E-Alert Case Updates

In Stockholder Derivative Suit, Stockholder Complaint is Dismissed in its Entirety

Laborers’ Dist. Council Constr. Indus. Pension Fund & Hallandale Beach Police Officers et al., derivatively on behalf of Lululemon Athletica, Inc., Plaintiffs, v. Robert Bensoussan et al., Defendants, Lululemon Athletica, Inc., a Delaware corporation, Nominal Defendant
No. 11293-CB (Del. Ch. June 14, 2016). Court of Chancery of the State of Delaware
by Matthew S. Sarna, Summer Associate
Semmes, Bowen & Semmes (www.semmes.com)

Available at: http://courts.delaware.gov/Opinions/Download.aspx?id=242210

In a derivative action on behalf of Lululemon, Athletica, Inc., the Court dismissed the two stockholders’ complaint in its entirety. The Court ruled that the claims, a claim for demand futility and a Brophy claim against the founder of the company, were barred by both collateral estoppel (issue preclusion) and res judicata (claim preclusion), based on prior actions by a group of similarly situated stockholders.

On December 10, 2012, Dennis Wilson, the founder of Lululemon Athletica, Inc. (“Lululemon”) informed the company that he intended to sell off a portion of his shares through a trading plan established to comply with Rule 10b5-1 of the Securities Exchange Act of 1934. Rule 10b5-1 allows “insiders to implement written, pre-arranged stock trading plans when they are not in possession of material non-public information.”17 C.F.R. § 240.10b5-1(c). To comply with Rule 10b5-1, Wilson granted Merrill Lynch authority and exclusive discretion to execute trades of his shares under certain pre-arranged parameters, and warranted not to disclose any material nonpublic information to Merrill Lynch. At the time, Wilson owned 30% of Lululemon’s outstanding shares. Importantly, under the trading plan, Merrill Lynch could sell up to 5.4 million shares for no less than $81.25 per share between January 10, 2013 and June 30, 2014. Further, no more than 1 million shares could be sold in any given month.

On June 5, 2013, Wilson and Christine Day, Lululemon’s CEO, apparently came to an impasse in their respective long-term goals for Lululemon, prompting an email from Day to Wilson stating that she intended to resign from her position. Day stated that she wanted to announce her resignation the following week. Day informed an outside director of her departure on June 5 and informed the board of directors of her intent to resign on June 7. On June 10, following the public announcement of Day’s resignation, Lululemon’s stock fell by more than 17%.

Prior to Day’s public announcement, on June 7, Merrill Lynch executed a trade on behalf of Wilson for 607,545 shares at around $81.50 per share, which constituted the largest single trade of the trading plan. This trade exhausted the maximum amount of 1 million shares for the month of June. This specific trade is at the crux of the Claimants’ complaint. On June 12, 2013, the Wall Street Journal and Reuters generated several articles questioning the suspiciousness of Wilson’s trading activity. Specifically, the articles noted that had Wilson sold this number of shares after Day’s public announcement, the trade would have garnered $8 million less.

Prior to the current litigation, two Lululemon stockholders filed derivative complaints in the District Court for the Southern District of New York (“NY Action”), claiming demand futility based on a lack of independence amongst the board of directors, and that Wilson breached his fiduciary duty as a Lululemon director by allegedly selling shares while in the possession of non-public information. In March of 2014, the current litigants (“Delaware Plaintiffs”) motioned for the court to grant a limited stay of the NY Action so that their 8 Del. C. § 220 action could succeed, which would grant them access to Lululemon’s books and records. The Delaware Plaintiffs also asked the Court to, if a dismissal was granted on the Brophy action, make it so without prejudice. See Brophy v. Cities Service Co., 70 A.2d 5 (Del. Ch. 1949). The Delaware Plaintiffs referred to the NY Action’s Brophy claim as “virtually identical” to the claim they were investigating.

On April 9, 2014, in the NY Action, the district court granted the defendants’ motion to dismiss the amended complaint for failure to allege particularized facts showing that demand was excused. The Second Circuit affirmed the ruling on April 3, 2015.

On July 15, 2015, the Delaware Plaintiffs filed a complaint, alleging the individual defendant directors breached their fiduciary duties of loyalty and good faith by failing to investigate Wilson’s trading activity. They also asserted a Brophy claim against Wilson for breaching his fiduciary duties by using material non-public information to influence stock sales for his personal gain. On August 18, 2015, the defendants moved to dismiss the complaint under Court of Chancery Rules 23.1 and 12(b)(6), asserting that the complaint was barred by both issue and claim preclusion based on the NY Action.

