Case Name:   Ira J. Gaines, IRA, et al. vs. Leland F. Wilson, et al.

Case No.:       1-13-CV-249436

 

This is a shareholder derivative action brought by Ira J. Gaines, IRA and Mattes Friesel (“Plaintiffs”), shareholders of nominal defendant Vivus, Inc. (“Vivus”), a Delaware corporation headquartered in Mountain View, California that develops therapies to address obesity.[1]  According to the operative Amended Shareholder Derivative Complaint (the “Amended Complaint”), Vivus sells the Federal Drug Administration (“FDA”) approved drug “Qsymia” for weight loss.[2]  The named defendants include Vivus (nominally) and members of its Board of Directors.  The case arises out of Vivus’s unsuccessful launch of Qysmia, as well as allegations that some individual directors sold $26.5 million worth of Vivus stock while in possession of material, non-public information that Vivus would be unable to profitably launch Qysmia.[3]

 

The original Complaint was filed on July 12, 2013.             On March 21, 2013, Vivus’s demurrer to the Complaint was sustained with 30 days’ leave to amend on the grounds that Plaintiffs failed to allege demand futility with sufficient particularity.

 

On April 21, 2014, Plaintiffs filed their Amended Complaint for: (1) breach of fiduciary duty; (2) misappropriation of confidential information; (3) corporate waste; (4) unjust enrichment; (5) violations of California Corporations Code section 25402; and (6) violations of California Corporations Code section 25403.  On May 21, 2014, Vivus filed a demurrer to the Amended Complaint, with a hearing set for September 19, 2014.

 

On May 23, 2014, counsel for Plaintiffs and Vivus participated in an Informal Discovery Conference (“IDC”) with the Court regarding Plaintiffs’ need for limited discovery to aid in their opposition to the demurrer to the Amended Complaint.  Thereafter, the Court scheduled a hearing and set a briefing schedule on a formal motion to compel.

 

Plaintiffs now move to compel limited discovery from Vivus in order to assist in amending their Amended Complaint.  Alternatively, Plaintiffs move to stay this action while they commence an action in Delaware for inspection of Vivus’s books and records.

 

Plaintiffs submit that on February 7, 2014, they served their First Request for Production of Documents and First Set of Special Interrogatories to Vivus.[4]  In March of 2014, Plaintiffs’ counsel requested a limited production of documents from Vivus to assist in amending the Complaint, including “all board minutes, minutes of any committee of the board and any presentations or hand outs pertinent to the board minutes or committee meeting at which Qysmia was discussed.  Plaintiffs also sought any 10b5-1 plan(s), and amendments thereof pursuant to which any of the Insider Trading defendants…traded during the Insider Trading Period, or the identification of any public filing containing such plans and amendments.”[5]  Vivus’s counsel refused to provide Plaintiffs with any discovery until after the Court issued an Order on any demurrer filed on the grounds of demand futility.[6]  On April 14, 2014, Vivus served its Responses and Objections to Plaintiffs’ First Request for Production of Documents.[7]  Among its many objections, Vivus stated that the requests for production were premature due to the Court’s ruling sustaining Vivus’s demurrer and holding that Plaintiffs failed to sufficiently allege demand futility.[8]

 

Plaintiffs argue that under California law, they are entitled to discovery concerning demand futility.  Plaintiffs cite Mattco Forge v. Arthur Young & Co. (1990) 223 Cal.App.3d 1429, Credit Managers Ass’n v. Superior Court (1975) 51 Cal.App.3d 352 and Union Mut. Life Ins. Co. v. Superior Court (1978) 80 Cal.App.3d 1 in support of the position that pleading deficiencies do not affect a party’s right to conduct discovery, as discovery is often necessary for plaintiffs to plead a cause of action against a wrongdoer.  Plaintiffs argue that the results would be the same under Delaware law.  Plaintiffs argue that the cases cited in Vivus’s IDC brief are distinguishable because they concerned the demand-refused context, not the demand-excused context.

 

In the alternative to compelling limited discovery, Plaintiffs request a stay of this action to enable them to commence an action in Delaware for inspection of Vivus’s books and records.  Plaintiffs cite King v. VeriFone Holdings, Inc. (Del. 2011) 12 A.3d 1140 for the position that a previously filed derivative action does not per se preclude a Section 220 action.

