OPINION
On September 1, 2010, Allergan, Inc. entered into a settlement with the United States Department of Justice pursuant to which Allergan pled guilty to criminal misdemeanor misbranding and paid a total of $600 million in civil and criminal fines. Various specialized plaintiffs’ law firms quickly filed derivative actions in both this Court and in the United States District Court for the Central District of California (the “California Federal Court”).
Litigation proceeded in both courts. The California Federal Court initially dismissed a consolidated complaint pursuant to Rule 23.1 without prejudice, then later dismissed an amended and consolidated complaint pursuant to Rule 23.1 with prejudice (the “California Judgment”). Meanwhile, I postponed briefing on the defendants’ motions to dismiss to accommodate the efforts of one stockholder, U.F.C.W. Local 1776 & Participating Employers Pension Fund (“UFCW”), to obtain books and records using Section 220 of the General Corporation Law, 8 Del. C. § 220. UFCW subsequently intervened in this action, and the plaintiffs jointly filed an 84-page, 241-paragraph Verified Second Amended Derivative Complaint dated July 8, 2011 (the “Complaint”).
The defendants have moved to dismiss the Complaint. First, they say that the California Judgment mandates dismissal with prejudice under the doctrine of collateral estoppel. Second, they say that even if reviewed independently, the Complaint fails to plead demand futility under Rule 23.1. Third, they say that the Complaint fails to state a claim under Rule 12(b)(6). I reject these arguments and deny the defendants’ motions.
The facts for purposes of the motions to dismiss are drawn from the Complaint and the documents it incorporates by reference. The incorporated documents include publicly available information, such as a government sentencing memorandum, and non-public books and records that UFCW obtained by using Section 220, such as Allergan’s internal board-approved strategic plans and warning letters from the U.S. Food and Drug Administration (the “FDA”). The Complaint contains numerous particularized factual allegations from which inferences reasonably could be drawn in favor of either the plaintiffs or the defendants. At this stage of the case, the plaintiffs receive the benefit of all reasonable inferences.
A. Allergan And The Growth Of Botox
Nominal defendant Allergan is a Delaware corporation that develops and commercializes specialty pharmaceuticals, bio-logies, and medical devices. Allergan’s stock trades on the New York Stock Exchange under the symbol “AGN.” The twelve individual defendants comprised Al-lergan’s board of directors (the “Board”) at the time this action was initiated. Defendant Pyott has served as Allergan’s CEO since 1998 and as Chairman of the Board since 2001. Defendants Boyer, Gallagher, Herbert, and Schaeffer have served as outside directors since before 2000. Defendants Ryan, Ray, and Jones joined the board as outside directors in 2002, 2003, and 2004, respectively. Defendants La-vigne and Ingram joined the board in 2005. Defendants Dunsire and Hudson joined the board in 2006 and 2008, respectively.
Allergan manufactures Botox, a drug widely known for its muscle-relaxing properties. The trade name derives from its active ingredient, the neurotoxin botulinum toxin type A. The government settlement and this opinion address only Botox Therapeutic; they do not address its better-known sibling, Botox Cosmetic, which has its own FDA-approved label and drug code.
The FDA first approved Botox for therapeutic use in 1989 for treating two eye muscle disorders: strabismus (crossed eyes) and blepharospasm (abnormal spasm of the eyelids). In December 2000, the FDA approved Botox for treating pain associated with cervical dystonia (involuntary neck muscle contraction). In July 2004, the FDA approved the product for treating severe primary axillary hyperhidrosis (underarm sweating). Not until 2010 would the FDA approve two additional treatments: upper-limb spasticity (approved in March 2010) and migraine headaches (approved in October 2010).
A small market existed for the limited Botox uses approved by the FDA before 2010. Treating physicians, however, were not limited to FDA-approved applications. In the United States, a physician may prescribe an approved pharmaceutical product for any use, including uses not approved by the FDA. Prescribing a pharmaceutical product for an FDA-approved use is referred to as “on-label” use; prescribing the same product for an unapproved use is referred to as “off-label” use. “ ‘Off-label use is widespread in the medical community and often is essential to giving patients optimal medical care, both of which medical ethics, FDA, and most courts recognize.’ ” Buckman Co. v. Plaintiffs’ Legal Comm.,
Because a physician legally can prescribe a product for off-label use, a manu-
Allergan understood the critical distinction between off-label sales and marketing. Allergan’s 2004 Annual Report summarized the regulatory scheme as follows:
Physicians may prescribe pharmaceutical and biologic products for uses that are not described in a product’s labeling or differ from those tested by us and approved by the FDA. While such “off-label” uses are common and the FDA does not regulate a physician’s choice of treatment, the FDA does restrict a manufacturer’s communications on the subject of off-label use. Companies cannot actively promote FDA-approved pharmaceutical or biologic products for off-label uses.... If ... our promotional activities fail to comply with the FDA’s regulations or guidelines, we may be subject to warnings from, or enforcement action by, the FDA or another enforcement agency.
This derivative action arises out of Aller-gan’s failed efforts (as demonstrated by the guilty plea and government settlement) to walk the fine line between off-label sales and off-label marketing.
B. Allergan Provides Extensive Support For Off-Label Sales.
Allergan strongly advocated expanded uses for Botox and supported off-label Bo-tox sales with a phalanx of initiatives. The company sponsored Botox seminars and presentations about off-label uses, founded and financed organizations that advocated off-label uses, provided support services for physicians seeking reimbursement for off-label uses, and lobbied government healthcare programs.to expand reimbursement for off-label uses. Allergen CEO Pyott was such a vocal advocate for the drug that he earned the nickname “Mr. Botox.”
Most importantly, Allergan cultivated relationships with physicians, a strategy it considered critical to increasing off-label Botox use. Allergan instituted a Physician Partnership Program in which it paid selected physicians to be travelling mentors to promote Botox use among their peers, and it funded physician “preceptorships” in which Allergan personnel shadowed participating physicians. Allergan monitored physician prescription writing, identified those doctors who prescribed high levels of Botox, and recruited them for its Physician Partnership Program. Allergan also funded continuing medical education programs, seminars, and promotional dinners. In 2006 alone, the company sponsored more than 1,200 physician speaker programs.
Allergan recognized that growth in off-label Botox use largely depended on physicians receiving reimbursement from healthcare programs. To facilitate reimbursement, Allergan employed Provider Reimbursement Account Managers to counsel physicians concerning off-label Bo-tox prescriptions. The Provider Reimbursement Account Managers audited physician billing records and reviewed the payments physicians received to assist in maximizing reimbursement for off-label use. Allergan maintained a physician-assistance hotline that doctors could call for additional off-label reimbursement advice and billing assistance. To provide a financial incentive for physicians to write more
Allergan also financed a number of organizations to support off-label Botox use. Mitchell Bren, Allergan’s chief scientific officer for Botox, founded WE MOVE, the Worldwide Education and Awareness for Movement Disorders Organization. WE MOVE distributed medical literature to physicians thаt provided dosing guidelines for off-label uses, including a “Suggested Pediatric BOTOX® Dosing” manual. Al-lergan also funded the Neurotoxin Institute, an on-line organization that disseminated information about off-label Botox uses. Although funded by Allergan, the Institute described itself on its website as “a multidisciplinary organization created to serve as a comprehensive independent source of information related to the basic science and the clinical applications of neu-rotoxins.” Compl. ¶ 78 (emphasis added; internal quotation omitted). Allergan financed another entity, the Alliance for Patient Access, whose mission was to reduce coverage barriers to reimbursement for off-label Botox uses.
C. The Board Approves And Oversees The Strategic Plan.
The Allergan Board played an active role in planning and monitoring the growth of Botox, which was one of the company’s most promising products. From at least 1997, the Board discussed and approved a series of annual strategic plans that sought to expand off-label Botox sales. A slide deck summarizing the 1997-2001 Strategic Plan listed “BOTOX — Spasticity, migraine, and pain” as one of Allergan’s “Top Corporate Priorities.” German Aff. Ex. D, Plan Slides, at 10 [hereinafter the Plan Slides]. At the time, those uses were not approved by the FDA. The slides further noted that Botox “represents] immediate growth” for Allergan and that the “[expansion strategy enables Allergan to maximize ... BO-TOX® now. ” Id. at 11. The plan noted that Botox would enable Allergan to compete in the “pain market” and “migraine headache market,” which were estimated to grow to a combined $6 billion by 2007. Written Plan at 3. The plan described Bo-tox as having “tremendous growth potential as we fund opportunities ... such as spasticity, pain, migraine, and tension headache.” Id. Each remained an off-label use until at least 2010.
