The Delaware Supreme Court ruled Tuesday that former shareholders of Countrywide Financial Corporation, formerly one of the largest mortgage lenders in the country, lack standing to continue pursuing putative shareholder derivative claims on behalf of Countrywide as a result of its acquisition by a subsidiary of Bank of America Corporation (“BAC”) in 2008. The Court rejected the shareholder plaintiffs’ argument that it had modified Delaware law concerning post-merger derivative standing in an earlier decision in 2010.
In a unanimous en banc decision, the Supreme Court agreed that BAC’s acquisition of Countrywide had extinguished the former Countrywide shareholders’ standing to bring shareholder derivative claims. In doing so, the Court explained that under longstanding Delaware law a plaintiff no longer has standing to sue derivatively on behalf of a corporation when it ceases to be a shareholder in that corporation due to a merger. The Court held that only two exceptions to this rule exist: when the merger is simply a corporate reorganization or when the merger is entered into fraudulently, solely for the purpose of extinguishing the derivative claims. This latter exception is known as the “fraud exception.”
The shareholder plaintiffs argued that the Supreme Court had modified Delaware law in its 2010 opinion affirming the Chancery Court’s approval of the settlement of class action litigation challenging the fairness of the BAC/Countrywide merger. In that opinion, the Supreme Court stated that Delaware law recognizes an “inseparable fraud” when corporate directors seek to cover alleged wrongdoing with an “otherwise permissible merger” and where that claimed wrongdoing “necessitated the merger.” The shareholder plaintiffs argued that they had alleged such conduct by Countrywide’s former officials, thus triggering the “fraud exception,” even though the Chancery Court had found that there was no evidence the Countrywide directors had entered into the merger for the purpose of extinguishing plaintiffs’ derivative claims.
The Supreme Court rejected plaintiffs’ argument, holding that its 2010 opinion “did not ‘clarify,’ ‘expand,’ or constitute ‘a new material change’” in Delaware law. To the contrary, the Court confirmed that the “inseparable fraud” claims it referred to in its earlier opinion were direct – not derivative – claims that the shareholder plaintiffs had never brought, and which were released (along with all other direct claims relating to the merger) as part of the merger litigation settlement. Standing to pursue derivative claims was thus extinguished when the merger went forward and the plaintiffs ceased to be Countrywide shareholders.
Tuesday’s decision was an answer to a question certified to the Delaware Supreme Court by the United States Court of Appeals for the Ninth Circuit in an appeal brought by the shareholder plaintiffs seeking to overturn the dismissal of their claims in 2008 by the federal district court in Los Angeles for loss of standing due to the consummation of the BAC/Countrywide merger. The question, which the Supreme Court answered in the negative, was: “Whether, under the ‘fraud exception’ to Delaware’s continuous ownership rule, shareholder plaintiffs may maintain a derivative suit after a merger that divests them of their ownership interest in the corporation on whose behalf they sue by alleging that the merger at issue was necessitated by, and is inseparable from, the alleged fraud that is the subject of their derivative claims.”
Goodwin Procter partner Brian Pastuszenski, co-chair of the firm’s Securities Litigation & SEC Enforcement Practice, argued the case for nominal defendant Countrywide before the Delaware Supreme Court in July 2013, and earlier before the Ninth Circuit Court of Appeals in November 2012. The Goodwin team included partner Dan Roeser and associate Nicole Naghi.