IN RE EZCORP INC. CONSULTING AGREEMENT DERIVATIVE LITIGATION
C.A. No. 9962-VCL
Court of Chancery of Delaware.
Submitted: October 27, 2015 Decided: January 15, 2016
934
LASTER, Vice Chancellor.
Edward P. Welch, Edward B. Micheletti, Cliff C. Gardner, Lauren N. Rosenello, SKADDEN, ARPS, SLATE, MEAGHER & FLOM LLP, Wilmington, Delaware; Counsel for Defendants Phillip Ean Cohen, MS Pawn Corporation, MS Pawn Limited Partnership, and Madison Park, LLC.
David C. McBride, Elena C. Norman, Nicholas J. Rohrer, Benjamin M. Potts, YOUNG CONAWAY STARGATT & TAYLOR, LLP, Wilmington, Delaware; Counsel for Defendant Thomas C. Roberts.
A. Thompson Bayliss, John M. Seaman, ABRAMS & BAYLISS LLP, Wilmington, Delaware; Randall W. Bodner, Peter L. Welsh, Jesse M. Boodoo, ROPES & GRAY LLP, Boston, Massachusetts; Counsel for Defendants Joseph J. Beal, William C. Love, and John Farrell.
Srinivas Raju, Sarah A. Clark, RICHARDS, LAYTON & FINGER, P.A., Wilmington, Delaware; Counsel for Nominal Defendant EZCORP, Inc.
OPINION
LASTER, Vice Chancellor.
The complaint in this action named as defendants Joseph J. Beal, William C. Love, and John Farrell. They were three outside directors of nominal defendant EZCORP, Inc. (“EZCORP” or the “Company“) who, in varying combinations, approved transactions challenged in this litigation.
After Cornerstone, plaintiff‘s counsel reevaluated the strength of their allegations against Beal, Love, and Farrell. Recognizing that they had not pled a non-exculpated claim against them, they proposed a dismissal without prejudice.
Beal, Love, and Farrell rejected that idea. They sought a dismissal with prejudice that would bind all potential plaintiffs. As their counsel agreed at oral argument, they wanted a dismissal that would be binding “[a]s to the world.” Unable to agree on a form of dismissal, the outside directors pressed on with their motion.
Rule 15(aaa) defines what should happen. It provides that when a plaintiff chooses to stand on his complaint and files an answering brief in opposition to a motion to dismiss, then any dismissal in a class or derivative action is with prejudice as to the named plaintiff, but without prejudice to other potential plaintiffs. Under an exception to the general rule, the court can grant a dismissal without prejudice for good cause shown. In this case, good cause does not exist for a without prejudice dismissal. The claims against the outside directors are dismissed with prejudice as to the named plaintiff only.
I. FACTUAL BACKGROUND
The relevant facts are few. They are drawn from the currently operative pleading, which is the Verified Amended Stockholder Derivative Complaint (the “Complaint“).
A. The Company And The Services Agreements
EZCORP is a publicly traded Delaware corporation headquartered in Austin, Texas. Its controlling stockholder is Phillip Ean Cohen.
In 2004, EZCORP entered into a services agreement with defendant Madison Park, LLC, an entity affiliated with Cohen. The agreement called for EZCORP to pay Madison Park $100,000 per month for a period of three years. Beginning in September 2007, when the initial agreement expired, EZCORP and Madison Park entered into annual renewals. In 2008, the monthly fee increased to $150,000. In each of the ensuing five years, the monthly fee increased again: in 2009 to $200,000, in 2010 to $300,000, in 2011 to $400,000, in 2012 to $500,000, and in 2013 to $600,000. In 2014 it remained at $600,000. In return for these payments, Madison Park agreed to consult with EZCORP as needed about mergers, acquisitions, divestitures, strategic planning, corporate development, investor relations, and other matters.
A special committee of the board of directors approved the services agreements for 2007, 2008, and 2009. The board‘s audit committee approved the later agreements. When the audit committee approved the agreement with Madison Park for 2012 and 2013, its members included Love and Farrell. When the audit committee approved the agreement with Madison Park for 2014, its members were Beal, Love, and Farrell.