The Board regularly monitored Botox sales. For example, at a September 2002 Board meeting, Pyott “reviewed BOTOX® growth in average daily -sales.” Compl. ¶ 15. At a July 2003 Board meeting, Pyott “discussed BOTOX® sales growth over last 12 months, the then-current sales mix of BOTOX® Therapeutic (58%) v. BO-TOX® Cosmetic (42%), intra-therapeutic growth rates for BOTOX®, and BOTOX® capacity utilization and scenarios.” Id.
D. Government Scrutiny Of Allergan’s Botox Programs
Allergan first drew government scrutiny for its Botox initiatives on August 22, 2001, when Allergan received a warning letter from the FDA. The letter noted that the FDA had “reviewed [Allergan] promotional activities and materials and has concluded that they are misleading and lacking in fair balance.... ” German Aff. Ex. F. The letter requested that Allergan take
Despite the FDA warnings, Allergan continued to drive Botox sales, which increased rapidly. Between 2000 and 2004, net sales of Botox grew between 25% and 42% annually, despite being approved by the FDA for only four limited uses. Compl. ¶ 58. Off-label sales skyrocketed. Between 1999 and 2006, spasticity sales grew by 332%; headache sales grew by 1,407%; and pain sales grew by 504%. Id. ¶ 12. By 2005, Botox accounted for 33% of Allergan’s total net sales. Id. ¶ 170.
E. The Schim Incident
On September 21, 2006, the FDA sent a letter to Allеrgen concerning off-label marketing during a presentation by an Aller-gan-sponsored speaker, Dr. Jack Schim. Dr. Schim is the co-director of the Headache Center of Southern California and was a frequent participant in Allergan’s sponsored-physician speaker program.
On October 24, 2006, Allergan’s General Counsel Douglas S. Ingram advised the Board by email about the FDA inquiry. Ingram noted that Dr. Schim’s speech “contained a large volume of information on the use of Botox for the treatment-of headache,” which was an off-label use at the time. German Aff. Ex. E. Ingram reminded the directors that the dinner programs were “directly funded, hosted, and controlled by Allergan” and that “the presentations are considered commercial promotion and Allergan is responsible for their content.” Id. Ingram reported that
[u]pon our internal investigation into this dinner meeting, it was discovered that Dr. Schim had been provided the approved ... slide deck but had, instead, used another deck of slides that were not approved [by Allergan].... These slides, many of which presumably came from continuing medical education events, contained some information about the mechanism of action of Botox and some information on the use of Bo-tox for the treatment of cervical dysto-nia. However, the deck also contained a large volume of information on the use of Botox for the treatment of headache. Moreover, we have discovered that there were a total of 8 such dinner meetings over the last 12 months at which Dr. Schim presented these or similar slides.
Id. (emphasis added).
Ingram advised the Board that “[i]t appears that the primary basis for this failure to comply with policy related to a perceived lack of responsibility within the sales and marketing organization.” Id. According to Ingram, “[t]he sales representative and sales manager knew or should have known that [unapproved] slides were being used but apparently did not believe it was their responsibility to ensure that only [approved] slides were being used, as they were not part of the approval process for the slide decks.” Id. Ingram warned that “[t]his is a potentially serious matter and in the current environment, the chance of receiving Agency action, including but not limited to a Warning Letter, on this matter is in my opinion very high.” Id.
F. The Board Approves The 2007-2011 Strategic Plan And Off-Label Botox Sales Continue To Grow.
After the Schim incident, the Board continued to authorize aggressive efforts to increase Botox sales. For example, the Board approved Allergan’s 2007-2011 Strategic Plan, which explicitly linked the number of sales representatives, or Neuroscience Medical Consultants (“NMCs”), to increased off-label sales. Compl. ¶ 176
During the same period, the Board received detailed reports on Botox sales. For example, management presented the Board with a 2007 Customer Survey that showed U.S. Botox sales figures for on-label and off-label uses. By 2007, annual Botox sales for therapeutic uses totaled nearly $600 million, with 70-80% generated by off-label use.
G. The Government Settlement
On September 1, 2010, Allergan entered into a settlement with the United States Department of Justice. The settlement followed a three-year joint investigation of Allergan’s off-label marketing practices by the Federal Bureau of Investigation, the FDA’s Office of Criminal Investigation, and the Department of Health and Human Services, Office of Inspector General. Under the terms of the settlement, Allergan agreed to plead guilty to criminal misdemeanor misbranding for the period from 2000 through 2005 and pay criminal fines of $375 million. Allergan also agreed to pay an additional $225 million in civil fines to resolve False Claims Act lawsuits which alleged similar off-label marketing claims. The $600 million penalty equaled 96% of the company’s reported net income in 2009 and exceeded both its 2007 and 2008 net income.
As part of the settlement, Allergan entered into a five-year Corporate Integrity Agreement with the Department of Health and Human Services, Office of Inspector General. The agreement mandates that Allergan implement a strict compliance program, notify physicians of the government settlement, and post information on payments to physicians on the company’s website.
H. The Derivative Actions
The public announcement of the settlement on September 1, 2010, prompted plaintiffs’ firms who specialize in stockholder representative litigation to rush to the courthouse. For reasons described below, this unfortunate behavior reflects understandable choices made by these rational economic actors given the incentives currently created by our legal system. See infra Part II.A.3.
On September 3, 2010, Louisiana Municipal Police Employees’ Retirement System (“LAMPERS”) filed this action. The original complaint relied solely on the Allergan press release and other publicly available information. Given the short time frame involved, counsel had minimal opportunity to investigate the claims. Nor could counsel have evaluated meaningfully whether or not a sufficient number of Allergan directors were disabled such that the Board was not the appropriate corporate actor to address the fallout from the government investigation.
Between September 9 and 24, 2010, other specialized stockholder plaintiffs’ firms filed similar derivative actions in the California Federal Court. See Rosenbloom v. Pyott, No. SACV10-01352-DOC; Himmel v. Pyott, No. SACV10-01417-JVS; Pompano Beach Police & Firefighters’ Ret. Sys. v. Pyott, No. SACV10-01449-DOC. On October 25, the California Federal Court consolidated the cases. See In re Allergan Inc. S’holder Deriv. Litig., Case No. SACV10-01352-DOC,
On November 3, 2010, UFCW sent Al-lergan a Section 220 demand for books and records. On November 30, UFCW moved to intervene in this action. LAMPERS joined the defendants in vehemently opposing the motion to intervene. Rather than welcoming UFCW as a litigation partner and potential source of information to craft an even better complaint, LAM-PERS attacked UFCW in an effort to maintain control over the case. LAM-PERS’ opposition maligned UFCW’s efforts as “indefensible” and “serving] only to unduly delay the adjudication of the rights of the original parties, while providing absolutely no benefit to Allergan, Inc.” Dkt. 37, Opp’n Mem. 1-2. In doing so; LAMPERS seemed oblivious to the Delaware courts’ repeated exhortations that plaintiffs use Section 220 before filing derivative actions, as UFCW was doing, or that defendants regularly prevail when moving to dismiss hastily filed derivative complaints prepared without the benefit of books and records. See infra Part II.A.3.
On January 21, 2011, I denied the motion to intervene without prejudice as prematurely filed, but postponed any hearing on the motions to dismiss “until after the 220 process is over.” La. Mun. Police Empls. Ret. Sys. v. Pyott, C.A. No. 5795-VCL, at 56-57,
Meanwhile, in the California Action, the California Federal Court dismissed the plaintiffs’ first complaint without prejudice on April 12, 2011. The California plaintiffs asked Allergan for the Section 220 production, and Allergan shared it. The California plaintiffs subsequently filed an amended complaint that incorporated the documents Allergan provided, and the California defendants again moved to dismiss.
For reasons that are not clear to me, briefing on the motions to dismiss moved forward more quickly in California than in Delaware. On January 17, 2012, without the benefit of oral argument, the California Federal Court issued the California Judgment, a five-page order dismissing the California Action with prejudice pursuant to Rule 23.1 for failure to plead demand futility. On February 22, the California Federal Court denied a motion for reargument. The defendants then supplemented their motions to dismiss in this action to invoke collateral estoppel.
II. LEGAL ANALYSIS
The defendants identify three bases on which they say judgment should be entered in their favor: collateral estoppel, Rule 23.1, and Rule 12(b)(6). If collateral estoppel applies, then I need not consider the others, so I start there.
Controlling Delaware Supreme Court precedent makes clear that until a Rule 23.1 motion has been denied, a derivative plaintiff whose litigation efforts are opposed by the corporation does not have authority to sue in the name of the corporation. Consequently, at the time of the first Rule 23.1 dismissal, other stockholders are not in privity with the stockholder plaintiff in the first derivative action, and a decision granting a Rule 23.1 dismissal cannot have preclusive effect. The dismissal remains persuasive authority, but it is not preclusive.