 

In opposition, Vivus argues that under controlling Delaware law, Plaintiffs are not entitled to discovery to assist them in satisfying the pre-suit demand requirement, either in a demand-refused or demand-excused case.  Vivus further argues that the requested discovery is simply not relevant to the demand futility analysis the Court must perform because under Delaware law, demand allegations in an amended complaint are tested against the board in place when the amended complaint is filed, and here, Vivus’s board composition has changed dramatically since Plaintiffs filed their original Complaint, with five directors resigning and seven new directors joining the board.  Vivus argues that Plaintiffs’ discovery requests, which cover the period of February to August of 2012, cannot relate to the new board’s ability to impartially consider a demand.  For the same reasons, Vivus argues the Court should not stay this action to accommodate a Section 220 demand, as Plaintiffs would lack a proper purpose for inspecting irrelevant books and records.

 

Motion to Compel

Vivus is a Delaware corporation.[9]  In general, disputes regarding the internal affairs of a corporation are governed by the state of incorporation, and demand futility requirements involve the internal affairs of the corporation.  (See Leyte-Vidal v. Semel (2013) 220 Cal.App.4th 1001, 1007-1008 [applying Delaware law to test demand futility allegations in derivative suit involving Delaware corporation].)  Thus, Delaware law should apply.

 

Delaware Chancery Court Rules, rule 23.1(a) provides, in part:  “The complaint shall … allege with particularity the efforts, if any, … to obtain the action the plaintiff desires from the directors … and the reasons for the plaintiff’s failure to obtain the action or for not making the effort.”  “[T]he demand requirement of Rule 23.1 is a rule of substantive right designed to give a corporation the opportunity to rectify an alleged wrong without litigation, and to control any litigation which does arise.  [Citation.]  . . . . [T]he test of futility is ‘whether the Board, at the time of the filing of the suit, could have impartially considered and acted upon the demand’.  [Citation.]”  (Aronson v. Lewis (Del. 1984) 473 A.2d 805, 809, overruled on other grounds by Brehm v. Eisner (Del. 2000) 746 A.2d 244.)

 

In Scattered Corporation v. Chicago Stock Exchange, Inc. (Del. 1997) 701 A.2d 70, the Delaware Supreme Court held that “[t]he law in Delaware is settled that plaintiffs in a derivative suit are not entitled to discovery to assist their compliance with the particularized pleading requirement of Rule 23.1 in a case of demand refusal.  A plaintiff’s standing to sue in a derivative suit, whether based on demand-refused or demand-excused, must be determined on the basis of the well-pleaded allegations of the complaint.”  (Scattered Corporation, supra, 701 A.2d at p. 77, footnotes omitted.)  The California Court of Appeal in Bezirdijian v. O’Reilly (2010) 183 Cal.App.4th 316 relied on Scattered Corporation in denying a shareholder’s request for discovery of materials of a special committee of directors that had found it was not in the corporation’s best interests to sue.  “Under Delaware law, discovery of evidence pertaining to a corporation’s decision to refuse to pursue a lawsuit is generally not available.”  (Bezirdijian, supra, 183 Cal.App.4th at p. 326.)

 

As Plaintiffs point out, Scattered Corporation and Bezirdijian were demand-refused cases, not demand-excused cases.  However, Vivus cites the portion of Scattered Corporation which states, “[a] plaintiff’s standing to sue in a derivative suit, whether based on demand-refused or demand-excused, must be determined on the basis of the well-pleaded allegations of the complaint.”  (Scattered Corporation, supra, 701 A.2d at p. 77, italics added.)  This language suggests that even in demand-excused cases, a derivative plaintiff must establish the demand futility on the face of the complaint alone.

 

In distinguishing demand-excused cases, Plaintiffs quote the following portion of Bezirdijian:  “Again, the instant case is a demand refusal derivative lawsuit, not a demand excused claim.”  (Bezirdijian, supra, 183 Cal.App.4th at p. 327, original italics.)  However, this quote is taken out of context.  The court in Bezirdijian was distinguishing the rationale of Zapata Corp. v. Maldonado (Del. 1981) 430 A.2d 779, which held that where a shareholder files a derivative action without demand and the board appoints a corporate committee to investigate the derivative suit, limited discovery may be ordered to facilitate inquiries into the independence and good faith of the committee.  The Bezirdijian court noted that “‘[t]he rationale for allowing discovery in a demand excused-Zapata context has no application in the case of either demand refused or demand excused, absent the Zapata context.’ [Citation.]”  (Bezirdijian, supra, 183 Cal.App.4th at p. 327.)  This does not suggest that discovery is allowed in a non-Zapata demand-excused case.[10]