B. This Litigation
On July 9, 2014, plaintiff Lawrence Treppel sent EZCORP a demand for books and records pursuant to
On July 28, 2014, Treppel filed this action. On September 23, 2014, he filed the Complaint. It contains four counts:
- Count I asserts a claim for breach of fiduciary duty against Love, Beal, Farrell, and other director defendants.
- Count II asserts a claim for waste of corporate assets against the same defendants as Count I.
- Count III asserts a claim against Cohen and two of his affiliates for aiding and abetting the directors in breaching their fiduciary duties.
- Count IV asserts a claim against Cohen and Madison Park for unjust enrichment.
C. The Motion To Dismiss
On October 13, 2014, the defendants filed pro forma motions to dismiss pursuant to Court of Chancery Rules 12(b)(6) and 23.1. On November 12, 2014, they filed their opening briefs. On January 9, 2015, Treppel filed his answering brief, and on February 6, 2015, the defendants filed their reply briefs. Vice Chancellor Parsons, to whom the case was then assigned, scheduled oral argument for July 7, 2015.
On May 14, 2015, the Delaware Supreme Court issued its decision in Cornerstone, which addressed what a plaintiff must plead against outside director defendants to overcome a motion to dismiss based on the existence of an exculpatory charter provision in a setting where the transaction under challenge is governed by the entire fairness standard of review.
Before Cornerstone, the Delaware Supreme Court had referred to the effect of an exculpatory charter provision as being “in the nature of an affirmative defense.” Emerald P‘rs v. Berlin (Emerald I), 726 A.2d 1215, 1223 (Del. 1999). The Emerald I decision and other opinions from the high court could be read to distinguish between the application of Section 102(b)(7) at the pleading stage in a case governed by the business judgment rule versus in a case governed by the entire fairness standard.1 In Cornerstone, however, the high court squarely held that “[a] plaintiff seeking only monetary damages must plead non-exculpated claims against a director who is protected by an exculpatory charter provision to survive a motion to dismiss, regardless of the underlying standard of review for the board‘s conduct—be it Revlon, Unocal, the entire fairness standard,
Treppel‘s counsel had named Beal, Love, and Farrell as defendants based on a more plaintiff-friendly understanding of the law, which the Delaware Supreme Court recognized in Cornerstone was at least an arguable reading of its earlier precedent. See id. at 1185. Treppel‘s Delaware counsel in fact represented the plaintiffs in Cornerstone, where they advanced their interpretation.
With Cornerstone having clarified matters, Treppel‘s counsel re-examined their pleading. Recognizing the paucity of factual allegations against defendants Beal, Love, and Farrell, they offered to stipulate to a dismissal of those defendants without prejudice pursuant to Court of Chancery Rule 41(a)(1). Treppel‘s counsel proposed a without-prejudice dismissal because, assuming they had the benefit of Cornerstone before filing the Complaint, they would not have named Beal, Love, and Farrell as defendants. In turn, they would not have faced the prospect of a with-prejudice dismissal and would have retained the freedom to name those individuals as defendants later.
Beal, Love, and Farrell rejected that proposal. They insisted that any dismissal should be with prejudice, not only as to Treppel but as to all other potential plaintiffs. As their counsel conceded at oral argument, Beal, Love, and Farrell wanted a dismissal with prejudice “[a]s to the world.” Dkt. 72 at 31.
Unable to agree on a stipulated order, Beal, Love, and Farrell pressed forward with argument on their motion to dismiss. Treppel‘s counsel agreed that dismissal was warranted, but argued that good cause existed for it to be without prejudice.
Due to Vice Chancellor Parson‘s retirement, the case was re-assigned to me.
