Delaware Supreme Court Weighs In On “Direct v. Derivative” Question Certified By Second Circuit

In Citigroup Inc. v. AHW Investment Partnership, No. 641, 2015 (Del. May 24, 2016), the Delaware Supreme Court answered a certified question of law presented by the Second Circuit Court of Appeals allowing shareholders claiming Citigroup deceived them into holding on to their stock by misrepresenting its exposure to mortgage-backed securities can sue its officers directly.

This case arose when certain investors in Citigroup filed a federal suit in 2010 in the Southern District of New York.  The suit claims that the investors would not have held their Citigroup shares had they known about Citigroup’s sub-prime mortgage investments and that they relied upon Citigroup’s representations to their detriment. Plaintiffs sought $800 million in damages based upon common law fraud and negligent misrepresentation. Citigroup moved to dismiss arguing that these claims must be brought derivatively and that New York law barred “holder claims” such as those brought in this suit. The trial court held that Delaware law permitted the direct suit because the plaintiffs’ reliance was unique and the damages would go directly to the plaintiffs, but New York law applied to the substantive claims of the suit and, for that reason, plaintiffs failed to state a claim. Plaintiffs appealed to the Second Circuit, and Citigroup cross-appealed arguing that plaintiffs’ claims were derivative, not direct.

The Second Circuit certified the following question to the Delaware Supreme Court:

Are the claims of a plaintiff against a corporate defendant alleging damages based on the plaintiff‘s continuing to hold the corporation‘s stock in reliance on the defendant‘s misstatements as the stock diminished in value properly brought as direct or derivative claims?

Following a comprehensive review of the record, the Supreme Court held that Plaintiffs claims are direct because under the laws governing those claims —either New York or Florida—the claims belong to the stockholder who allegedly relied on the corporation‘s misstatements to her detriment. Under those state laws, the holder claims are not derivative because they are personal to the stockholder and do not belong to the corporation itself. Since the claims were not governed by Delaware law, such as a claims for breach of fiduciary duty would have been, the familiar two-pronged test articulated in Tooley v. Donaldson, Lufkin & Jenrette, Inc. to determine direct versus derivative claims was not necessary in this instance.

The full opinion can be found here.

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