I OVERVIEW A. A Public Solution to the Problem of Unmeritorious Shareholder Litigation B. Notice Pleading, Fact Pleading, and Early Stage Triage C. The Efficiency Role of Pleading Stage Evaluation D. Mapping the Territory: Derivative Suits and Deal Cases II. THE PROCEDURAL FOUNDATIONS OF PLEADING STAGE EVALUATION A. Information Gap-Reducing Measures 1. Mechanisms of Pleading Stage Access to Information 2. Requiring Particularized Pleading 3. Considering Facts Not Specifically Pleaded in the Complaint B. Measures to Improve the Predictive Value of Pleading Stage Evaluation 1. Judicial Assignment 2. Disposition of Motions to Dismiss C. Cost-Avoidance Measures III. PLEADING-STAGE EVALUATION OF REPRESENTATIVE SHAREHOLDER LITIGATION A. Aronson: Building the Triage System for Derivative Litigation B. Extending the Fact Pleading Approach to Other Cases 1. Trifoods 2. Caremark and Stone v. Ritter: Fact Pleading in Oversight Cases 3. Krim: Fact Pleading Emerges in Deal Cases 4. Dismissing Non-Revlon Revlon Cases 5. Dismissing Deal Cases Involving Controlling Stockholders a. Claims Against Disinterested Directors b. Sales by a Controller to a Third Party c. Controller Freeze-Outs Conditioned on Special Committee and Minority Stockholder Approval C. The Evolution and Importance of the Motion to Expedite Discovery D. Cases Denying Motions to Dismiss, and the Promotion of Efficient Settlements E. Limits of Pleading Stage Evaluation of Shareholder Litigation IV. CONCLUSION I. OVERVIEW
A Public Solution to the Problem of Unmeritorious Shareholder Litigation
The torrid pace of recent merger and acquisition activity has heartened--and enriched--the lawyers, bankers, and financial advisers who negotiate, craft, and finance those transactions. (1) At the same time, however, many observers have noted and criticized the fact that litigation by shareholders challenging those transactions has become ubiquitous: at least until recently, almost every deal valued at over $100 million was subjected to litigation. (2) Given the size of the financial stakes involved, and the prospect that even modestly successful litigation in that arena can yield substantial fee awards for the plaintiffs' counsel who initiate it, (3) the frequency of such litigation is not surprising. The rampant phenomenon of early settlements of such litigation, however, usually for modified disclosure only, (4) with no improvement in the deal price, has led some to claim that Delaware "hasn't done enough to curb" a "growing tide of shareholder litigation," (5) and that such litigation amounts to a wasteful "merger tax" ultimately borne by shareholders and collected by the plaintiffs' class action bar. (6)
A tax on mergers, however, is not a deadweight loss to the system if the litigation that it funds encourages managerial conduct that enhances shareholder value. But that enhancement could be more than offset if corporate defendants (and, indirectly, their shareholders) were required to bear the substantial costs of discovery and trial (or pay substantial plaintiff's attorneys fees in settlements to avoid such costs) in cases with little or no merit. And given the high percentages of deal transactions that lead to complaints, it would be difficult to conclude that all deal litigation has substantial merit. That problem, in turn, presents the central conundrum addressed in this Article: how can the corporate litigation system separate meritorious shareholder derivative and deal claims from those that lack merit, and do so early enough in the proceedings to avoid the costs of discovery and trial?
One possible approach surfaced prominently after the Delaware Supreme Court's 2014 opinion in ATP Tour Inc. v. Deutscher Tennis Bund. (7) Some corporations and their advisers engaged in a brief dalliance with bylaws that purported to shift the costs of defending shareholder litigation to plaintiff shareholders whose lawsuits were anything other than totally successful. (8) At least in Delaware, that dalliance was thwarted before it became a commonly adopted practice: the use of such bylaws has now been prohibited by legislation. (9) The Delaware State Bar Association committee that drafted that legislation nevertheless recognized that it was important to identify ways "to address and deter litigation of limited merit." (10) Instead of private ordering, however, that committee advocated a solution based on public ordering--specifically, it urged that "courts can and should be trusted to address real problems effectively when and if they arise on a case by case basis." (11) That public ordering solution is the focus of this Article. To assure, or at least make it more likely, that only meritorious cases reach the stage of full discovery and trial, the Delaware courts have developed an intricate but highly efficient system for managing the flow of shareholder complaints.