II. LEGAL ANALYSIS
Subject to payment of costs and the provisions of
Rule 23(e) andRule 23.1 an action may be dismissed by the plaintiff without order of court (i) by filing a notice of dismissal at any time before service by the adverse party of an answer or of a motion for summary judgment, whichever first occurs.... However, no such dismissal pursuant to subpart (i) above shall be effective where the complaint is subject to a motion to dismiss and the plaintiff has chosen to file an answering brief rather than seeking to amend.... Unless otherwise stated in the notice of dismissal ..., the dismissal is without prejudice, except that a notice of dismissal operates as an adjudication upon the merits when filed by a plaintiff who has once dismissed in any court of the United States or of any state an action based on or including the same claim.
As indicated by the rule‘s introductory phrase, when the complaint asserts a derivative claim, a
[A derivative] action shall not be dismissed or compromised without the approval of the Court, and notice by mail, publication or otherwise of the proposed dismissal or compromise shall be given to shareholders or members in such manner as the Court directs; except that if the dismissal is to be without prejudice or with prejudice to the plaintiff only, then such dismissal shall be ordered without notice thereof if there is a showing that no compensation in any form has passed directly or indirectly from any of the defendants to the plaintiff or plaintiff‘s attorney and that no promise to give any such compensation has been made.
Yet another rule,
a party that wishes to respond to a motion to dismiss under Rules 12(b)(6) or 23.1 by amending its pleading must file an amended complaint, or a motion to amend in conformity with this Rule, no later than the time such party‘s answering brief in response to either of the foregoing motions is due to be filed. In the event a party fails to timely file an amended complaint or motion to amend under this subsection (aaa) and the Court thereafter concludes that the complaint should be dismissed under Rule 12(b)(6) or 23.1, such dismissal shall be with prejudice (and in the case of complaints brought pursuant to Rules 23 or 23.1 with prejudice to the named plaintiffs only) unless the Court, for good cause shown, shall find that dismissal with prejudice would not be just under all the circumstances. Rules 41(a), 23(e) and 23.1 shall be construed so as to give effect to this subsection (aaa).
When originally adopted in 2001,
In this case, Beal, Love, and Farrell filed their opening brief in support of their motion to dismiss, Treppel filed a combined answering brief in opposition to their motion and similar motions filed by other defendants, and Beal, Love, and Farrell
Given this sequence,
A. Rule 15(aaa) Does Not Contemplate A With-Prejudice Dismissal “As To The World.”
Beal, Love, and Farrell reject the prospect of a dismissal that only would be with prejudice as to Treppel. They insist that they are “entitled to under Rule 15(aaa)” a dismissal with prejudice “[a]s to the world.” Dkt. 72 at 31-32. The difference between a dismissal with prejudice and without prejudice is consequential. “In general, a dismissal with prejudice constitutes a final decree for res judicata purposes.” RBC Capital Mkts., LLC v. Educ. Loan Tr. IV, 87 A.3d 632, 643 (Del. 2014). By contrast, “the phrase ‘without prejudice’ will mean only that the otherwise final judgment does not operate as a res judicata bar to preclude a subsequent lawsuit on the same cause of action.” Braddock v. Zimmerman, 906 A.2d 776, 784 (Del. 2006). A with-prejudice dismissal that applies only to Treppel permits other plaintiffs, including EZCORP and other stockholders, to litigate in the future against Beal, Love, and Farrell about the issues raised in the Complaint. Any future plaintiffs still would need to plead facts sufficient to state a claim, but they would not be barred at the gate by res judicata. By contrast, a with-prejudice dismissal “as to the world” would bar anyone else, including EZCORP and other stockholders, from litigating against Beal, Love, and Farrell, no matter what the future might reveal about their conduct.
The three directors base their claimed entitlement to a dismissal with prejudice “as to the world” on the absence of any reference in
In the event a party fails to timely file an amended complaint or motion to amend under this subsection (aaa) and the Court thereafter concludes that the complaint should be dismissed under Rule 12(b)(6) or 23.1, such dismissal shall be with prejudice (and in the case of complaints brought pursuant to Rules 23 or 23.1 with prejudice to the named plaintiffs only) unless the Court, for good cause shown, shall find that dismissal with prejudice would not be just under all the circumstances.
