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Delaware Court Of Chancery Denies Motion To Dismiss Fiduciary Duty Breach Claim Against Derivative Plaintiffs For Failing To Turn Over Derivative Award To The Corporation
08/03/2021On July 15, 2021, Vice Chancellor Morgan T. Zurn of the Delaware Court of Chancery denied a motion by stockholders of OptimisCorp (the “Company”) to dismiss claims brought by the Company against them for breach of fiduciary duty and unjust enrichment for failing to turn over to the Company a derivative arbitration award that they won in their capacity as derivative plaintiffs. OptimisCorp v. Atkins, C.A. No. 2020-0183-MTZ (Del. Ch. June 1, 2021). After succeeding in the derivative case against another stockholder—who had been the Company’s outside counsel and a “confederate” of the Company’s CEO—defendants allegedly escrowed the award with intentions to distribute it to certain stockholders but exclude their adversaries. At an earlier stage in this action, the Court directed defendants to transfer the award to the Company. In this decision, the Court held that defendants “owed fiduciary duties to the Company and its stockholders with respect to the corporate asset entrusted to them” and the Company adequately alleged that defendants “breached their duty of loyalty by withholding the Award out of animus toward [the CEO] and the Company, and to benefit themselves.”
Defendants were stockholders of the Company who had previously but unsuccessfully sought to remove the Company’s CEO. Notably, defendants were also allegedly the principals of a competitor to the Company in the physical therapy business. Defendants won a derivative award in an arbitration against the Company’s outside counsel, who was also a stockholder, for legal malpractice and for breach of fiduciary duties in connection with legal advice related to defendants’ prior efforts to remove the CEO.
According to the complaint, the Company was significantly short on operating capital and had been preparing to raise funds through an equity sale until it received notice of the derivative award, at which point it determined that it no longer needed to raise capital and dilute stockholders. Nevertheless, defendants refused to turn the award over to the Company. Defendants allegedly separately filed a levy against the Company’s accounts receivable funds, which was subsequently lifted by a California state court as improper. The simultaneous withholding of the derivative award allegedly forced the Company to rely on short-term loans with unfavorable terms and also damaged the Company in the form of lost market share, referral sources, patients, payors, goodwill and revenue.
Defendants argued that (i) their fiduciary duties as derivative plaintiffs, if any, were to their fellow stockholders and not to the Company itself, (ii) they were only obligated to maintain the derivative action for the benefit of the Company’s stockholders, and (iii) a derivative plaintiff cannot be held liable for money damages for breaching a fiduciary duty. As to all three arguments, the Court held that defendants “are wrong under Delaware law.”
According to the Court, defendants—as derivative plaintiffs—owed fiduciary duties to the Company and all its shareholders. Moreover, defendants “were entrusted with a corporate asset—the derivative claim—and that claim as transmogrified into a satisfied judgment must be returned to the corporation.” Further, the Court explained that it has “broad discretion” to craft a remedy for a breach of fiduciary duty and whether the Company is entitled to damages must be assessed with the benefit of discovery.
The Court also held that the Company’s claim for unjust enrichment was not subject to dismissal because the complaint adequately pleaded that defendants put the Company in a “bleak financial situation” and thereby enabled the Company’s competitor—defendants’ affiliate—to “capitalize in a competitive market.”
