Thursday, January 05, 2012

Applying Spanish Law and Citing Internal Affairs Doctrine, Delaware Supreme Court Affirms Dismissal of Derivative Action

The Delaware Supreme Court has upheld the Chancery Court’s application of Spanish law to dismiss a derivative action by a Spanish minority shareholder on behalf of a Spanish parent company with a Delaware subsidiary that aided in effectuating the challenged acquisition of another company. The parent’s majority shareholder, a Spanish entity, also held a majority interest in the acquired company. Invoking the internal affairs doctrine, the Supreme Court said it would violate the principle of comity for a Delaware court to disrupt the internal affairs of a Spanish corporation by displacing Spanish derivative standing rules with those of Delaware. Sagarra Inversiones, S.L. v. Cementos :Portland Valderrivas, et al.,Uniland Acquisition Corp., Nominal Defendant, C.A. No. 6179-VCN, Aug. 5, 2011.

The internal affairs doctrine recognizes that only one state should have the authority to regulate a company’s internal affairs and that is the state of incorporation. In a double derivative action of this type involving a wholly-owned subsidiary, a shareholder must plead demand futility at the parent level. Thus, where the parent is not a Delaware corporation, under the internal affairs doctrine, the law of the state of incorporation determines the showing that a plaintiff must make to show it has standing to bring a multiple derivative action. Because the minority shareholder only owns shares in the parent corporation organized under the laws of Spain, the Chancery Court properly considered whether it had standing to bring a derivative claim under Spanish law.

In an en banc opinion, the Delaware Supreme Court rejected the notion that the presuit demand requirement in derivative actions is not within the embrace of the internal affairs doctrine. The Court held that the presuit demand requirement is quintessentially an internal affair that falls within the scope of the internal affairs doctrine. Noting that the internal affairs doctrine is a dominant and overarching choice of law principle, the Supreme Court said that an important rationale for the doctrine is to prevent companies from being subjected to inconsistent legal standards, and thus the authority to regulate a corporation’s internal affairs should not rest with multiple jurisdictions. The term internal affairs encompasses matters pertaining to relationships among or between the corporation and its officers, directors, and shareholders The doctrine requires that the law of the sovereign nation of incorporation must govern those relationships.

The presuit demand requirement serves a core function of substantive corporation law, said the Court, in that it allocates as between directors and shareholders the authority to sue on behalf of the corporation. The entire question of demand futility is inextricably bound to issues of business judgment and the standards of that doctrine's applicability. The decision to bring a lawsuit or to refrain from litigating a claim on behalf of a corporation is a decision concerning company management.

In the Court’s view, those contours of the demand requirement fall firmly within the gravitational pull of the internal affairs doctrine, and thus are determined by the law of the jurisdiction of incorporation of the entity on whose board a presuit
demand is required. In this case, the law of Spain governs the presuit demand requirements that the shareholder must satisfy to sue derivatively.

The Court also rejected the claim that public policy should displace the internal affairs doctrine. It would violate the principle of comity, said the Supreme Court, and serve no legitimate Delaware interest, for a Delaware court to disrupt the internal affairs of a Spanish corporation by displacing Spanish derivative standing rules with those of Delaware.

Public policy cannot operate as a protean ethic that trumps, on an ad hoc basis, settled choice of law rules that govern the right of a stockholder to enforce, derivatively, claims that belong to the corporation in which it owns shares. When the shareholder took ownership of its shares, reasoned the Court, it did so with presumed knowledge that its ownership interest was subject to the legal rights conferred, and the restrictions imposed, by the Spanish legal regime.