The defendants rely on LeBoyer, a California collateral estoppel decision that conflicts with controlling Delaware Supreme Court authority on the effect of a Rule 23.1 dismissal. If the collateral estoppel issue were properly presented to the California Federal Court, that court should decline to follow LeBoyer and hold instead that collateral estoppel does not bar a later derivative action by a different stockholder.
Because the California Judgment does not have preclusive effect, I analyze the defendants’ motions to dismiss pursuant to Rules 23.1 and 12(b)(6). Respectfully disagreeing with the California Federal Court, I deny the Rule 23.1 motion. With all reasonable inferences drawn in favor of the plaintiffs, as required at this procedural stage, the Complaint’s particularized allegations raise a reasonable doubt that a majority of the Board could properly consider a demand. Read as a whole, the particularized allegations support a reasonable inference that the Board consciously approved a business plan predicated on violating the federal statutory prohibition against off-label marketing. “[0]ne cannot act loyally as a corporate director by causing .the corporation to violate the positive laws it is obliged to obey.” Guttman v. Huang,
Determining that the Complaint alleges particularized facts that present a substantial threat of liability under the heightened Rule 23.1 pleading standard necessarily determines that the Complaint states a
A. Collateral Estoppel
The defendants observe that in LeBoyer, the California Federal Court applied collateral estoppel to hold that a California state court’s dismissal with prejudice of one stockholder plaintiffs derivative action pursuant to Rule 23.1 barred a different stockholder plaintiff from suing derivatively. The defendants correctly point out that when applying collateral estoppel, this Court must give a judgment the same force and effect that it would be given by the rendering court.
LeBoyer described collateral estoppel as having five elements:
First, the issue sought to be precluded from relitigation must be identical to that decided in a former proceeding. Second, this issue must have been actually litigated in the former proceeding. Third, it must have been necessarily decided in the former proceeding. Fourth, the decision in the former proceeding must be final and on the merits. Finally, the party against whom preclusion is sought must be the same as, or in privity with, the party to the former proceeding.
For purposes of this case, I need only consider privity. I need not contemplate whether a Rule 23.1 dismissal is “on the merits” for purposes of collateral estop-pel.
1. Choice of Law
Whether successive stockholders are sufficiently in privity with the corporation and each other is a matter of substantive Delaware law governed by the internal affairs doctrine. See Sonus Networks,
The United States Supreme Court has held that “the function of the demand doctrine in delimiting the respective powers of the individual shareholder and of the directors to control corporate litigation clearly is a matter of ‘substance,’ not ‘procedure,’ ” and is therefore governed by the internal affairs doctrine. Kamen v. Kemper Fin. Servs., Inc.,
As in Kamen, applying the internal affairs doctrine in this setting promotes the important objective of treating directors, officers, and stockholders uniformly across jurisdictions. See Conflict of Laws § 302, cmt. e (“Uniform treatment of directors, officers and shareholders is an important objective which can only be attained by having the rights and liabilities of those persons with respect to the corporation governed by a single law.”).
Large corporations that are listed on national exchanges, or even regional exchanges, will have shareholders in many States and shares that are traded frequently. The markets that facilitate this national and international participation in ownership of corporations are essential for providing capital not only for new enterprises but also for established сompanies that need to expand their businesses. This beneficial free market system depends at its core upon the fact that a corporation — except in the rarest situations — is organized under, and governed by, the law of a single jurisdiction, traditionally the corporate law of the State of its incorporation.
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It thus is an accepted part of the business landscape in this country for States to create corporations, to prescribe their powers, and to define therights that are acquired by purchasing then’ shares. A State has an interest in promoting stable relationships among parties involved in the corporations it charters, as well as in ensuring that investors in such corporations have an effective voice in corporate affairs.
CTS Corp.,
2. The Same Party Or A Party In Privity
In determining that successive stockholders were in privity for purposes giving collateral estoppel effect to a Rule 23.1 dismissal, LeBoyer relied on the legal truism that a derivative plaintiff sues in the name of the corporation. In the court’s words, “the fifth element is satisfied in that in both suits the plaintiff is the corporation itself. The differing groups of shareholders who can potentially stand in the corporation’s stead are in privity for the purposes of issue preclusion.”
It is a matter of black-letter law that the plaintiff in a derivative suit represents the corporation, which is the real party in interest. Under Massachusetts law, a derivative suit is prosecuted in the right of the corporation. Standing to represent a foreign corporation is governed by the laws of the state of incorporation, and Delaware law is in accord with the prevailing rule that the shareholder in a derivative suit represents the corporation.
These cases miss that 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
Because directors are empowered to manage, or direct the management of, the business and affairs of the corporation, the right of a stockholder to prosecute a derivative suit is limited to situations where the stockholder has demanded that the directors pursue the corporate claim and they have wrongfully refused to do so or where demand is excused because the directors are incapable of making an impartial decision regarding such litigation.
[P]re-suit demand under Chancery Court Rule 23.1 is an objective burden which must be met in order for the shareholder to have capacity to sue on behalf of the corporation. 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.
The derivative plaintiffs 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 v. Lewis, the seminal demand-futility decision, “[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.”
The 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 directors, the complainants as stockholders have a right in equity to compel the аssertion of the corporation’s rights to redress. This is their individual right. A bill filed by stockholders in their derivative right therefore has two phases — one is the equivalent of a suit to compel the corporation to sue, and the other is the suit by the corporation, asserted by the stockholders in its behalf, against those liable to it. The former belongs to the complaining stockholders; the latter to the corporation.
Cantor v. Sachs,
Under these controlling Delaware precedents, until the derivative action passes the Rule 23.1 stage, the stockholder does not have authority to assert the corporation’s claims and is not suing in the name of the corporation. Until a Rule 23.1 motion is denied or the board decides not to oppose the derivative action, the stockholder plaintiff is only suing to “compel the corporation to sue.” Aronson,
In my view, therefore, the legal truism that the underlying claim in a derivative action belongs to the corporation and ultimately will be asserted in the corporation’s name if the stockholder plaintiff receives permission to sue does not support the proposition that stockholders are in privity for purposes of the preclusive effect of an order granting a Rule 23.1 motion. At that phase of the case, the competing stockholders are asserting only their individual claim to obtain equitable authority to sue. See Aronson,
Courts giving preclusive effect to Rule 23.1 dismissals also have relied on generally accurate statements to the effect that a judgment in an action brought by or on behalf of the corporation binds all stockholders. For example, in Henik, a decision often cited as authority for giving preclusive effect to a Rule 23.1 dismissal, the court quoted a 1942 decision for the proposition that ‘“[a] judgment in the stockholders’ derivative action is res judi-cata both as to the corporation and as to all of its stockholders, including stockholders who were not parties to the original action in subsequent actions based upon the same subject matter.’ ”
This Court has held squarely that the adjudication of one stockholder’s individual claim does not have preclusive affect on a second stockholder’s ability to assert the claim. Kohls v. Kenetech Corp.,
The Court of Chancery in Kohls started from the foundational principle that “[a] person who is not a party to an action is not bound by the judgment in that action.”
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
This leaves the third and most pertinent exception: a properly commenced and maintained representative action. Kohls,
Despite determining that neither res ju-dicata nor collateral estoppel applied, the Kohls Court nevertheless dismissed the second lawsuit as a matter of stare decisis: “[Bjecause the [plaintiffs] fail to distinguish their claims, either factually or legally, from those adjudicated” in the prior action, “[n]ormal respect for the principle of stare decisis ” required dismissal under Rule 12(b)(6).
When a stockholder representative pursues claims on a class basis, authority is conferred by the Court’s class certification ruling. See Ct. Ch. R. 23; Schwarzschild v. Tse,
When the same stockholder responds to a Rule 23.1 dismissal by attempting to file a second complaint alleging demand futility, the “same party” requirement is met and a Rule 23.1 dismissal may have preclusive effect. See W. Coast Mgmt.,
Consequently, when a different stockholder attempts to plead demand excusal, an earlier Rule 23.1 dismissal should not have preclusive effect. The earlier dismissal terminated the first phase of the prior derivative action, in which the complaining stockholder asserted an individual claim to seek equitable authority to sue on behalf of the corporation. Under Kohls, the prior ruling does not affect the individual claims of other stockholders to seek equitable authority to sue. It similarly has no effect on the second-phase issue of the corporation’s cause of action. The decision does, of course, carry persuasive weight and can operate as stare decisis.
The Court of Chancery traditionally has recognized these principles. “It is common practice in this court where there are inadequate allegations of demand futility to dismiss derivative suits as to the named plaintiff, but not as to the corporation or its other stockholders.” W. Coast Mgmt.,
[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).