Beal, Love, and Farrell misread
B. The Substantive Law Of Derivative Actions Precludes A With-Prejudice Dismissal “As To The World.”
Assuming for the sake of argument that
In a derivative suit, a stockholder plaintiff like Treppel seeks to displace the board‘s authority. Aronson, 473 A.2d at 811. As a matter of Delaware law, a stockholder whose litigation efforts are opposed by the corporation does not have authority to sue on behalf of the corporation until there has been a finding of demand excusal or wrongful refusal:
Because directors are empowered to manage, or direct the management of, the business and affairs of the corporation, the right of a stockholder to
Rales v. Blasband, 634 A.2d 927, 932 (Del. 1993) (emphases added; citation omitted). “The right to bring a derivative action does not come into existence until the plaintiff shareholder has made a demand on the corporation to institute such an action or until the shareholder has demonstrated that demand would be futile.” Kaplan v. Peat, Marwick, Mitchell & Co., 540 A.2d 726, 730 (Del. 1988).3
The derivative plaintiff‘s lack of authority to sue on behalf of the corporation until the denial of a Rule 23.1 motion likewise flows from the two-fold nature of the derivative suit. As the Delaware Supreme Court explained in Aronson, “[t]he nature of the [derivative] action is two-fold. First, it is the equivalent of a suit by the shareholders to compel the corporation to sue. Second, it is a suit by the corporation, asserted by the shareholders on its behalf, against those liable to it.” 473 A.2d at 811. Later Delaware Supreme Court decisions reaffirmed the two-fold nature of the derivative suit.4 Nor was this a new concept. One of Delaware‘s greatest jurists, Chancellor Josiah Wolcott, wrote half a century before Aronson that
[t]he complainants’ case, being asserted by them in their derivative right as stockholders, has a double aspect. Its nature is dual. It asserts as the principal cause of action a claim belonging to the corporation to have an accounting from the defendants and a decree against them for payment to the corporation of the sum found due on such accounting. In this aspect, the cause of action is the corporation‘s! It does not belong to the complainants. Inasmuch however as the corporation will not sue because of the domination over it by the alleged wrongdoers who are its di-
A Rule 23.1 motion addresses the first phase of the derivative action in which the stockholder sues individually to obtain authority to assert the corporation‘s claim.
Under these controlling Delaware precedents, until the derivative action passes the Rule 23.1 stage, the named plaintiff does not have authority to sue on behalf of the corporation or anyone else. The stockholder plaintiff is only suing in the plaintiff‘s own name to “compel the corporation to sue.” Aronson, 473 A.2d at 811. The only plaintiff legitimately in the case at that point is the stockholder plaintiff.
Because of the substantive law that governs a derivative action, the named plaintiff is the only party who could be bound by a dismissal with prejudice entered before the denial of a Rule 23.1 motion or before the board or a duly empowered committee permits the stockholder to sue. Here, the only plaintiff validly in the case, and the only plaintiff to whom the with-prejudice dismissal would apply, is Treppel.
The stage of the case differentiates a with-prejudice dismissal under
C. Due Process Precludes A With-Prejudice Dismissal “As To The World.”
Beyond the Delaware substantive law of derivative actions, there is even a more fundamental doctrine that prevents Beal, Love, and Farrell from obtaining a with-prejudice dismissal “as to the world“: due process of law. A foundational principle of American law is that “[a] person who is not a party to an action is not bound by the judgment in that action.” Restatement (Second) of Judgments § 62 cmt. a (1982) [hereinafter Judgments]. This “basic principle of law” is subject to three exceptions. Id. One applies “where a non-party has a specific type of pre-existing legal relationship with a named party, such as bailor and bailee, predecessor and successor or indemnitor and indemnitee.” Kohls v. Kenetech Corp., 791 A.2d 763, 769 (Del. Ch. 2000), aff‘d, 794 A.2d 1160 (Del. 2002). “Being fellow stockholders is plainly not the type of legal relationship that fits [this] exception.... An individual stockholder is not, solely because of potentially aligned interests, presumed to act in the place of (and with the power to bind) the other stockholders.” Id.
