In re Massey Energy Co. Derivative & Class Action Litigation

Delaware Court of Chancery · Corporations

CorporationsDerivative litigationDirect vs. derivative claimsStanding after mergerCaremark oversightderivative standingmergercontinuous ownership

Facts

Plaintiffs alleged that Massey directors and officers caused the company to follow a deliberate plan of disregarding mine-safety regulations, leading to the Upper Big Branch disaster and exposing Massey to major liabilities, reputational harm, and operational impairment. In 2011, after a sale process involving multiple bidders, Massey merged with Alpha, and Massey stockholders received Alpha stock and cash. Plaintiffs contended that the misconduct forced a sale at an inadequate fire-sale price and tried to plead one count as a direct claim for "inseparable fraud" and another as a derivative claim. The merger terminated plaintiffs' stock ownership in Massey.

Issue

Whether former Massey stockholders could continue to pursue a derivative Caremark-type claim after the merger with Alpha, and whether the same underlying allegations could be recast as a direct claim for inseparable fraud. More specifically, the court had to decide whether either exception to the continuous ownership rule applied and whether the complaint alleged a direct injury under Tooley.

Rule

Under Delaware law, stockholders must continuously own shares throughout derivative litigation, and a merger terminates derivative standing unless either (1) the merger itself is the subject of a fraud claim perpetrated merely to deprive stockholders of standing, or (2) the merger is merely a reorganization that does not affect ownership in the business enterprise. A claim of inseparable fraud is not a third exception to the continuous ownership rule; it survives only if the challenged pre-merger misconduct itself states a direct claim under Tooley, meaning the stockholders suffered the harm individually and would receive the benefit of the remedy individually, and the merger was necessitated or made inevitable by that misconduct.

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One of 10 multiple-choice questions for this case. Pick an answer to see why.

Stockholders of Redwood Transit Holdings, a Delaware corporation based in Phoenix, sue derivatively in Delaware, alleging that directors knowingly ignored rail-maintenance laws for years, causing fines, service shutdowns, and major repair costs. While the suit is pending, Redwood is acquired in a cash-and-stock merger by Prairie Meridian Logistics, and the former Redwood stockholders receive merger consideration and cease owning Redwood shares.

What is the best result on the former stockholders' derivative claim after the merger closes?

Explanation. Under Delaware's continuous ownership rule, a stockholder asserting a derivative claim must own shares continuously through the litigation. A merger that eliminates the plaintiff's stock ownership ends derivative standing unless one of the two Lewis v. Anderson exceptions applies. The fact that the underlying oversight claim may be strong does not save standing. The claim remains corporate property that passes to the acquiror. (Derived from In re Massey Energy Co. Derivative & Class Action Litigation (n.d.).)