Ct. Ch. R. 15(aaa) (emphasis added). The language of Rule 15(aaa) confirms that a dismissal pursuant to Rule 23.1 is “with prejudice to the named plaintiffs only.” Id.
This Court took a different approach in Career Education, a decision with which I respectfully disagree. Career Education followed the federal cases holding that a Rule 23.1 dismissal has broad preclusive effect.
[A] trend in recent federal case law extend[s] collateral estoppel to different plaintiffs in a second derivative suit. Those cases justified the extension of [estoppel] doctrine based on the unique position of the parties in derivative suits. Because the corporation is the true party in interest in a derivative suit, courts have precluded different derivative plaintiffs in subsequent suits. This commonality lends itself to the application of collateral estoppel or issue preclusion.
In my view, contrary to Career Education, an earlier Rule 23.1 dismissal does not have preclusive effect on a subsequent derivative action brought by a different plaintiff because, as the earlier Rule 23.1 decision itself established, the prior plaintiff lacked authority to sue on behalf of the corporation and therefore was not in privity with the corporation or other stockhold
3. Inadequate Representation
As an independent basis for declining to give collateral estoppel effect to the California Judgment, I find that the California plaintiffs did not adequately represent Allergan. The decisions that give preclusive effect to a Rule 23.1 dismissal universally recognize that another stockholder still can sue if the first plaintiff provided inadequate representation.
Chancellor Strine has suggested Delaware law presume that a fast-filing stockholder with a nominal stake, who sues derivatively after the public announcement of a corporate trauma in an effort to shift the still-developing losses to the corporation’s fiduciaries, but without first conducting a meaningful investigation, has not provided adequate representation. See King v. VeriFone Hldgs., Inc.,
When a derivative plaintiff files a damages action hastily in the wake of a public announcement, there is no basis for expediting the case to further the interests of the corporation and its stockholders, and, when the derivative plaintiff forewent a books and records investigation and a period of deep reflection on the publicly available documents and the law, should not the presumption be that the plaintiff is not fit to serve as the lead fiduciary for the corporation and its stockholders? What rational argument is there that it advances the legitimate interests of investors to give aleg up to the first to get to court in a situation when being first to court is likely to compromise the ability of the filing plaintiff to sustain his derivative complaint? Admittedly, there are no easy answers to the question of how to select lead counsel in representative actions, but what is certain is that rewarding plaintiffs and their counsel who sue first, and investigate and think second is likely to maximize the costs to investors of representative suits and minimize the benefits. Put simply, the speed racer approach might benefit certain interests, but those interests do not include the investors of corporations or the other societal constituencies dependent on the effective and efficient governance of corporations.
King I,
a. The Fast-Filing Problem
Appreciating the need for the fast-filer presumption requires a big-picture understanding of the role derivative actions play in the corporate landscape. For publicly traded Delaware corporations, the enforcement of fiduciary obligations is largely carried out by specialized plaintiffs’ firms who bring claims on a contingent basis.
[a] fundamental condition of the corporate form when stockholders are widely dispersed, as typically occurs in public corporations, is that individual shareholders have little incentive to bear the costs associated with activities that monitor board of director (or management) performance. Of course, a fundamental advantage that the corporate form offers to owners of capital is the utility that an investor gains through centralized management. Centralized management allows passive (low cost) ownership and promotes investor diversification. Limited liability and the entity status of a corporation similarly allow investors to be relatively passive. While the conditions that allow investors to be rationally passive are a primary source of utility, they can also lead to inefficiency to the extent centralized management may have incentives that are not perfectly aligned with those of the residual owners of the firm, which is inevitably the case. This imperfect alignment of incentives will inevitably lead to excess costs associated with centralized management. For that reason some expenditures for shareholder monitoring would be efficient. Such monitoring is, of course, more or less costly to the shareholder who engages in it. In a public company with widely distributed shares any particular shareholder has very little incentive to incur those costs himself in pursuit of a collective good, since unless there is some method to force a sharing of costs, he will bear all of the costs and only a (small) pro rata share of any gains that the monitoring yields.
Bird v. Lida, Inc.,
Because specialized plaintiffs’ firms ultimately receive compensation from awards of attorneys’ fees, their interests can diverge from the class or entity they represent.
A plaintiffs’ firm only can obtain a fee if it first obtains a result. A firm cannot obtain a result if a competitor gains control of the case. Many jurisdictions are perceived to follow a “first-filed” rule that gives control within that jurisdiction to the first stockholder plaintiff and associated law firm to file a representative action.
The conflict arises because fast-filing imposes real costs on corporations and their stockholders. When fast-filed complaints follow the announcement of a transaction or other event that likely will require expedited litigation, they at least perform the beneficial function of identifying the firms who wish to compete for leadership status. In a quickly evolving deal setting, fast-filing enables a leadership structure to be put in place so that expedited litigation can begin in earnest. But in contexts that do not warrant expedition, any administrative benefit disappears. When plaintiffs sue derivatively to recover damages from directors and senior officers for harm suffered by the corporation, the hastily filed complaints have little chance of surviving a Rule 23.1 motion, yet the defendant fiduciaries must respond, and the corporation must underwrite the costs of defense, either directly through indemnification and advancement or indirectly through insurance.
b. The Idealized Derivative Action
When a corporation suffers harm, the board of directors is the institutional actor legally empowered under Delaware law to determine what, if any, remedial action the corporation should take, including pursuing litigation against the individuals involved. See 8 Del. C. § 141(a). “A cardinal precept of the General Corporation Law of the State of Delaware is that directors, rather than shareholders, manage the business and affairs of the corporation.” Aronson,
Absent sufficient reason to doubt the directors’ ability to make disinterested and independent decisions about litigation, the board is not only empowered but optimally positioned to make decisions on behalf of the corporation and, if appropriate, pursue litigation. The board can deploy the corporation’s resources to investigate the wrongdoing and seek a remedy. The directors have full access to the corporation’s internal information, including privileged communications. The board can seek cooperation from management and employees and utilize the company’s internal expertise. In contrast to the Court, which typically only can award some form of damages, the board can bargain with alleged wrongdoers and craft remedies that may better serve the entity. Perhaps most significantly, the board can take into consideration and balance the interests of multiple constituencies when determining what outcome best serves the interests of stockholders. See, e.g., 1 R. Franklin Balotti & Jesse A. Finkelstein, The Delaware Law of Corporations and Business Organizations § 13.15, at 13-75 (3d ed.1998) (listing factors that special litigation committee should consider, including “[t]he magnitude and merits of the claims; [t]he size and likelihood of a recovery of damages or other relief; [t]he possible detriment to the company from the assertion of any claims, as well as the indirect costs, such as the effect upon other potential litigation to which the company is a party, and relationships with customers or suppliers; and [t]he remedial steps already taken and that, in the future, could be taken by the corporation to prevent a reoccur-rence of the challenged actions”). Consequently, both as a matter of legal authority and optimal resource allocation, the “board of directors, unless legally disabled, should be presented with the opportunity to manage litigation that seeks to redress harm inflicted upon the corporation.” Saito v. McCall,
In a derivative suit, a stockholder seeks to displace the board’s authority. Aronson,
A stockholder cannot displace the board’s authority simply by describing the calamity and alleging that it occurred on the directors’ watch. “ ‘[M]ost of the decisions that a corporation, acting through its human agents, makes are, of course, not the subject of director attention.’ ” Stone ex rel. AmSouth Bancorporation v. Ritter,
To plead a sufficient connection between the corporate trauma and the board, the plaintiffs first and most direct option is to allege with particularity actual board involvement in a decision that violated positive law. In Caremark, Chancellor Allen framed the test as whether the directors “knew or ... should have known” about illegality. Caremark,
If the plaintiff cannot point to a decision, then the next alternative is to plead that the board consciously failed to act after learning about evidence of illegality — the proverbial “red flag.” A plaintiff might plead, for example, that the directors
ignored “red flags” indicating misconduct in defiance of their duties. A claim that an audit committee or board had notice of serious misconduct and simply failed to investigate, for example, would survive a motion to dismiss, even if the committee or board was well constituted and was otherwise functioning.
Shaev,
If there is no evidence of direct board action or conscious inaction, then the plaintiff might seek to plead “that a board of directors is dominated or controlled by key members of management, who the rest of the board unknowingly allowed to engage in self-dealing transactions.” Shaev,
Generally where a claim of directorial liability for corporate loss is predicated upon ignorance of liability creating activities within the corporation, as in Graham [v. Allis-Chalmers Manufacturing Company,188 A.2d 125 (Del.1963) ] or in [the Caremark case itself], ... only a sustained or systematic failure of the board to exercise oversight — such as an utter failure to attempt to assure a reasonable information and reporting system exists — will establish the lack of good faith that is a necessary condition to liability.