A second exception applies when “a person who is not a party to an action ... is involved with it in a way that falls short of becoming a party but which justly should result in his being denied opportunity to relitigate the matters previously in issue.” Judgments § 62 cmt. a. “Several kinds of conduct by a non-party are recognized as having this effect. These include allowing the use of one‘s name as a party when the effect is to mislead an opposing litigant; assuming control of litigation being maintained by another; and agreeing to be bound by an adjudication between others.” Id. (citations omitted). Concrete, case-specific actions by a stockholder plaintiff or its counsel might well trigger this exception, such as, for example, if the same counsel represented both stockholders or the plaintiffs otherwise collaborated. Cf. Beiser v. PMC-Sierra, Inc., 2009 WL 483321, at *3 (Del. Ch. Feb. 26, 2009); Cohen v. El Paso Corp., 2004 WL 2340046, at *2 (Del. Ch. Oct. 18, 2004). But the general scenario of parallel, overlapping, or seriatim efforts by unaffiliated stockholders to assert or prompt the assertion of corporate claims does not implicate this exception.
The third and most pertinent exception is a properly commenced and maintained representative action. Kohls, 791 A.2d at 769. Stockholder class and derivative actions qualify, but even here, the authority to represent others is not conferred automatically by filing a complaint. “A representative party must be granted ... authority, either by the represented party itself (in accordance with agency principles) or, in the class action context, by the court.” Id. It is “self-evident that if a litigant never seeks to and is never compelled to act in a representative capacity, the class of people that theoretically could have been represented by that litigant is in no way precluded from asserting their own claims in a subsequent
When a stockholder representative pursues claims on a class basis, authority is conferred by a class certification ruling.8 When a stockholder representative pursues claims in a derivative action, authority can be conferred in two ways. First, the board of directors or a duly empowered committee can approve the litigation expressly or by failing to oppose it. See Peat, Marwick, 540 A.2d at 730. Second, and more commonly, a court can determine that the stockholder plaintiff has authority to proceed by denying a Rule 23.1 motion because the complaint adequately pleads either that demand should be excused as futile or that demand was made and wrongfully refused. Until authority is conferred, the representative plaintiff only represents himself.
The limitations that due process places on the scope of a judgment find support in more august authority than common law doctrine. They are embodied in the Due Process Clause of the United States Constitution. The United States Supreme Court has held that to bind other litigants to an adjudication in a case where they were not parties “deprive[s] them of the due process of law guaranteed by the Fourteenth Amendment.” Richards v. Jefferson Cty., Ala., 517 U.S. 793, 797 (1996); accord S. Cent. Bell Tel. Co. v. Ala., 526 U.S. 160, 168 (1999).
For present purposes, the most analogous decision is Smith v. Bayer Corp., 564 U.S. 299 (2011), where the United States Supreme Court applied this principle to a putative class action. The Bayer litigation began in 2001, when a different plaintiff—George McCollins—sued Bayer Corporation in West Virginia state court. His complaint asserted various state-law claims relating to Baycol, a drug sold by Bayer. McCollins sought to represent a class comprising all West Virginia residents who purchased Baycol. A month later, another West Virginia resident, Keith Smith, filed a similar action in a different county court. Neither knew about the other‘s suit. Bayer removed McCollins’ case to federal court based on diversity jurisdiction, but Smith‘s case remained in state court for lack of complete diversity. Six years later, with both cases moving at roughly the same pace, the federal court denied class certification in McCollins’ action. Bayer then moved to have the federal court enjoin the state court from certifying a class in Smith‘s action, arguing that “the proposed
The Supreme Court reversed, holding that “[n]either a proposed class action nor a rejected class action may bind nonparties.” Id. at 315. In reaching this conclusion, the Court rejected Bayer‘s argument that “Smith—an unnamed member of a proposed but uncertified class—qualifies as a party to the McCollins litigation.” Id. at 312. The Court explained that this argument “ill-comports with any proper understanding of what a ‘party’ is,” and that while an unnamed member of a certified class can be considered a party for limited purposes, no one would “advance the novel and surely erroneous argument that a nonnamed class member is a party to the class-action litigation before that class is certified.” Id. (internal quotation omitted).
