estoppel. The court explicitly rejects federal precedents that found privity in such situations. As an independent basis for denying preclusive effect, the court finds that the California plaintiffs provided inadequate representation. They were "fast-filers" who rushed to litigate without conducting a meaningful investigation or using Section 220, acting in their self-interest (to gain control of litigation for legal fees) rather than Allergan's best interests. Yes, the plaintiffs in this Delaware action adequately plead demand futility under Rule 23.1. The particularized factual allegations in the Complaint, supported by internal documents obtained through Section 220, create a reasonable doubt that a majority of Allergan's Board of Directors could have properly exercised its independent and disinterested business judgment in responding to a demand, thus presenting a substantial threat of liability for at least ten of the twelve defendant directors. The Complaint alleges direct board involvement in a business plan premised on illegal activity. Specifically, the Board discussed and approved strategic plans from 1997 onward that aimed to expand Botox sales into new markets involving off-label uses in the U.S., implicitly requiring illegal marketing. The Board then closely monitored Allergan’s dramatic sales success, much of which stemmed from off-label uses. Even after receiving FDA warning letters in 2001 and being explicitly informed by General Counsel in October 2006 about a "potentially serious matter" concerning off-label promotion by an Allergan-sponsored speaker (the Schim incident), the Board approved further strategic plans (e.g., 2007-2011 plan) that continued to link sales growth to off-label initiatives and continued to receive reports showing significant off-label sales. From these allegations, a reasonable inference can be drawn that the Board knowingly approved and oversaw a business plan that required illegal off-label marketing. Such knowing violation of positive law constitutes a non-exculpated breach of the duty of loyalty, as directors cannot loyally cause a corporation to violate the law. Because the Complaint meets the more stringent Rule 23.1 standard by showing that the claims have "some merit," it also states a claim under the more plaintiff-friendly Rule 12(b)(6) standard.

Analysis:

This decision significantly clarifies and reinforces Delaware's stance on shareholder derivative litigation. First, it limits the preclusive effect of Rule 23.1 dismissals, distinguishing between a stockholder's individual right to seek authority to sue and the corporation's claim, thereby providing a pathway for diligent plaintiffs to pursue claims even after prior, poorly prepared attempts fail. Second, it strongly discourages "fast-filing" by adopting a presumption of inadequate representation, encouraging plaintiffs to utilize Section 220 for thorough pre-suit investigation. Finally, the finding of demand futility highlights the stringent standard for director oversight in Caremark claims, particularly when a business plan is plausibly alleged to have knowingly incorporated illegal activity. This places a clear obligation on directors to actively ensure corporate compliance with law, with serious implications for boards who might otherwise consider the risk of legal penalties as merely a cost of doing business.

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