This Article presents for the first time an inventory and analysis of the interrelated procedures and doctrines that constitute this system and resolves disputes in a relatively efficient manner. Most fundamentally, this system resolves shareholder litigation by encouraging the early presentation of relevant facts pleaded in the complaint and by either dismissing the complaint if those facts fail to demonstrate legal merit, (12) or identifying how the complaint is meritorious, in a fashion that encourages the protagonists to settle. With its emphasis on early, and often extensive, factual inquiry, the motion to dismiss in Delaware representative shareholder litigation--specifically, derivative litigation and class actions asserting breaches of fiduciary duty by the corporation's directors--functions in a fashion similar to the motion for summary judgment, but with substantially less pre-motion discovery and its associated costs.
Notice Pleading, Fact Pleading, and Early Stage Triage
At least until fairly recently, those familiar with principles of civil procedure would not ordinarily have expected the motion to dismiss to be such an important tool for early stage triage: (13) to survive a motion to dismiss, a complaint is only required to set forth "a short and plain statement of the claim showing that the pleader is entitled to relief." (14) As first year law students have been taught for decades, this embrace of "notice pleading" is intended to promote the resolution of disputes based on facts presented in evidence at trial, rather than based on the content of pleadings. (15) And in litigation in which both sides generally bear the costs of litigation equally, and the burdens of gathering evidence fall upon them more or less equally, the "notice pleading" concept makes sense as a means to avoid unnecessarily costly attention to the formulation of pleadings when the resolution of the dispute ought to turn instead on an evaluation of actual facts. (16)
In representative stockholder litigation, however, the burdens of discovery fall almost exclusively on the defendants. Thus, one cannot count on symmetry of litigation costs to generate an efficient equilibrium in which unmeritorious cases are either dismissed or not brought at all: the one-sided threat of unchecked discovery costs (17) becomes a source of leverage for extracting settlement payments without regard to the merits of the litigation. (18) In that setting, efficiency depends upon a system of judicial supervision and triage at an early stage of the litigation, so that cases lacking merit are dismissed and thereby deprived of their extortive effect, and meritorious cases are identified as such early on and settled so that the enormous costs of discovery and trial can be avoided.
This Article describes the unique and highly evolved system employed in the Delaware courts to achieve that efficiency. For good reasons, that system is notably different from the "notice pleading" system extolled in civil procedure courses. As we demonstrate below, Delaware's system affirmatively encourages reliance on factually specific pleadings as a basis for substantive evaluation of shareholder litigation at an early stage of the proceedings. On the other hand, the Delaware system provides or depends on mechanisms that enable and encourage the plaintiff and the defendants as well to supply relevant information that meaningfully assists the courts in improving the fairness and utility of that substantive, pleading stage evaluation.
As we explain more fully below, the role served by the motion to dismiss in Delaware representative shareholder litigation has come to more closely resemble the role of the motion for summary judgment: it has evolved into a procedure in which, despite occurring at the pleading stage and before formal discovery, the court often evaluates the merits with the benefit of a substantial record, assembled from publicly available information or provided by defendants, consisting of facts essentially beyond dispute. In essence, with the benefit of significant factual inquiry, the motion to dismiss has evolved in Delaware shareholder litigation practice to constitute something of a proxy for a trial: a relatively inexpensive inquiry that approximates the result of a trial, and either avoids further litigation and its attendant costs altogether, or provides the parties with an informed prediction of the result at trial that facilitates rational settlement at an early stage, again, before the bulk of litigation costs is incurred.
Also, as we explain more fully below, (19) where time pressures in shareholder litigation make the motion to dismiss unavailable as a practical matter--typically, where a shareholder plaintiff seeks a preliminary injunction against completion of a merger--the efficiency-promoting function of the motion to dismiss has been taken over by the motion to expedite discovery. Instead of examining whether a complaint sets forth facts establishing a "reasonably conceivable" basis for relief, (20) the court on a motion to...