Id. “Concretely, this latter allegation might take the form of facts that show the company entirely lacked an audit committee or other important supervisory structures, or that a formally constituted audit committee failed to meet.” Shaev,
The standard for Caremark liability thus parallels the standard for imposing damages when a corporation has an exculpatory provision adopted pursuant to 8 Del. C. § 102(b)(7). See Desimone,
A failure to act in good faith may be shown, for instance, [1] where the fiduciary intentionally acts with a purpose other than that of advancing the best interests of the corporation, [2] where the fiduciary acts with the intent to violate applicable positive law, or [3] where the fiduciary intentionally fails to act in the face of a known duty to act, demonstrating a conscious disregard for his duties. There may be other examples of bad faith yet to be proven or alleged, but these three are the most salient.
In re Walt Disney Co. Deriv. Litig.,
Because a plaintiff must plead a connection to the board, only the extremely rare complaint will be able to establish the necessary linkage without referring to internal corporate documents. To obtain the necessary documents, the Delaware
If dispersed stockholders could act collectively following a corporate trauma, they would want the corporation to pursue claims vigorously against its fiduciaries only if there was a risk-adjusted prospect of a net-positive recovery. They would not file suit hastily, thereby imposing needlessly on themselves both the cost of their offensive litigation and the burdens of defense. The hypothetical stockholder collective would recognize there was no need to rush. The statute of limitations on a breach of fiduciary duty claim is three years. In re Tyson Foods, Inc.,
Rather than filing hastily, the hypothetical stockholder collective would proceed deliberately. It would hire well-qualified counsel. Through counsel, it would conduct an investigation and seek books and records using Section 220. After obtaining books and records, counsel would evaluate whether it made sense to sue. The books and records might show that the board had an appropriate monitoring system in place, but that the system did not alert the board. Or the books and records might show that despite their good faith efforts, the directors were misinformed or misled. Under these or other circumstances, the hypothetical stockholder collective logically might decide not to sue, preferring to leave their elected fiduciaries to the task of remedying the harm suffered by the corporation and dispensing with expensive litigation that likely would founder on Rule 23.1. If the stockholders had concerns, they might make a litigation demand, provide the board with the results of their
By contrast, if the books and records showed director misconduct, then the stockholders could decide to pursue a claim. Them counsel at that point would be well positioned to plead demand futility and survive a motion to dismiss. Importantly for all concerned, the costly process of briefing and arguing motions to dismiss would take place once, based on the stockholders’ post-inspection complaint.
Under a first-to-file system, plaintiffs’ lawyers cannot act as stockholders collectively would want because by proceeding deliberately, a law firm risks losing control of the case to competitors who file immediately. For fast-filing lawyers, the resulting action has the dynamics of a lottery ticket. In most cases, the fast-filing plaintiff will not have pled a derivative claim that can overcome Rule 23.1. But in the rare case, fate may bless the fast-filer with something implicating the board, or a court might be offended by the magnitude of the corporate trauma and allow the derivative action to proceed. If the action survives a motion to dismiss, then its settlement value increases exponentially. See Kenneth B. Davis, Jr., The Forgotten Derivative Suit, 61 Vand. L.Rev. 387, 429-30 (2008) (“At least four of the eight [Caremark]| cases where plaintiffs survived a motion to dismiss ultimately settled, all with significant attorneys’ fees or monetary awards.... [T]he substantial corporate losses incurred in these cases increase the settlement value of a successful demand-excused claim.”).
A fast-filer can readily build a portfolio of cases in the hope that one will hit. Filing a derivative claim is relatively cheap. Search costs are minimal because corporations publicly announce material adverse events. Public disclosures, news stories, and analyst reports provide the background information for the claim. See id. at 417 (finding empirical evidence “consistent with the critique that derivative suits simply piggyback on what the government (or perhaps even the media) already has uncovered and investigated”); John C. Coffee, Jr., Rescuing the Private Attorney General: Why the Model of the Lawyer as Bounty Hunter Is Not Working, 42 Md. L.Rev. 215, 221 n.15 (1983) (observing phenomenon of “piggybacking” by private plaintiffs’ attorneys on efforts by government investigators to unearth wide range of classes of misconduct). Indeed, derivative plaintiffs often piggyback on the efforts of other specialized plaintiffs’ firms by filing indemnification-based claims that crib from other complaints. See, e.g., Guttman,
c. This Court’s Efforts To Address Fast Filing
The fast-filer presumption suggested by Chancellor Strine comports with other steps this Court has taken to shape the-legal incentives of specialized plaintiffs’ firms. In addition to criticizing fast-filed, nоn-substantive complaints, this Court has made clear that when stockholder plaintiffs sue in a representative capacity, first-to-file does not control which plaintiff has the substantive right to proceed.
representative actions pose certain dangers — in particular, the potential divergence in the best interests of the plaintiffs’ attorneys and the plaintiffs they are purporting to represent — that are not addressed, and indeed may be exacerbated, by a legal rule that places determinative weight on which complaint was filed first.
... The mere fact that a lawyer filed first for a representative client is scant evidence of his adequacy and may, in fact, support the contrary inference.
This Court also adopted Rule 15(aaa), quoted above, to limit a plaintiffs ability to re-plead. Ct. Ch. R. 15(aaa). Under this rule, a plaintiff who files a derivative action cannot freely amend after engaging in briefing on the motion to dismiss. See Braddock,
The Delaware Supreme Court has rejected two other attempts by this Court to address the first-to-file problem, but in each case expressed support for the effort. In King I, Chancellor Strine held that by filing a derivative action, a stockholder plaintiff represented consistent with Rule 11 that the plaintiff and his counsel had sufficient information to plead demand futility and did not require additional information. See
Similarly in White I, Vice Chancellor Lamb suggested that a plaintiffs failure to obtain books and records could be taken into account when evaluating whether a complaint’s allegations were sufficiently particularized to satisfy Rule 28.1. See
d. Applying The Fast-Filer Presumption
In Rales, the Delaware Supreme Court made clear that “[njothing requires the Court of Chancery, or any other court having appropriate jurisdiction, to countenance [fast-filing] by penalizing diligent counsel who has employed [investigative] methods, including section 220, in a deliberate and thorough manner in preparing a complaint that meets the demand excused test of Aronson.”
The origins of this case exemplify the race-to-the-courthouse problem. Less than 48 hours after Allergan announced its settlement, LAMPERS filed the first derivative complaint, without using Section 220, without conducting any serious investigation, and without any meaningful allegations that could defeat a demand-futility motion. Within weeks, three comparably scant complaints had been filed in the California Federal Court. These prematurely filed complaints were filed hastily for one reason only: to enable the specialized law firms to gain control of a case that could generate legal fees.
Fast-filing might have benefited the specialized law firms, but it did not benefit Allergan. The complaints forced Allergan to fund the teams of the lawyers hired by the individual defendants to respond in each jurisdiction, address coordination issues, and brief parallel motions to dismiss. The fast-filed complaints also forced two separate court systems to expend judicial resources on the litigation. Ironically, when one stockholder — UFCW—attempt-ed to proceed properly by using Section 220, the defendants and the fast-filing Delaware plaintiff joined forces to oppose its effort to develop the facts needed to plead a complaint with a meaningful chance of success.
By leaping to litigate without first conducting a meaningful investigation, the California plaintiffs’ firms failed to fulfill the fiduciary duties they voluntarily assumed as derivative action plaintiffs. Rather than seeking to benefit Allergan, they sought to benefit themselves by rushing to gain control of a case that could be harvested for legal fees. In doing so, the fast-filing plaintiffs failed to provide adequate representation.
Subsequent events did not transform the fast-filing plaintiffs into adequate representatives. True, the defendants voluntarily provided the California plaintiffs with the Section 220 materials, after UFCW invested the time and resources to obtain them, and the California plaintiffs used the materials to file an amended complaint. But in my view, the fast-filing plaintiffs already had shown where their true loyalties lay. Asking for and receiving the benefit of another lawyer’s work did not rehabilitate them. It rather evidenced their continuing desire to control the case. In this regard, I disagree that the policy goal of encouraging plaintiffs to use Section 220 will not be undercut by a rule that affords priority to fast filers if the corporation gives them the same books and records that a diligent stockholder fought to obtain. But see Career Educ.,
Assuming LeBoyer accurately states the law of collateral estoppel as I am bound to apply it (a point with which I disagree), the doctrine does not require dismissal in the current case because the plaintiffs in the California Action provided inadequate representation for Allergan. Rather than representing the best interests of the corporation, the California plaintiffs sought to maximize the potential returns of the spe
B. Rule 23.1
Having determined that collateral estop-pel does not require judgment for the defendants, I must consider independently whether Rule 23.1 requires dismissal. Although not binding, the California Judgment is potentially persuasive.