 

As discussed above, the demand futility test is set forth in Aronson.  Notably, in holding that a derivative plaintiff must plead demand futility with particularized (but not evidentiary) facts, the court in Aronson distinguished a case called Kaplan v. Centex Corp. (Del. Ch. 1971) 284 A.2d 119 that “was decided after trial and full discovery” in order to “stress that the plaintiff need only allege specific facts; he need not plead evidence.”  (Aronson, supra, 473 A.2d at p. 816.)  The Delaware Supreme Court in Pogostin v. Rice (Del. 1984) 480 A.2d 619 held that the Aronson test “strikes the essential balance between avoiding abuse of the derivative action and forcing a plaintiff to plead evidence without the benefit of discovery.”  (Pogostin, supra, 480 A.2d at p. 625, italics added.)  Finally, the Delaware Supreme Court in Rales v. Blasband (1993) 634 A.2d 927 made clear that derivative plaintiffs “are not entitled to discovery to assist their compliance with Rule 23.1” but still “have many avenues available to obtain information bearing on the subject of their claims” such as public media or governmental sources and “the summary procedure embodied in 8 Del. C. § 220 to investigate the possibility of corporate wrongdoing.”  (Rales, supra, 634 A.2d at p. 934, fn. 10.)

 

For all of these reasons, the Court finds that under Delaware law, Plaintiffs are not entitled to discovery to assist them in satisfying the demand futility pleading requirements of Aronson.  Accordingly, the motion to compel is DENIED.

 

Alternative Motion to Stay

 

“Trial courts generally have the inherent power to stay proceedings in the interests of justice and to promote judicial efficiency.  [Citations.]”  (Freiberg v. City of Mission Viejo (1995) 33 Cal.App.4th 1484, 1489.)

 

In moving to stay, Plaintiffs argue that under King, supra, 12 A.3d 1140, a previously-filed derivative action does not per se preclude a Section 220 action.  Vivus argues that while King does not prohibit a Section 220 action, the Court should not encourage this method of proceeding.  Vivus suggests that in order to redress the waste of resources caused by Plaintiffs’ premature derivative suit, the Court may order Plaintiffs to pay attorneys’ fees incurred by Vivus in responding to all previous complaints.

 

In King, the Delaware Supreme Court held that a shareholder was not precluded from bringing an action in the Delaware Court of Chancery to inspect books and records under Section 220 after his earlier-filed shareholder derivative suit was dismissed without prejudice by a California federal court.  In so holding, the King court reviewed several cases that allowed a Section 220 inspection despite an earlier-filed derivative action, including Melzer v. CNET Networks (Del. Ch. 2007) 934 A.2d 912 where a California federal court granted a motion to dismiss the derivative suit with leave to amend, but suggested that the plaintiffs file a Section 220 books and records action and issued a stay of the derivative action pending the books and records inspection in Delaware.  (See King, supra, 12 A.3d at pp. 1147-1148 & fn. 45.)  The King court suggested various ways that a plenary court could remedy any abuse caused by premature derivative actions, including: denial of “lead plaintiff” status for a plaintiff that has “rushed to the courthouse”; dismissal of the derivative action with prejudice and without leave to amend as to the named plaintiff; and conditioning leave to amend on the plaintiff paying the defendants’ attorney’s fees incurred on the initial motion to dismiss.  (See King, supra, 12 A.3d at pp. 30-31.)

 

The Court finds that King and Melzer support staying this action pending a Section 220 action in Delaware.  The issue of whether Plaintiffs have a proper purpose for their Section 220 action is for the Delaware Court of Chancery to decide.

 

King also supports an order requiring Plaintiffs to pay Vivus’s attorney’s fees that were incurred as a result of Plaintiffs’ premature derivative suit.  Vivus’s opposition brief posits this as an option, but does not make a formal request for attorney’s fees or provide billing information to calculate the amount.

 

The alternative motion to stay is GRANTED.  The action shall be stayed upon commencement of the Section 220 books and records inspection action in Delaware and will continue until further Order of the Court.  The Court invites Vivus to file an appropriate motion to recover its attorney’s fees either before the stay goes into effect (if time permits), or once the stay is lifted.

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