Delaware Court Of Chancery Applies Contemporaneous Ownership Requirement And Declines To Extend Equitable Derivative Standing
On May 13, 2022, Chancellor Kathaleen St. J. McCormick of the Delaware Court of Chancery dismissed certain stockholder derivative claims for breaches of fiduciary duty brought against the founder-CEO and other directors of Flashpoint Technology, Incorporated (the “Corporation”). SDF Funding LLC v. Fry, C.A. No. 2017-0732-KSJM (Del. Ch. May. 13, 2022). Plaintiffs were a limited liability company (the “New LLC”) that held shares in the Corporation and its sole owner (the “Beneficial Owner”). The New LLC received its shares from another limited liability company (the “Old LLC”) — a nonparty to the suit — also wholly owned by the Beneficial Owner. Plaintiffs challenged certain related-party transactions, including leases from and loans to entities affiliated with the CEO. Applying the “contemporaneous ownership requirement,” the Court granted summary judgment to defendants for claims based on conduct that predated the acquisition of shares by the New LLC. In doing so, the Court rejected plaintiffs’ contention that the Beneficial Owner should have “equitable standing.”
Delaware Court Of Chancery Finds That Consent To Merger In Stockholders Agreement Did Not Waive Right To Bring Post-Closing Fiduciary Duty Claims
On February 14, 2022, Vice Chancellor Sam Glasscock III of the Delaware Court of Chancery denied a motion to dismiss a post-closing damages action for breaches of fiduciary duty brought by former stockholders of Authentix Acquisition Company, Inc. (“Authentix” or the “Company”), rejecting defendant’s claim that stockholders waived the right to bring suit. Manti Holdings, LLC v. Carlyle Grp. Inc., C.A. No. 2020-0657-SG, (Del. Ch. Feb. 14, 2022). The Court concluded that language in a Stockholders Agreement consenting to the transaction was not sufficiently specific to waive the stockholders’ right to challenge the sale.
Delaware Court Of Chancery Dismisses Section 220 Action Initiated Hours After Certificate Of Merger Was Filed With Delaware Secretary Of State
On December 3, 2021, Vice Chancellor Lori W. Will of the Delaware Court of Chancery granted a motion to dismiss claims to compel inspection of books and records brought by a former stockholder of Houston Wire & Cable Company (the “Company”) in connection with the Company’s all-cash merger into Omni Cable, LLC. Swift v. Houston Wire & Cable Co., C.A. No. 2021-0525-LWW (Del. Ch. Dec. 3, 2021). The merger agreement provided that each share of the Company would be cancelled and converted into the right to receive $5.30 in cash at the “Effective Time,” which it explained was “such time as [a] Certificate of Merger” is filed. Plaintiff filed the action under Section 220 of the Delaware General Corporation Law (“DGCL”) hours after the Company’s certificate of merger was filed with the Delaware Secretary of State. The Court held that Section 220 requires a plaintiff to be a current stockholder at the time the litigation is initiated. The Court found that plaintiff “ceased to own stock” when the certificate of merger was filed and, therefore, lacked standing when the complaint was filed later the same day.
Delaware Supreme Court Overrules Gentile Carve-out, Holding An Improper Transfer Of Economic Value And Voting Power To A Controlling Stockholder Through An Equity Overpayment Is A Derivative Claim
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
Delaware Court Of Chancery Holds That Former Stockholders Can Pursue Direct Claims For Breach Of Fiduciary Duty Arising From Issuance Of Shares To Controlling Stockholder For Allegedly Insufficient Consideration
On October 30, 2020, Vice Chancellor Sam Glasscock III of the Delaware Court of Chancery upheld breach of fiduciary duty claims brought by former stockholders of TerraForm Power, Inc. (the “Company”) against its majority stockholder, CEO, and several directors. In re TerraForm Power, Inc. Stockholder Litigation, C.A. No. 2019-0757-SG (Del. Ch. Oct. 30, 2020). Plaintiffs alleged that the Company engaged in a private placement of stock to the controlling stockholder at a price that undervalued the shares that were issued. Accordingly, plaintiffs contended that the transaction diluted the financial and voting interest of the minority stockholders. Defendants moved to dismiss for lack of standing, arguing that such dilution claims are “quintessential derivative claims” that cannot be asserted by former stockholders. Vice Chancellor Glasscock, however, denied the motion to dismiss under “controlling precedent” because the Delaware Supreme Court upheld similar claims by former stockholders in Gentile v. Rossette, 906 A.2d 91 (Del. 2006).