The Court found the non-binding nature of the district court‘s determination all the more clear because class certification was denied. Id. at 314 (“Still less does [Bayer‘s] argument make sense once certification is denied.“). The Court held that “[t]he definition of the term ‘party’ can on no account be stretched so far as to cover a person ... whom the plaintiff in a lawsuit was denied leave to represent.” Id.
If we know one thing about the McCollins suit, we know that it was not a class action. Indeed, the very ruling that Bayer argues ought to be given preclusive effect is the District Court‘s decision that a class could not properly be certified. So Bayer wants to bind Smith as a member of a class action (because it is only as such that a nonparty in Smith‘s situation can be bound) to a determination that there could not be a class action. Id. at 315. The Court held that a decision properly authorizing the plaintiff to represent a class was a precondition for binding unnamed class members. Id.
In reaching this conclusion, the Court rejected the defendant‘s policy-based arguments. Bayer contended that without a broad judgment that would bind all unnamed class members, multiple plaintiffs could file seriatim lawsuits, forcing the “serial relitigation of class certification.” Id. at 316. The Court responded that “[t]his form of argument flies in the face of the rule against nonparty preclusion.... [O]ur legal system generally relies on principles of stare decisis and comity among courts to mitigate the sometimes substantial costs of similar litigation brought by different plaintiffs.” Id. See generally Taylor v. Sturgell, 553 U.S. 880, 898-901 (2008) (rejecting on similar grounds the theory of preclusion by “virtual representation“).
In my view, just as the Due Process Clause prevents a judgment from binding absent class members before a class has been certified, the Due Process Clause likewise prevents a judgment from binding the corporation or other stockholders in a derivative action until the action has survived a Rule 23.1 motion to dismiss, or the board of directors has given the plaintiff authority to proceed by declining to oppose the suit. Cf. Parfi Hldg. AB v. Mirror Image Internet, Inc., 954 A.2d 911, 940 (Del. Ch. 2008) (Strine, V.C.) (“Although it is too often overlooked, derivative suits are a form of representative action. Indeed, they should be seen for what they are, a form of class action.“). In this case, a dismissal order that would be binding “as to the world” would parallel the anti-suit injunction that the district court issued in Bayer. Like the order in Bayer, it would purport to bind persons who are not parties to the suit and whose interests Trep-
D. Treppel‘s Request For A Without-Prejudice Dismissal
For the reasons described in the previous sections, Beal, Love, and Farrell cannot obtain a with-prejudice dismissal “as to the world.” Treppel takes the polar opposite view, arguing that any dismissal should be without prejudice. To reiterate, Treppel posits that if his counsel had the benefit of Cornerstone, he would not have sued Beal, Love, and Farrell. He then would not be in the position of facing a dismissal with prejudice as to himself under
In my view, Treppel has not established good cause for a without-prejudice dismissal. A similar situation arose in Quadrant Structured Products Co., Ltd. v. Vertin, 2014 WL 5465535 (Del. Ch. Oct. 28, 2014). That decision granted a motion to dismiss in part, dismissing derivative claims for breach of fiduciary duty against certain directors due to the absence of allegations that would have called into question the defendants’ loyalty or good faith. Under
The same reasoning applies here. As in Quadrant, the with-prejudice dismissal of Beal, Love, and Farrell can be revisited if a “compelling reason to do so appears.” Zirn v. VLI Corp., 1994 WL 548938, at *2 (Del. Ch. Sept. 23, 1994) (Allen, C.). That possibility alleviates any need to grant a without-prejudice dismissal now, and good cause does not exist for departing from the default rule established by
III. CONCLUSION
Beal, Love, and Farrell‘s motion to dismiss is granted. The dismissal is with prejudice only as to Treppel.
J. Travis Laster
Vice Chancellor