Under New York law, to invoke issue preclusion against a party in privity with another party: 1) the party seeking the benefit of issue preclusion must prove that the identical issue was necessarily decided in the previous action and is decisive in the present action; and 2) the party seeking a denial of issue preclusion must have had a full and fair opportunity to contest the previous determination. D’Arata v. N.Y. Cent. Mut. Fire Ins. Co., 564 N.E.2d 634, 636 (N.Y. 1990). While the Delaware Plaintiffs did not challenge the express language in the district court’s decision rejecting the NY plaintiffs challenge to the board’s independence for reasons of a demand futility claim, they argued that issue preclusion should have no effect because the “allegations” in the NY Action were not identical to the current action. Specifically, the Delaware Plaintiffs argued that the NY Action complaint largely focused on securities violations, as opposed to demand futility. As the Court explained however, “claims ‘grounded on the same gravamen of the wrong upon which the action is brought’ preclude ‘the plaintiff from raising the prior cause of action in the guise of a new legal theory of claim.’” See Robert L. Haig, Commercial Litigation in New York State Courts § 93:3 (4th ed. 4C West’s N.Y. Prac. Series 2015). This same rule applies even when there are variations in the allegations. Accordingly, the Court determined that the same gravamen of wrongdoing established the demand futility issue decided in the NY Action and alleged in the current litigation.

Moving on to the question of whether the Delaware Plaintiffs had a full and fair opportunity to litigate the NY Action, the Court analyzed the presumption that privity exists between different stockholders of a corporation in derivative actions for the purposes of preclusion. See Levin ex rel. Tyco Int’l Ltd. V. Kozlowski, 2006 WL 3317048, at *10 (N.Y. Sup. Ct. Nov. 14, 2006). The Delaware Plaintiffs argued that privity did not exist because the NY plaintiffs did not adequately represent their interests. However, while “grossly deficient” management of litigation would create no justifiable reliance interest in the prior adjudication, failure to invoke all legal theories or utilize all available resources does not make representation ineffective. The Delaware Plaintiffs purported that the failure of the NY plaintiffs to utilize information generated through the review of Lululemon’s books and records constituted representative inadequacy. However, the Court, citing Pyott v. La. Mun. Police Emps.’ Ret. Sys., determined that the Delaware Plaintiffs could not assert an irrebuttable presumption of inadequacy for derivative plaintiffs who filed quickly, without seeking the company’s books and records. 74 A.3d 612, 618 (Del. 2013).

Accordingly, the Court held that the district court had decided the same demand futility issue that was determinative in the present litigation, and that the Delaware Plaintiffs had been adequately represented, providing the full and fair opportunity to litigate. As such, the doctrine of issue preclusion barred the Delaware Plaintiffs from re-litigating the issue of demand futility.

While unnecessary for the Court to decide, the Court next reviewed whether claim preclusion otherwise barred the Delaware Plaintiffs from bringing these claims. Under New York law, claim preclusion applies if: 1) the prior action involved a judgment on the merits; 2) the previous action involved the same plaintiffs or a party in privity with them; and 3) the claims asserted in the subsequent action could have or were raised in the previous action. See Monahan v. N.Y. City Dept. of Corrs., 214 F.3d 275, 285 (2d Cir. 2000). Because privity had already been established, the Court focused on elements one and three.

In New York, the dismissal of a derivative action for the failure to adequately plead demand futility is a final judgment on the merits for purposes of claim preclusion. See City of Providence v. Dimon, 2015 WL 4594150, at *6 (Del. Ch. July 29, 2015). However, a dismissal without prejudice, by definition, is not a final judgment on the merits. The Delaware Plaintiffs point to this exception, asserting that the language of the district court decision explicitly shows that the Court had dismissed the complaint without prejudice. Unfortunately, the Delaware Plaintiffs did not continue reading to the end of the same sentence of the decision, which states “… in the event plaintiffs seek to pursue these claims after making a demand on the board.” Under the plain meaning of this language, the Court determined that the plaintiffs could only re-litigate this claim if they made a demand to the board of directors, were refused, and subsequently believed that such refusal was wrongful. By necessary implication of the district court’s prior decision, the dismissal was with prejudice as to the ability of the Delaware Plaintiffs’ ability to re-plead demand futility.

Under the third prong of the test for claim preclusion, “once a claim is brought to a final conclusion, all other claims arising out of the same transaction or series of transactions are bared, even if based upon different theories or if seeking a different remedy.” In re Hunter, 827 N.E.2d 269, 274 (N.Y. 2005) (quoting O’Brien v. City of Syracuse, 429 N.E.2d 1158, 1159 (N.Y. 1981)). The Delaware Plaintiffs argued that their claim did not fall under the same subject matter because, at the time of the NY Action, there had been no review of Lululemon’s books and records. Further, the Delaware Plaintiffs asserted that the NY Action began before the Wall Street Journal article even came out, which had raised red flags about the suspicious trading activity. The Court rebuked this assertion as factually incorrect. In fact, the NY Action amended complaint was filed seven months after the article came out. Additionally, the Court determined that there was no legitimate dispute as to whether the claims at issue arose out of the same transaction that supported the NY Action. The Delaware Plaintiffs’ complaint essentially was a repackaging of the prior complaint, satisfying the subject matter requirement for claim preclusion.

Accordingly, the Court found that the elements for claim preclusion under New York law had been satisfied, and as such, as an alternative to dismissing the complaint under issue preclusion, the complaint could be dismissed under claim preclusion.