Delaware Supreme Court Affirms Dismissal For Pleading Inadequacy When Plaintiffs Could Have Demanded Books And Records To Develop Facts
On November 16, 2016, the Delaware Supreme Court affirmed a Delaware Court of Chancery decision by Vice Chancellor Sam Glasscock III that dismissed derivative and direct claims against two board members of Premium of America, LLC (“Premium”) and an affiliate. Joseph Penar Family Trust v. Adams, No. 250-2016 (Del. Nov. 16, 2016), aff’g, C.A. No. 10441 (Del. Ch. Apr. 28, 2016). Plaintiffs—members of Premium, a Delaware limited liability company (“LLC”)—had alleged that defendants misappropriated funds when liquidating the company’s assets in breach of their fiduciary duties. The Supreme Court held that the Chancery Court “correctly determined that the appellants’ failure to allege in a non-conclusory fashion the circumstances of the alleged misappropriation required dismissal of the amended complaint.”
Premium was formed in the wake of a 2002 bankruptcy of two affiliated viatical life-insurance companies, which purchased life insurance policies from insured individuals with HIV. Plaintiffs alleged that the defendants breached their duty to act in good faith by “apparently” diverting corporate assets because an asset liquidation yielded just $7 million when, a few months before the liquidation, the board had rejected a transaction (in which the defendants were interested) that valued the assets at $8.75 million.
Vice Chancellor Glasscock found that the complaint failed to describe a number of essential facts, including to whom the supposedly diverted assets were transferred, the details of that transfer, and the liabilities that were discharged before the distribution to the members. Although plaintiffs argued that they were unable to allege more detailed facts because the defendants provided discovery of those as part of confidential settlement communications, Vice Chancellor Glasscock dismissed the claims anyway under Court of Chancery Rule 12(b)(6). In doing so, he noted that plaintiffs never explained why they failed to seek the books and records relating to the liquidation transaction pursuant to 6 Del. C. § 18-305—the LLC provision analogous to Section 220 of the Delaware General Corporation Law—which presumably would have enabled plaintiffs to develop the necessary facts in their complaint.
The Supreme Court affirmed on the basis of the Court of Chancery decision. The Supreme Court highlighted that the Chancery Court “rightly express[ed] frustration with the [plaintiffs’] failure exercise [their] statutory right to demand books and records before filing suit.” This case thus suggests that pleading deficiencies might be perceived more critically by Delaware courts when they accompany a failure to take advantage of statutory rights that likely would have enabled the amelioration of those infirmities.