Rule 23.1 requires that a derivative plaintiff “allege with particularity the efforts, if any, made by the plaintiff to obtain the action the plaintiff desires from the directors or comparable authority and the reasons for the plaintiffs failure to obtain the action or for not making the effort.” Ct. Ch. R. 23.1. For a board to consider a demand properly, a majority of the directors must be able to exercise their independent and disinterested business judgment about whether to pursue litigation. Aronson,
The requirement of factual particularity does not entitle a court to discredit or weigh the persuasiveness of well-pled allegations. “The well-pleaded factual allegations of the derivative complaint are accepted as true on such a motion.” Rales,
Similarly, to show that a director faces a “substantial risk of liability,” the plaintiff does not have to demоnstrate a reasonable probability of success on the claim. In Rales, the Delaware Supreme Court rejected such a requirement as “unduly onerous.”
In this case, the plaintiffs do not seek to impose liability on the Allergan directors for making a “wrong” business decision or taking imprudent business risks. Cf. Citigroup,
Corporate misconduct involving fraud or illegality presents a different situation. Even under a pure Caremark monitoring theory,
[t]here are significant differences between failing to oversee employee fraudulent or criminal conduct and failing to recognize the extent of a Company’s business risk. Directors should, indeed must under Delaware law, ensure that reasonable information and reporting systems exist that would put them on notice of fraudulent or criminal conduct ■within the company. Such oversight programs allow directors to intervene and prevent frauds or other wrongdoing that could expose the company to risk of loss as a result of such conduct.
Citigroup,
“Delaware law does not charter law breakers.” Massey Energy,
In short, by consciously causing the corporation to violate the law, a director would be disloyal to the corporation and could be forced to answer for the harm he has caused. Although directors have wide authority to take lawful action on behalf of the corporation, they have no authority knowingly to cause the corporation to become a rogue, exposing the corporation to penalties from criminal and civil regulators. Delaware corporate law has long been clear on this rather obvious notion; namely, that it is utterly inconsistent with one’s duty of fidelity to the corporation to consciously cause the corporation to act unlawfully. The knowing use of illegal means to pursue profit for the cоrporation is director misconduct.
Desimone,
The plaintiffs in this case have alleged a direct connection between the Board and a business plan premised on illegal activity. The Complaint pleads that from 1997 onward, the Board discussed and approved a series of annual strategic plans that contemplated expanding Botox sales dramatically within geographic areas that encompassed the United States. The plans contemplated new markets for Botox that involved applications that were off-label uses in the United States. So significant was the scope of the expansion that it necessarily contemplated marketing and promoting off-label uses within the United States. The Board then closely monitored Allergan’s dramatic success in increasing its sales of Botox at rates far exceeding what the market for existing on-label uses could support or that could be generated by physicians serendipitously learning about and trying new off-label applications. The Board kept Allergan’s business plan in
Critically, the Complaint does not merely allege that this misconduct took place. Unlike the parade of hastily filed Can-mark complaints that Delaware courts have dismissed, and like those rare Care-mark complaints that prior decisions have found adequate, the Complaint supports these allegations with references to internal Allergan books and records that UFCW obtained using Section 220. For example, the Complaint references a slide presentation to the Board that summarized the Strategic Plan for 1997-2001. The presentation projected ramping up Botox sales in North America from $86.1 million to $141.1 million. Plan Slides at 5. A slide entitled “Top Corporate Priorities” identified “Maximize New Products” as the second of three bullet points. Id. at 10. The fourth bullet point under the “Maximize New Products” heading read “BOTOX— Spasticity, migraine, and pain.” Id. At the time, none were approved uses in the United States, which one can readily infer at the pleadings stage constituted a non-trivial part of the North American Botox-pur-chasing market.
Other slides in the deck provide further support for the inference that the Board-approved plan contemplated affirmative marketing and support for off-label uses. A slide described the “Charter” for the Botox “Business Portfolio Strateg[y]” in North America as “[ijnvest to grow new indications & develop follow-on toxins.” Id. at 5. It listed “[sjpasticity,” “[bjack pain,” and “[hjead ache.” Id. None were FDA-approved uses in the United States.
Another slide entitled “Transitioning to a Future with Sustainable Growth” stated:
• BOTOX®, Tazorac®, Alphagan®, and Array® represent immediate growth
• Major opportunities exist to expand into other specialty therapeutic areas with tremendous growth
—Back pain & head ache
—Oncology
—Diabetes
• Expansion strategy enables Allergan to maximize Eye, Skin, & BOTOX® now, while establishing technology platforms to build our businesses in new areas.
Id. at 11. One can reasonably infer from these slides that the plan contemplated pursuing as “Top Corporate Priorities” new Botox uses not yet approved by the FDA as a source of “immediate growth” for Allergan and a means for “Allergan to maximize ... BOTOX® now.”
The text of Allergan’s actual, written strategic plan expanded on the points identified in the slides. It identified “Maximize New Products” as the number 1 item on Allergan’s list of six “Top Corporate Priorities.” Written Plan at 14. The fourth bullet point under this number 1 item read: “Botox — Maximize sales for spasticity and new indications such as migraine.” Id. Neither was an FDA-approved use. The section of the plan entitled “Corporate Portfolio Strategy” identified the “Role/Charter” for “Bo-toxfNeuromuscular” as follows: “Invest to develop follow-on toxins with improved performance characteristics that protect and expand our toxin franchise. Sales expected to grow from $94 million in 1997 to $215 million in 2001.” Id. at 22. The “Strategic Rationale” for this step was that
Botox will continue to be one of Aller-gan’s fastest growing business areas asusage expands to new indications and penetration expands in all regions. Investments in new indications of pain and migraine headache represent two of the top three future growth opportunities in our portfolio with combined peak year sales of $1.26 billion!
Id. One can reasonably infer that “all regions” included the United States, where “pain” and “migraine headaches” were off-label applications. See also id. at 3 (identifying Botox as one of “five core Allergan businesses” and describing the treatment as having “tremendous growth potential as we fund opportunities with new indications and uses such as spasticity, pain, migraine and tension headache”).
Allergan’s plan projected that the company would enter the “Migraine Headache” market in 2001 and achieve estimated peak-year, risk-adjusted sales of $596 million. Id. at 5. “Migraine headache” was an off-label use. The plan also projected that Allergan would enter the back pain market in 2002 and achieve estimated peak-year, risk-adjusted sales of $666 million. Id. “Back pain” was an off-label use.
The plan further anticipated that Aller-gan’s sales growth would be driven in part by “continued growth from Botox ” and that Allergan’s improvement in gross profit margin would be “driven by changes in the sales mix as sales growth comes from higher priced and higher margin products such as Alphagan, Botox, and Zorac.” Id. at 8. The plan further noted that
Allergan is at the beginning of major new product launches with Alphagan, Zorac, the Array IOL and new indications for Botox. Each of these new product opportunities represents significant advances in technology which have the potential to change the way physicians approach the management of their patients’ conditions. Also they all participate in relatively large markets. As a result, there are best case scenarios for these products which are not prudent to include in our projections, but which do represent potential upside opportunities.
Id. at 9. The plan warned that Allergan was largely dependent on these products, and that “[t]he majority of Allergan’s growth over the next five years is expected to come from Alphagan, Array IOL, Zorac and Botox.” Id. at 10.
As the Complaint alleges, Allergan pursued the Board’s strategic plan by deploying an array of programs to support off-label Botox use. These efforts included sponsoring physicians to speak about and promote off-label use, assisting physicians in seeking reimbursement for off-label use, and providing pricing support to promote off-label use. The strategic plan specifically cited “U.S.-Reimbursement assistance” as one of the reasons “Why Customers Buy From Us Now.” Id. at 59.
The Complaint pleads that the Board regularly monitored Botox sales and cites specific occasions where the Board was made aware of growth in average daily sales and the revenue mix across different usage categories. The Complaint specifically pleads that between 2000 and 2004, Botox achieved annual sales growth of 25% to 42%, despite being approved by the FDA for only four uses where demand was limited. Off-label sales skyrocketed with spasticity sales growing by 332%, headache sales by 1,407%, and pain sales by 504%. Although it is not the only possible inference, one can reasonably infer at the pleadings stage that the Board knew physicians were not harmonically converging on off-label uses in the same areas that Allergan happened to be targeting aggressively for sales growth.
