On May 24, 2016, the Delaware Supreme Court, sitting en banc, issued an opinion in Citigroup Inc. v. AHW Investment Partnership, No. 641, 2015, in response to a question certified by the U.S. Court of Appeals for the Second Circuit. The issue before the Court related to whether stockholders of a Delaware corporation can assert direct claims for damages for a stock’s loss of value after opting to hold their shares in reliance upon the corporation’s alleged misstatements. While the Court’s opinion (a copy of which may be accessed here) specifically addressed the nature of so-called “holder claims,” it also offered guidance on how the Court views the distinction between direct and derivative causes of action available to stockholders – the latter of which require factual allegations demonstrating that pre-suit demand upon the board of directors would be futile.
The plaintiffs were owners of Citigroup stock who at one time held 17.6 million shares valued at $35 per share in 1998. In May 2007, the plaintiffs developed a plan to liquidate their Citigroup stock and sold one million shares at $55 per share. After this initial sale, however, they decided to hold their remaining shares based on Citigroup’s public filings and financial statements - documents the plaintiffs allege did not disclose Citigroup's true exposure to subprime mortgage risks, which later caused the company’s stock price to plummet. The plaintiffs ultimately sold their remaining stock in March 2009 for $3.09 per share, after three more occasions when they declined to sell at a higher price in reliance upon Citigroup’s public statements.
The plaintiffs then filed a complaint against Citigroup and certain of its directors and officers in the U.S. District Court for the Southern District of New York, alleging that the decision to retain their shares - rather than sell them for a much higher price than they ultimately received - resulted from Citigroup’s failure to disclose accurate information about its true financial condition. The complaint asserted claims for fraud and negligent misrepresentation under Florida law and sought damages equal to what the plaintiffs would have realized had they sold 16.6 million shares at $55 per share in May 2007 rather than at $3.09 in March 2009.
The District Court granted the defendants’ motion to dismiss for failure to state a claim, while nonetheless finding that the plaintiffs’ claims were direct, rather than derivative, under the Delaware Supreme Court’s holding in Tooley v. Donaldson, Lufkin & Jenrette, Inc., 845 A.2d 1031 (Del. 2004). (Tooley held that a stockholder’s claim will be characterized as derivative or direct based on whether the corporation or the stockholder “suffered the alleged harm” and “would receive the benefit of any recovery or other remedy,” 845 A.2d at 1033.) When the plaintiffs appealed the dismissal to the Second Circuit, Citigroup cross-appealed the District Court’s ruling that the plaintiffs alleged direct claims. The Second Circuit, after determining that the issue was governed by the law of Delaware (Citigroup’s state of incorporation), then asked the Delaware Supreme Court to decide whether the plaintiffs’ “holder claims” were derivative or direct.
The Court answered this question by stating that the plaintiffs “may assert their Holder Claims against Citigroup directly if those claims are otherwise cognizable.” Citigroup, p. 24. This analysis, however, did not apply Tooley, as the Second Circuit had presumed; rather, the Court found the claims to be direct “because they belong to the holders and are ones that only the holders can assert, not claims that could plausibly belong to the issuer corporation.” Id. The Court noted that “determining whether a claim is direct or derivative depends on the nature of the claims itself,” and that Tooley and its progeny are limited to “the distinct question of when a cause of action for breach of fiduciary duty or to enforce rights belonging to the corporation itself must be asserted derivatively.” Id., p. 25 (quoting NAF Holdings, LLC v. Li & Fung (Trading) Ltd., 118 A.3d 175, 176 (Del. 2015)) (emphasis added). As the Court further explained:
“Because directors owe fiduciary duties to the corporation and its stockholders, there must be some way of determining whether stockholders can bring a claim for breach of fiduciary duty directly, or whether a particular fiduciary duty claim must be brought derivatively on the corporation’s behalf. We established Tooley’s two-pronged test as a means of determining whether such claims are direct or derivative. … [W]hen a plaintiff asserts a claim based on the plaintiff’s own right, such as a claim for breach of a commercial contract, Tooley does not apply.”
Id., p. 27 (footnotes omitted). Since the plaintiffs’ common law fraud and negligent misrepresentation claims did not seek to enforce fiduciary duties or rights belonging to Citigroup, neither Delaware law nor Tooley was implicated. Instead, the Court looked to Florida law (cited by the plaintiffs) and New York law (applied by the District Court) in concluding that the claims assert individual rights of the plaintiffs:
“That the holder claims under both New York and Florida law belong to the holder, not the issuer, alone is enough to make the [plaintiffs’] Holder Claims direct. Delaware law cannot convert a direct claim that another state’s law has granted to securities holders by deciding that it actually belongs to the corporation that the securities holder is suing. Thus, because the Holder Claims here could not possibly belong to the corporation, Delaware law has nothing to do with what type of claims the [plaintiffs] are asserting.”
Id., pp. 27-28 (footnotes omitted).
Apart from its discussion of holder claims, the Court’s opinion is instructive because it further refines an area of Delaware law – the distinction between derivative and direct stockholder claims – that traditionally has evaded precise application. In particular, the Court re-emphasized that questions of harm and remedy under Tooley are not addressed until a preliminary inquiry about the nature of the claim is answered – does the stockholder seek to enforce rights belonging to the corporation or arising from the directors’ fiduciary duties? If that answer is “no,” Citigroup suggests that the stockholder’s claim is direct and does not raise issues of demand futility.
Wilks, Lukoff & Bracegirdle, LLC represented an amicus curiae in the Citigroup appeal. The foregoing views are solely those of the author and do not necessarily reflect the views of the firm or its clients.