On September 20, 2021, in a decision authored by Justice Karen L. Valihura, the Delaware Supreme Court sitting
en banc reversed the denial of defendants’ motion to dismiss breach of fiduciary duty claims brought by former stockholders of TerraForm Power, Inc. (the “Company”).
Brookfield Asset Management, Inc. v. Rosson, No. 406, 2020, 2021 WL 4260639 (Del. Sept. 20, 2021). As we discussed in our
prior post, plaintiffs alleged that a private placement of stock to the Company’s controlling stockholder at a price that undervalued the shares diluted the financial and voting interest of the minority stockholders. The trial court found that the claims were nearly identical to corporate overpayment claims asserted by former stockholders and upheld as “direct”—rather than “derivative”—by the Delaware Supreme Court in
Gentile v. Rossette, 906 A.2d 91 (Del. 2006). Reversing, the Delaware Supreme Court reaffirmed the “classic” test for distinguishing stockholder “derivative” claims from “direct” claims established in
Tooley v. Donaldson, Lufkin & Jenrette, Inc., 845 A.2d 1031 (Del. 2004), and expressly overruled
Gentile and its carve-out from
Tooley.
As we explained in our prior post, stockholder “derivative” claims belong to the corporation, but may be asserted by current stockholders (who were also stockholders at the time of the alleged wrongdoing) on behalf of the corporation (subject to various limitations). Claims that are “direct” can be asserted directly by the allegedly injured stockholders themselves. The Delaware Supreme Court held in
Tooley that the determination “must turn solely on the following questions: (1) who suffered the alleged harm (the corporation or the suing stockholders, individually); and (2) who would receive the benefit of any recovery or other remedy (the corporation or the stockholders, individually)?”
However, in
Gentile—decided two years after
Tooley—the Delaware Supreme Court addressed breach of fiduciary duty claims for the alleged issuance of stock for inadequate value to a controlling stockholder, resulting in the transfer of economic value and voting power from the minority stockholders. The Court held that the claims could be maintained by former stockholders as direct claims.
In this case, the Delaware Court of Chancery noted that “dilution claims” such as those asserted by plaintiffs “are classically derivative, i.e., the quintessence of a claim belonging to an entity: that fiduciaries, acting in a way that breaches their duties, have caused the entity to exchange assets at a loss.” The Court explained that plaintiffs’ claims thus “neatly fall into the derivative category” under
Tooley notwithstanding that it was the controlling stockholder that “allegedly cause[d] a corporate overpayment in stock and consequent dilution of the minority interest.” But the Court of Chancery concluded that it was “not free” to diverge from the Delaware Supreme Court’s decision in
Gentile where the facts alleged “fit
Gentile’s transactional paradigm to a T.”
The Delaware Supreme Court confirmed that plaintiffs’ claims are derivative under
Tooley “because they allege an overpayment (or over-issuance) of shares to the controlling stockholder constituting harm to the corporation for which it has a claim to compel the restoration of the value of the overpayment.” The Court explained that “to plead a direct claim under
Tooley, a stockholder must demonstrate that the duty breached was owed to the stockholder and that he or she can prevail without showing an injury to the corporation,” which plaintiffs could not do here.
As to
Gentile, the Court concluded: “Carving out an exception to the
Tooley test and allowing for a separate, direct claim in such circumstance presents both practical and doctrinal difficulties.” For instance, the Court noted that the presence of a controlling stockholder should not alter the fact that equity overpayment/dilution claims are “normally exclusively derivative” because the
Tooley test does not turn on the identity of the alleged wrongdoer. The Court also highlighted that courts have had difficulty applying
Gentile in a logically consistent way. Further, the Court noted that
Gentile could create the problem of double recovery, where stockholders assert direct claims and the corporation asserts its own parallel claims for which the recovery would flow to the stockholders.