The Complaint specifically pleads that in October 2006, the Board learned that the FDA was inquiring about off-label market
The Complaint pleads that after the Schim incident, the Board approved the 2007-2011 Strategic Plan which explicitly linked the number of sales representatives to increased off-label sales. During the same period, the Board continued to receive detailed reports on Botox sales and the revenue mix, including reports showing that 70% to 80% of Botox sales were generated from off-label use. These particularized allegations support a reasonable inference that the Board knew Allergan personnel wеre engaging in or turning a blind-eye towards illegal off-label marketing and promotion and that the Board nevertheless decided to continue Aller-gan’s existing business practices in pursuit of greater sales.
Ten of the twelve defendant directors have served on the Board since 2005 and earlier. One can reasonably infer that these directors approved multiple iterations of Allergan’s strategic plan, monitored Botox’s explosive sales growth, learned of the Schim incident in October 2006, then approved the 2007 Strategic Plan, fully conscious of the role of off-label marketing in Allergan’s success. The inference is more tenuous for Dunsire and Hudson, who joined the Board in 2006 and 2008, respectively. Because the Complaint implicates more than half of the Board, I need not make any determination one way or the other as to those two directors.
It is not unreasonable to infer that the Allergan Board, led by a hard-charging CEO who earned the nickname “Mr. Bo-tox,” could have believed that Allergan knew better than the FDA which Botox applications were safe, particularly off-label uses already approved (or at least permitted) in other countries. It is not unreasonable to infer that the Board and CEO saw the distinction between off-label selling and off-label marketing as a source of legal risk to be managed, rather than a boundary to be avoided.
Obviously this is not the only inference that can be drawn. Alternatively, one could infer that the directors received advice from sophisticated counsel about the difference between legal off-label sales and illegal off-label marketing, understood where the boundary lay, and approved a business plan and management initiatives in the good faith belief that Allergan was remaining within the bounds of the law, although perhaps close to the edge. The directors then closely monitored Allergan’s performance with this understanding. Unfortunately for everyone, the directors’ good faith belief proved incorrect, and Al-lеrgan pled guilty to criminal misdemeanor misbranding for the period from 2000 through 2005, paid criminal fines of $375 million, and paid another $225 million in civil fines. If this scenario proves true, then the directors will not have acted in bad faith and will not be liable to Allergan for any of the harm it suffered. See id. at *22.
I cannot presently determine what actually happened at Allergan. I hold only that a reasonable inference can be drawn from the particularized allegations of the Complaint and the documents it incorporates by reference that the Board knowingly approved and subsequently oversaw a business plan that required illegal off-label marketing and support initiatives for Botox. At this stage of the case, I must credit this inference, even if I believe it more likely that the directors acted in good faith. The complaint need not “plead particularized facts sufficient to sustain ‘a judicial finding' either of director interest or lack of director independence” or other disabling factor. Grobow,
In reaching this conclusion, I part company with the California Federal Court and find unpersuasive the analysis in the California Judgment. The California Federal Court correctly described Delaware law in stating that that the California complaint only could survive a Rule 23.1 motion to dismiss if the particularized allegations presented the directors with a substantial threat of liability. The California Federal Court nevertheless determined that the California complaint failed to meet this test.
The California Federal Court held that the California complaint fell short because “[t]here is still no evidence of a decision by board members to promote the use of off-label marketing, nor are there any facts suggesting that the Directors would be incapable of making an impartial decision concerning litigation. The 1997-2001 Strategic Plan makes no mention of off-label marketing.” California Judgment at 4. The California Federal Court stated that the “Top Corporate Priorities” slide listed bullet points, “the first of which does not even mention Botox.” Id. As the California Federal Court recognized in denying the plaintiffs’ motion for reargument, the fourth bullet point identified Botox as one of four products the sales of which Aller-gan sought to maximize. In re Allergan Inc. S’holder Deriv. Action, Case No. SACV 10-1352, at 3 (C.D.Cal. Feb. 22, 2012). As discussed above, the underlying written plan identified “Maximize New Products” as the number 1 item on Aller-gan’s list of six “Top Corporate Priorities.” German Aff. Ex. D at 14. The fourth bullet point under this number 1 item reads: “Botox — Maximize sales for spas-ticity and new indications such as migraine.” Id. Neither was an FDA-approved use.
In my view, a plaintiff does not have to point to actual confessions of illegality by defendant directors to survive a Rule 23.1 motion in a Caremark case. Particularly at the pleadings stage, a court can draw the inference of wrongful conduct when supported by particularized allegations of fact.
The California Federal Court similarly concluded that a Board-sanctioned “Headache Development” program for Botox “had absolutely nothing to do with marketing; rather, it was a clinical presentation regarding Botox’s potential efficacy in treating migraines.” California Judgment at 4. The California Federal Court likewise dismissed the sufficiency of the allegation that the Board oversaw a “Cervical Dysto-nia/Headache Expansion Initiative” by noting that cervical dystonia was an approved FDA use at the time. Id.
In my view, both descriptions adopt one possible and defendant-friendly interpretation of the underlying documents and related allegations. At the pleadings stage, I believe the plaintiffs are entitled to the reasonable inference that the Board oversaw company-wide efforts to promote off-label use of Botox for treating migraine headaches, which was not an FDA-approved use at the time.
The California Federal Court also held that the Board’s knowledge of the Schim incident did not demonstrate wrongdoing by the Board. According to the California Judgment, “[n]ot only was the presentation approved prior to the presentation without the offending slides, but the Directors took appropriate remedial action after learning of the presentation.” Id. (citing defendants’ motion). Whether the directors took “appropriate remedial action” is unclear and strikes me as a factual issue that reasonably could be disputed at this stage of the case. Regardless, as I understand the plaintiffs’ theory, the argument is not that the Schim incident itself established wrongdoing. The point rather is that the Schim incident should have further illuminated the serious legal risks posed by Allergan’s various programs for supporting off-label use, including its sponsored-speaker program, and the existence of a culture of non-compliance at the company. Despite being confronted with this red-flag, the directors subsequently approved itеrations of the business plan that further ramped up Allergan’s support for off-label use. It may be that the directors in fact acted in good faith after the Schim incident and when taking these steps, but at the pleadings stage I do not believe that I can adopt a defendant-friendly interpretation of the plaintiffs’ allegations.
As should be abundantly clear, this is a pleadings-stage decision. To prevail ultimately, the plaintiffs actually will have to prove their claims. At later stages of the case, the plaintiffs will not be entitled to pleadings-stage presumptions, and the defendants will have strong arguments against liability. See Massey Energy,
C. Rule 12(b)(6)
“The standard for pleading demand futility under Rule 23.1 is more stringent than the standard under Rule 12(b)(6)....” Citigroup,
III. CONCLUSION
As Chancellor Allen famously observed, a Caremark theory “is possibly the most
Under my understanding of controlling Delaware Supreme Court precedent, collateral estoppel does not mandate dismissal. Separately and independently, by filing hastily and failing to conduct a meaningful investigation, the California plaintiffs acted self-interestedly and contrary to Allergan’s best interests. They did not provide adequate representation, rendering collateral estoppel inapplicable.
On the merits of the Rule 23.1 motion, the California Judgment is not persuasive because it adopts one possible defendant-friendly inference from the pled facts. Even under Rule 23.1, the plaintiffs receive the benefit of reasonable inferences that can be drawn from adequately pled facts. Here, the particularized allegations support a reasonable inference that the Board knowingly approved a business plan that contemplated illegal off-label marketing in the United States. The particularized allegations of the Complaint, which are supported by internal documents obtained through Section 220, present a substantial threat of liability for all but two members of the Board.
Demand is therefore excused as futile. For the same reasons, the Complaint states a claim under Rule 12(b)(6). The motions to dismiss are denied. IT IS SO ORDERED.
