Delaware justices to decide if New York ruling leaves door open for new Lululemon suit?

January 20, 2017

A Lululemon store logo is pictured on a store in Santa Monica, California, United States, April 12, 2016. REUTERS/Lucy Nicholson - RTX29OZF

After hearing oral argument Jan. 18, Delaware’s Supreme Court must decide whether a New York federal judge’s ruling in a shareholder suit against Lululemon Athletica allows investors to bring a derivative action over alleged insider trading by the company’s board chairman.

A lawyer for two employee pension funds argued that the Delaware Chancery Court erroneously tossed the derivative suit against the athletic clothing company’s directors based on the New York judge’s dismissal of a securities fraud suit that claimed the company made false or misleading statements about its quality controls in the wake of its 2013 recall of “see-through” yoga pants.

The appeal focuses on whether U.S. District Judge Katherine B. Forrest of the Southern District of New York’s decision in Canty v. Day, 13 F. Supp. 3d 333 (S.D.N.Y. 2014), created an exception to the general rule of corporate law that only one plaintiff may sue a board on behalf of all shareholders and no one may take his place in any court if he fails.

Parallel suits

Shareholders sued in Delaware and New York claiming Chairman Dennis J. Wilson sold $80 million of company stock in June 2013 just before CEO Christine M. Day publicly announced her resignation.

Both suits included claims the directors breached their duty to investigate Wilson’s alleged insider trading.

The attorney for the plaintiffs in the Delaware action, Louis M. Bograd of Motley Rice’s Washington, DC, office, told the justices that while the Delaware plaintiffs filed a books-and-records action to get factual support for their charges, the New York plaintiffs raced into court, risking a ruling that would throw out all shareholder suits.

That forced the Delaware shareholders to intervene in the New York securities fraud suit, he said.

Chancellor Andre G. Bouchard of the Delaware Chancery court dismissed the derivative action based on the procedural doctrines of issue and claim preclusion. Judge Forrest’s refusal to excuse the shareholders from failing to make a pre-suit demand on the Lululemon board barred them from relitigating the issue of whether demand would have been futile. Laborers’ Dist. Council Constr. Indus. Pension Fund v. Bensoussan, No. 11293, 2016 WL 3352088 (Del. Ch. June 14, 2016).

In his argument before the state high court, Bograd argued that Judge Forrest tailored her ruling to preserve the Delaware plaintiffs’ right to pursue claims in the Chancery Court that were different from those of the New York plaintiffs.

The same, but different?

The Delaware suit focused on Wilson’s alleged insider trading and the directors’ failure to investigate it, while the New York suit focused on Lululemon’s alleged failure to disclose its quality control issues and addressed Wilson’s stock sales only as an afterthought, Bograd said.

Chancellor Bouchard, however, ignored the difference between the suits in his June 14 ruling and wrongly lumped all the shareholder claims into one, permitting only one suit, Bograd argued.

Chief Justice Leo E. Strine questioned Bograd as to just how well-tailored Judge Forrest’s ruling effectively was to the Delaware plaintiffs’ suit when it came to the procedural hurdle posed by the pre-suit demand requirement.

Issue vs. claim preclusion

“The New York judge may have intended the Delaware plaintiffs claim to be preserved, but did she also intend to give them a pass on the issue of pre-suit demand?” Chief Justice Strine asked.

Shareholders suing on behalf of Delaware-chartered companies like Lululemon must either demand that the directors take up their suit or show why the majority of the board members lacked the independence or objectivity to fairly review the claims and decide whether to take them up.

Were not the Delaware plaintiffs required to show that the board was incapable of fairly reviewing their claim, Chief Justice Strine asked.

The pension funds’ appeal argues that the New York claims were dismissed without prejudice to them, which left the door open for them to reassert their claims with proper support in the Chancery Court.

How different

“We alleged a different set of facts and a different theory of liability than the New York plaintiffs” that could have gotten the pension funds past the pre-suit demand hurdle, but Chancellor Bouchard’s decision “put us between a rock and a hard place” procedurally, Bograd said.

Defense attorney Stephen A. Radin of Weil Gotshal & Manges in New York countered that the Delaware plaintiffs — the Laborers’ District Council Construction Industry Pension Fund and the Hallandale Beach Police Officers and Firefighters’ Personnel Retirement Fund — were “jockeying for control of the case” by intervening.

He said the pension funds were late to the table in New York because they spent two years fighting a Delaware books-and-records action in which they asked for more information than they needed to pursue their derivative suit.

After the New York ruling, the Delaware plaintiffs “made a tactical decision not to replead in New York” even though Judge Forrest’s decision did not leave the door open for a separate Delaware action, Radin argued.

Chief Justice Strine said the question the five-judge en banc panel must decide is “whether alleging a different theory of liability entitles you to a do-over on the issue of demand.”

The high court normally takes up to three months to issue an opinion on such thorny legal questions, but in similar cases concerning procedural issues, it has recently ruled within a few days of oral argument.

Laborers’ District Council Construction Industry Pension Fund et al. v. Bensoussan et al., No. 358, 2016, oral argument held (Del. Jan.18, 2017).

Related Filings:

Opening brief: 2016 WL 5914244

Answering Brief: 2016 WL 5867355

Reply Brief: 2016 WL 6469777