Smith & Wesson won a notable victory in the U.S. District Court for the District of Nevada last month. The plaintiffs, four groups of Catholic Sisters, brought a somewhat unusual lawsuit, a shareholder derivative action, against the firearms manufacturer. The lawsuit alleged that Smith & Wesson’s corporate leaders exposed the corporation to the risk of financial losses due to its marketing and distribution of the M&P-15 rifle, Smith and Wesson’s popular version of the AR-15-pattern rifle. A Nevada federal district judge, as a Nevada state court judge did just two years ago, found the Sisters’ allegations lacking and granted Smith & Wesson’s motion to dismiss.
While the case is a significant win for Smith & Wesson, the Sisters’ use of the shareholder derivative action reflects a notable litigation strategy that gun control advocates might take against gunmakers in the future. More broadly, it is one that issue-driven advocates occasionally pursue against corporations in other industries as they seek ideological, rather than financial, goals. Finally, the decision showcases the power of Nevada’s corporate law principles, which are poised to become more prominent as some corporations change their state of incorporation to Nevada from Delaware.
A shareholder derivative action is a special type of lawsuit that corporate shareholders may bring against a corporation’s management, i.e., its officers and directors. The usual derivative case alleges that the corporation lost money because the managers acted carelessly, failed to protect the corporation from legal liability or financial losses, or placed their own financial interests above those of the corporation. These standards are relatively difficult to meet in most states, including Delaware, but they are harder still in Nevada. Critically, the first step in derivative actions in many states is an assessment of whether the corporate managers have some conflict of interest with respect to the alleged misconduct – if they do, the case can proceed to costly, time-consuming, and disruptive discovery, and even to trial. Even if the managers ultimately win, the cost in time and disruption is substantial.
Why might the Sisters have chosen the shareholder derivative action instead of a traditional lawsuit? Likely, because the Protection of Lawful Commerce in Arms Act (“PLCAA”) presents major limitations. Often, issue advocacy litigation has relied on state courts’ willingness to entertain novel theories of, for example, tort liability, to raise litigation risk to an intolerable level for otherwise lawful businesses. PLCAA curtailed this in litigation against gunmakers, but the derivative action might be a workaround. A well-pled derivative suit might sneak past a motion to dismiss on legal grounds separate of the propriety of a corporation’s business activities themselves, thus raising the costs of defending its business on the merits. For example, in 2023, plaintiffs in Delaware pursued a shareholder derivative action claiming that certain McDonald’s, Inc., managers – including, embarrassingly, it’s chief human resources officer – engaged in sexual harassment. The plaintiffs alleged that the harassment, and management’s response to it, put the corporation at financial risk. The Delaware Court of Chancery denied a motion to dismiss a derivative action against the human resources officer, though it did dismiss the claims against the other management defendants. In both decisions, the Vice Chancellor made clear that well-pled derivative action alleging management ignored sexual harassment within the corporation could proceed past a motion to dismiss, noting cases against Twenty-First Century Fox, Inc. and Liberty Tax, Inc. where such claims had led to substantial settlements.
While perhaps only noted in passing outside the corporate law world, a boiling controversy has arisen in recent years in Delaware, the legal home of many major corporations. Nevada is a key competitor for incorporations, and the state has welcomed some high-profile new corporate residents in recent years. The Smith & Wesson decision demonstrated a key feature of Nevada corporate law in action: the powerful Nevada business judgment rule. The business judgment rule in most states bars shareholder derivative actions when the plaintiff fails to show that a decision was either grossly negligent, made in bad faith, or made with a disabling conflict of interest, that is, that the managers breached their fiduciary duties of care or loyalty.
While not an easy bar to traverse in Delaware and other states, once the plaintiff rebuts the business judgment rule, the court can consider the business decision on its merits. Nevada’s rule adds another, more difficult hurdle for plaintiffs. It imposes liability on directors only where the plaintiff sufficiently alleges – in addition to typical breaches of fiduciary duty – that the fiduciary breaches rose to the level of “intentional misconduct, fraud, or knowing violation of the law.” The Sisters failed to allege any particularized facts showing that Smith and Wesson’s managers engaged in that level of misconduct, or, for that matter, that they caused Smith & Wesson to break any laws at all.
Smith & Wesson’s victory shows the limits of advocacy litigation apparently brought for the purpose of raising the costs of engaging in lawful firearms business activities, as well as the power of Nevada’s business judgment rule. It remains to be seen whether derivative actions for issue-driven litigation will continue as a strategy, or if cases like this one show that its limits are even greater than those PLCAA may impose in traditional tort or regulatory litigation. Moreover, it illustrates the power of Nevada’s business judgment rule, especially its requirement of a heightened showing of intentional or willful wrongdoing.