Notes
. See, e.g., In re Sonus Networks, Inc., S’holder Deriv. Litig.,
. See U.S. Const, art. IV, § I (‘‘Full Faith and Credit shall be given in each State to the public Acts, Records, and judicial Proceedings of every other State. And the Congress may by general Laws prescribe the Manner in which such Acts, Records and Proceedings shall be proved, and the Effect thereof.”); 28 U.S.C. § 1738 ("Acts [of the legislature of any State, Territory, or Possession of the United States and] records and judiсial proceedings [of any such State, Territory or Possession] ... shall have the same full faith and credit in every court within the United States and its Territories and Possessions as they have by law or usage in the courts of such State, Territory or Possession from which they are taken.”); Thompson v. D'Angelo,
. Compare, e.g., Ex parte Capstone Dev. Corp.,
.Compare, e.g., W. Coast Mgmt.,
. Compare, e.g., W. Coast Mgmt.,
. Compare Henik, 433 F.Supp.2d. at 381 (applying both res judicata and collateral estop-pel to Rule 23.1 determination) and Bed Bath & Beyond, 2007 WL 4165389, at *8 (holding that relitigation of demand futility is precluded under the doctrine of claim preclusion) with Sonus Networks,
. See, e.g., Arduini,
. In Brehm v. Eisner,
. See Schoon v. Smith,
. See, e.g., In re First Interstate Bancorp Consol. S’holder Litig.,
. For similar propositions, see, e.g., Cramer v. Gen. Tel. & Elecs. Corp.,
. The Grimes Court also made clear that the same stockholder plaintiff can subsequently make a litigation demand, use Section 220 to explore whether the demand was wrongfully refused, and (if appropriate) file a demand-refused case. See
. See Career Educ.,
. See, e.g., Henik,
. See, e.g., Sonus Networks,
. See Reinier Kraakman et al., When Are Shareholder Suits in Shareholder Interests?, 82 Geo. L.J. 1733, 1733 (1994) ("Shareholder suits are the primary mechanism for enforcing the fiduciary duties of corporate managers.”); Jonathan R. Macey & Geoffrey P. Miller, The Plaintiffs' Attorney’s Role in Class Action and Derivative Litigation: Economic Analysis and Recommendations for Reform, 58 U. Chi. L.Rev. 1, 10 (1991) ("The shareholder’s derivative suit is one of many devices in corporate law for controlling these conflicts between managers and shareholders."); Donald E. Schwartz, In Praise of Derivative Suits: A Commentary on the Paper of Professors Fischel and Bradley, 71 Cornell L.Rev. 322, 323 (1986) ("Liability rules, enforced by shareholder litigation, are theoretically sound and profoundly affect the conduct of corporate managers, at least some aspects of their duties.”).
. See, e.g., In re Citigroup Inc. S’holder Deriv. Litig.,
. See, e.g., Elliot J. Weiss & John S. Beckerman, Let the Money Do the Monitoring: How Institutional Investors Can Reduce Agency Costs in Securities Class Actions, 104 Yale L.J.2053, 2062 (1995) ("Courts most often appoint as lead counsel the lawyer who files the first complaint. Thus, plaintiffs’ lawyers ‘race to the courthouse.’ " (footnote omitted)). In King II, the Delaware Supreme Court stated that ”[b]eing the ‘first to file’ does not automatically confer lead-plaintiff status.”
. See Edward P. Welch, et al., Mergers & Acquisitions Deal Litigation Under Delaware Corporation Law § 2.01 [B][3][a], at 2-16 to - 17 (noting that "either defendants or plaintiffs may cite to the ‘first-to-file’ rule” to support a motion to dismiss or stay later-filed actions in other jurisdictions (footnotes omitted)); Armour et al., supra, at 6 (noting that while defendants can seek a stay or dismissal by filing a forum non conveniens motion, "success ... is not assured, with the likelihood of success decreasing if the case was filed first in that state court”); Geoffrey P. Miller, Overlapping Class Actions, 71 N.Y.U. L.Rev. 514, 522 (1996) (reporting that "courts are more likely to defer to sister-state proceedings if the parallel case was filed first”).
. Rales,
. Caremark,
. See, e.g., Beam ex rel. Martha Stewart Living Omnimedia, Inc. v. Stewart,
. See, e.g., Wood v. Baum,
. See, e.g., Wood,
. Compare Ash v. McCall,
.See Baca,
. See, e.g., Brenner v. Albrecht,
. See, e.g., Amir Efrati, Madoff Trustee Sues Investors To Recover Funds, Wall Street Journal, Apr. 10, 2009, http://online.wsj.com/ article/SB 123930717747706017.html?mg= com-wsj (reporting that Madoff trustee initiated "[w]hat will likely be a bitter, years-long battle" by filing first of numerous clawback suits on April 9, 2009, nearly four months after Madoff was arrested and his company forced into liquidation proceedings); Jacqueline Palank, Trustee Sues Madoff Investors to Recover $187.5 Million, Wall Street Journal, Jan. 13, 2012, http://online.wsj.com/article/SB 100014240529702045424045771589810 83769316.html (reporting that Madoff trustee filed four lawsuits on January 12, 2012 that "are the latest of hundreds trying to recover money that Madoff fraudulently paid out to investors as part of the Ponzi scheme”); see also Azam Ahmed & Ben Protess, Trustee Report Details Possible Claims Against Corzine and Others, June 4, 2012, http://dealbook. nytimes.com/2012/06/04/report-details-last-days-of-mf-global/ (reporting that court-appointed trustee issued 275-page report “based on interviews with more than 100 people and the review of hundreds of thousands of documents” concerning October 2011 collapse of brokerage firm MF Global); Jacqueline Palank, Trustee Brings FBI, Accounting Experience to Solyndra Probe, Mar. 27, 2012, http://blogs.wsj.com/bankruptcy/ 2012/03/27/brings-fbi-accounting-experience-to-solyndra-probe/ (reporting that trustee "filed the results of his four-month-long investigation with the U.S. Bankruptcy Court in Wilmington, Del., which concludes that the now-liquidating Solyndra didn’t mislead the Department of Energy about its financial health in connection with its $535 million federal loan guarantee”).
. Cf. Weiss & Beckerman, supra, at 2060 ("[T]he usual pattern is for a lawyer who specializes in representing plaintiffs to take the initiative. The lawyer typically becomes aware of a significant move in the price of a company’s stock following disclosure of worse-than-expected earnings or other significant, unexpected information. She then conducts a brief investigation, generates a class action complaint, finds someone to serve as a 'representative' plaintiff, and files the complaint, oftеn within a few days of the disclosure at issue.”); Coffee, Jr., Understanding the Plaintiff’s Attorney, supra, at 679 ("[B]ecause the attorney as private enforcer looks to the court, not the client, to award him a fee if successful, the attorney can find the legal violation first and the client second.”).
. Lawrence A. Hamermesh, The Policy Foundations of Delaware Corporate Law, 106 Colum. L.Rev. 1749, 1763-64 (2006) (”[T]o-day’s drafters of the DGCL do not devote an iota of conscious effort to make that statute more friendly to management and less protective of stockholders....' [W]e favor a much more conservative approach that seeks to maintain whatever balance currently exists, and we are distinctly uncomfortable with any change that alters that balance in either direction.”); Leo E. Strine, Jr., The Delaware Way: How We Do Corporate Law and Some of the New Challenges We (and Europe) Face, 30 Del. J. Corp. L. 673, 680 (2005) (”[C]orporation law in Delaware is influenced by only the two constituencies whose views are most important in determining where entities incorporate: managers and stockholders.... [I]t is ... fair to say that both groups have a lot of clout, and that Delaware corporate lawmakers seriously consider each group's perspective on all key issues.... [T]he key takeaway point is that Delaware’s financial self-interest in legal excellence leads to a productive dynamic for the creation and maintenance of an efficient and fair corporation law.”).
. TCW Tech. Ltd. P'ship v. Intermedia Commc’ns, Inc.,
. See King II,
. Others have embraced this view. See, e.g., David L. Engel, An Approach to Corporate Social Responsibility, 32 Stan. L.Rev. 1, 34-55 (1979) (arguing that corporations can and should maximize profits by factoring in the cost of regulatory and legal sanctions discounted by likelihood of detection and successful enforcement); Frank H. Easterbrook & Daniel R. Fischel, Antitrust Suits by Targets of Tender Offers, 80 Mich. L.Rev. 1155, 1168 n.36 (1982) (asserting that "[mjanagers have no general obligation to avoid violating regulatory laws, when violations are profitable to the firm.”); id. at 1177 n. 57 (asserting that "managers do not have an ethical duty to obey economic regulatory laws just because the laws exist. They must determine the importance of these laws. The penalties Congress names for disobedience are a measure of how much it wants firms to sacrifice in order to adhere to the rules; the idea of optimal sanctions is based on the supposition that managers not only may but also should violate the rules when it is profitable to do so.”). See generally Cynthia A. Williams, Corporate Compliance With the Law In the Era of Efficiency, 76 N.C. L.Rev. 1265, 1285-1300 (1998) (collecting and summarizing authorities endorsing the view of "law-as-price”). Delaware law explicitly rejects the notion that a board of directors can act loyally by con
. See Williams, supra, at 1279-80 ("[P]art of the calculation to violate the law includes a calculation of the probability that the violation will go undetected; or if detected, that it will go unprosecuted for any one of a plethora of reasons; or if prosecuted, that liability will not be established; or if liability is established, that the penalty will be lower than the profits obtained; or that the penalty will not be upheld on appeal in any event. Moreover, the probabilities at each of these stages can be, and in many cases will be, driven downward by actions by the corporation and the corporation’s lawyers. So, although the theory may treat the question as one of violating a law deliberately and paying the penalty, the reality is that of risking paying a penalty at best.” (alterations, footnote, and internal quotation omitted)).
. See, e.g., Massey Energy,