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Friday
Nov022012

South v. Baker and the Race to the Courthouse in Caremark Actions (Part 2)

So what are the implications of this approach?

The decision is thoughtful in limiting the analysis to Caremark actions.  Those claims are tough to bring under the best of circumstances.  The court clearly believes that if the race to the courthouse can be slowed, shareholders (and their counsel) will proceed in a more deliberate fashion and, at least sometimes, will opt not to file Caremark claims. 

That is not, however, the likely outcome.  Shareholders still have an incentive to file quickly.  They will argue that they have alleged sufficient facts to withstand a motion to dismiss.  Assuming they are correct, they benefited from the fast filing.  Assuming they are wrong, they suffer nothing more than the usual consequence of a dismissal (although their dismissal will be with prejudice).  

To the extent representation is deemed inadequate, shareholders who do not file quickly but instead conduct a meaningful investigation (presumably by invoking their inspection rights).  They can then  file a claim in the same action.  Thus, derivative actions involving Caremark allegations are likely to produce a class of plaintiffs who file quickly and a class of plaintiffs who invoke their inspection rights.  The former will presumably succeed sometimes, albeit in rare circumstances, and when they do not, the latter will be in a position to file a follow up action.

It is possible that the second group of plaintiffs will decide not to file once they have completed the inspection process.  They may not uncover sufficient additional facts to allow them to adequate differentiate their complaint from the one filed by the first group of shareholders.  This seems to be what the Vice Chancellor hopes will happen.  Yet this "discretion" is for the most part unlikely.  Given the existing predilection to file even without significant investigation, it presumably will not be difficult for subsequent plaintiffs to find enough additional evidence to justify a second complaint. 

The effort by the Vice Chancellor is a worthy one.  He was careful to limit the approach to Caremark actions.  Moveover, he did not require shareholders to invoke inspection rights.  Instead, he more broadly required a "meaningful investigation," something that will often but not always mean the use of inspection rights.  

The real consequence of the risk of plaintiffs who file without adequate homework is a dismissal that ultimately bars other shareholders who do engage in the requisite investigation.  The Vice Chancellor has left open the door for those shareholders.  Morover, as the practice develops, the more sophisticated firms may opt increasingly to represent shareholders who prefer to conduct a more thorough investigation before filing an action.