Holder Claims: Potential Causes of Action in Delaware and Beyond?

Edward T. McDermott is a partner at McCarter & English LLP. This post is based on his recent article, published in Volume 41 of the Delaware Journal of Corporate Law, and is part of the Delaware law series; links to other posts in the series are available here.

This article addresses an unsettled legal issue in the securities law of Delaware and numerous other states: the viability of holder claims, i.e., common law claims by persons who alleged that they had been misled into holding rather than selling their securities investments and then saw the market price of those securities decline after the disclosure of information correcting the misstatement made to them. The investors then allege that that they suffered damages because they were deprived of the opportunity to secure the earlier, higher price.

In Citigroup, Inc. v. AHW Investment Partnership, 140 A.3d 1125(Del. 2015), Chief Justice Strine, speaking for a unanimous Delaware Supreme Court, discussed holder claims. However, to the disappointment of many, the court did not address directly their legal cognizability.

As no Delaware court has ever done so, this article attempts to fill that gap. This attempt is important not only because the law in many states is not settled on this issue but also because nationwide court rulings have been divided almost equally on whether a holder claim can be valid. Moreover, those rulings frequently have not dealt in detail with the arguments for an opposing view point.

The article, after outlining the nature of “holder claims” and noting the increased assertion of those claims over the last few years, scrutinizes the reasoning of the various courts which have recognized or rejected the legal viability of those claims. Initially, the article focuses on flaws in the reasoning of the court’s ruling that a holder claim may be legally viable. Special attention is paid to flaws which relate to essential elements of fraudulent and negligent misrepresentation claims: (i) the failure to address the actual economic loss requirement of common law fraud claims; (ii) the sub silentio reduction of the scope of liability in holder claims based on fraudulent misstatements or omissions; (iii) the erroneous contention that action (i.e., a purchase or sale) by the security holder is not required for a fraud claim of a holder because “inducement is the substance of reliance;” (iv) the recurring failure to provide a satisfactory explanation of a causal relationship between the alleged misrepresentation and the damages supposedly suffered by the holder of the security; and (v) the unfair awarding of “windfall profits” to holders should holder claims be recognized.

The article then points out how holders who claim that they have been misled often have other remedies. They have recourse to alternative claims to recover some or all of their alleged economic setback (especially, those of a derivative nature).

Finally, the article turns a critical eye on several rationales of the courts which have rejected holder claims. For example, some courts have spoken in a confusing way about how the economic loss in a fraud claim derives from the disclosure of the misrepresentation and the later correction in the market price of the security. A far superior articulation of the requisite causal relationship between the wrongdoing and an economic loss is found in the Second Circuit opinion, Lentell v. Merrill Lynch & Co., Inc., 396 F.3d 161, 173 (2d Cir. 2006).

Overall, the article concludes that the aforementioned fundamental flaws in the nature of holder claims should convince courts in Delaware and elsewhere that holder claims lack essential elements of fraudulent and negligent misrepresentation causes of action and thus are without merit as a matter of law.

The complete article, including footnotes, is available for download here.

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