A recent decision in the federal securities class action regarding the take-private transaction of Pattern Energy lends further support to plaintiffs invoking an aggressive pre-litigation strategy to pursue discovery through a 220 demand. Plaintiffs in the federal case chose not to make a pre-suit 220 demand. Instead, faced with a motion to dismiss, they sought relief from the discovery stay of the Private Securities Litigation Reform Act (PSLRA) to obtain the same 220 demand discovery obtained by Chancery Court plaintiffs in parallel litigation. The discovery motion was denied, and the motion to dismiss was recently granted. Conversely, for the Chancery Court plaintiffs, the breadth of 220 discovery they were able to obtain became the basis for the Chancery Court’s appointment of a lead plaintiff. These divergent outcomes send a further message to plaintiffs that they face real danger if they fail to aggressively pursue pre-suit 220 discovery.
The litigation surrounding Pattern Energy arises from a 2020 transaction that cashed out existing stockholders and took the company private. As is common in public company M&A, a securities class action was filed first in Delaware federal court challenging disclosures made to stockholders voting on the transaction. These cases, commonly known as strike suits, allege disclosure violations of Section 14 of the Securities and Exchange Act of 1934 (Exchange Act). An amended complaint was later filed to add breach of fiduciary duty claims. The federal case is captioned In re Pattern Energy Group, Inc. Securities Litigation, Case No. 20-275-MN-JLH. At the same time, stockholders initiated two class action cases in Chancery Court, also pursuing breach of fiduciary duty claims. Those cases were consolidated and titled In re Pattern Energy Group, Inc. Stockholders Litigation, Case No. 2020-0357-MTZ.
Though the claims made in state and federal court are similar, the strategy invoked by plaintiffs has been quite different. The federal plaintiffs, likely in a rush to get a case filed, did not make a demand for documents under Delaware General Corporation Law Section 220 before filing suit. However, both sets of plaintiffs who filed in Chancery Court did make 220 demands and received documents before filing their complaints. The difference may likely prove fatal to the federal plaintiffs.
Because the federal complaint contained Exchange Act claims, the case became immediately subject to the PSLRA, which, among other things, imposes an automatic stay of discovery until a complaint has survived a motion to dismiss. The general purpose of the automatic stay is to save defendants from facing costly discovery for what may otherwise be frivolous claims. It is a significant benefit for securities case defendants and imposes a logical progression for cases where discovery is often the largest cost of the litigation.
In the Pattern Energy federal case, just a week before defendants filed their motion to dismiss, plaintiffs filed a motion for relief from the PSLRA stay so they could obtain the same documents that the Chancery Court plaintiffs previously obtained through 220 demands. Why file such a motion just before defendants’ filed their motion to dismiss? Because a week prior the Chancery Court held a hearing to appoint a lead plaintiff in the state case, and the hearing argument revealed the extent to which the pre-suit discovery might bolster plaintiffs’ claims. In their motion for relief from the PSLRA stay, the federal plaintiffs argued (1) that permitting such discovery posed no burden because all they were asking for was a copy of documents already produced, and (2) that the federal plaintiffs would be acutely prejudiced because the record in their case did not include the discovery while the record in the state case, which involved the same claims, did include the favorable discovery. Defendants vigorously opposed the motion, arguing that any prejudice was the result of plaintiffs’ own strategic decision not to make a pre-suit 220 demand and pointing to Delaware case law forbidding plaintiffs in federal securities cases from making 220 demands.
The federal case magistrate judge denied plaintiffs’ motion for relief from the PSLRA stay and at the same time issued a recommendation to the district judge to grant defendants’ motion to dismiss. In denying the discovery motion, the court agreed with defendants that the conundrum was of plaintiffs’ own making: “The reason why Plaintiffs do not have the information that the Chancery Court plaintiffs have is because Plaintiffs chose to file their securities action in federal court before seeking that information.” (Discovery Order at 3). By filing their case, plaintiffs were subject to the PSLRA stay and the court would not save them, even if there would be little burden on defendants to make the 220 document productions. Id. The district judge granted the motion to dismiss, and plaintiffs must now try to amend their complaint without the benefit of the same 220 discovery at use in the state court.
At the same time, the decision by the Chancery Court plaintiffs to seek pre-suit discovery was vindicated. Two plaintiffs filed cases, supported by two different groups of plaintiff firms. In determining which would be appointed lead plaintiff, the Chancery Court’s decision was based entirely on selecting the plaintiff that had more aggressively pursued her 220 demand and as a result obtained more documents in pre-suit discovery than the other plaintiff. Lead Plaintiff Order at 5-7.
The Chancery Court has not been shy in recent years about guiding plaintiffs to seek pre-suit discovery through 220 demands. And the Delaware case law has continued to shift favorably to stockholders making 220 demands, most prominently AmerisourceBergen Corp. v. Lebanon County Employees’ Retirement Fund, et al., Case No. 60, 2020 (Del. Dec. 10, 2020). The divergent paths for the various Pattern Energy plaintiffs reinforces this approach and portends even more 220 demands made to public companies.