Delaware Court Of Chancery Dismisses Post-Merger Stockholder Challenge To Executive Incentive Compensation Stock Awards
On June 26, 2020, Chancellor Andre G. Bouchard of the Delaware Court of Chancery dismissed breach of fiduciary duty claims brought against former officers and directors of Twenty-First Century Fox, Inc. (“Old Fox”) in connection with a transaction in which it spun off part of its business into a new public company, Fox Corporation (“New Fox”), and sold the rest of its business to The Walt Disney Company in a merger (the “Transaction”). Brokerage Jamie Goldenberg Komen Rev Tru U/A 06/10/08 Jaime L Komen Tr. for the Benefit of Jamie Goldenberg Komen v. Breyer, No. 2018-0773-AGB (Del. Ch. June 26, 2020). According to the complaint, the compensation committee of Old Fox approved an incentive compensation program in connection with the Transaction, including an alleged $82.4 million in stock awards granted to Old Fox’s three top executives, who were allegedly the company’s controlling stockholders and collectively owned shares worth over $11.7 billion. Plaintiff was a stockholder of Old Fox that became a stockholder of New Fox in the Transaction. Plaintiff alleged that it was unnecessary and wasteful to approve any “incentive” compensation for these alleged controller-executives because they “already were highly incentivized to pursue and implement the transaction given their collective holdings.” The Court held that plaintiff’s claims were derivative because they challenged a compensation decision by the board of Old Fox and did not adequately plead that the Transaction was “tainted by unfair dealing.” The Court dismissed plaintiff’s claims for lack of standing because plaintiff was not a stockholder of New Fox at the time of the alleged misconduct and, therefore, could not satisfy the continuous ownership requirement for derivative claims.
Delaware Court Of Chancery Holds That Concurrent Appraisal Action Does Not Preclude Post-Closing Fiduciary Duty Breach Claims
On December 11, 2018, Vice Chancellor Joseph R. Slights III of the Delaware Court of Chancery denied a motion to dismiss breach of fiduciary duty claims against the former CEO of a technology company (the “Company”) in connection with its take-private sale to a private equity firm. In re Xura, Inc. Stockholder Litigation, C.A. No. 12698-VCS (Del. Ch. Dec. 11, 2018). Plaintiff alleged that the CEO was conflicted by self-interest while he steered the Company into the transaction. As a stockholder at the time of the transaction, plaintiff simultaneously pursued appraisal of its shares of the Company. Defendant argued that plaintiff lacked standing to pursue breach of fiduciary duty claims in light of the pending appraisal petition and, in any event, the approval by the majority of the stockholders cleansed the transaction under Corwin v. KKR Fin. Hldgs. LLC, 125 A.3d 304 (Del. 2015). The Court, however, held that a plaintiff seeking appraisal can nevertheless maintain breach of fiduciary duty claims related to the same transaction and that the alleged omission from the proxy of various information material to the stockholder vote precluded the application of the Corwin doctrine at the pleading stage.
New York Appellate Court Reverses Dismissal Of Derivative Claims Involving U.K. Company
On November 14, 2018, the New York State Appellate Division Second Judicial Department reversed the dismissal of a shareholder derivative suit against directors and officers of a U.K. company and certain of its affiliates asserting claims for breaches of fiduciary duties in connection with the companies’ conduct underlying penalties and settlement agreements related to alleged sanctions violations. Michael Mason-Mahon v. Douglas J. Flint, 602052/14 (N.Y. App. Div. Nov. 14, 2018).
Delaware Court Of Chancery Validates Ratification Of Defective Corporate Acts Impacting Merger And Declines To Expand Universe Of Claims Classified As Both Direct And Derivative
On August 17, 2018, Chancellor Andre G. Bouchard of the Delaware Court of Chancery denied all of plaintiffs’ claims challenging a series of transactions culminating in the acquisition of defendant Design Within Reach, Inc. (“DWR”) by Herman Miller, Inc. (“HM”) in July 2014. Charles Almond as Trustee for the Almond Family 2001 Trust v. Glenhill Advisors LLC, C.A. No. 10477-CB (Del. Ch. Aug. 17, 2018). The claims related in large part to the documentation of a reverse stock split by DWR in 2010 that had the unintended effect of diluting the number of shares of common stock into which preferred stock could be converted by a factor of 50. As this went unnoticed until after the merger, the preferred stock was converted into common stock as if there had been no error. Plaintiffs, who were pre-merger minority stockholders of DWR, asserted various claims that defendants, including DWR’s controlling stockholder, thus improperly benefited from a greater percentage of equity and merger consideration than that to which they were legally entitled. HM ratified the correction of the conversion factor (pursuant to 8 Del. C. § 204) and asserted a counterclaim for judicial validation of the defective corporate acts (under 8 Del. C. § 205). Finding all relevant factors weighed “overwhelmingly in favor of judicial validation” the Court granted defendants’ request to validate the defective corporate acts and rejected plaintiffs’ claims. Separately, the Court rejected breach of fiduciary duty claims unrelated to the merger.
New York Court Of Appeals Reverses Dismissal Of Derivative Claims Involving Cayman Islands Company, Finding Cayman Islands Gatekeeping Rule Inapplicable
On November 20, 2017, the New York State Court of Appeals reversed the dismissal of derivative claims brought by a shareholder of Scottish Re Group, Limited (“Scottish Re”)—a Cayman Islands company—against the company, its directors, and various other entities. Davis v. Scottish Re Grp. Ltd
., No. 111 (N.Y. Nov. 20, 2017). The New York State Appellate Division had previously affirmed the dismissal of those derivative claims for lack of standing because plaintiff had not sought leave of the Cayman Islands Grand Court to commence a derivative action, as required under Rule 12A of the Rules of the Grand Court of the Cayman Islands. Reversing and remanding, the Court of Appeals held that “Rule 12A is procedural, and therefore does not apply where, as here, a plaintiff seeks to litigate his derivative claims in New York.”
Delaware Court Of Chancery Dismisses Derivative Action, Finding Demand Unexcused Because Plaintiff Did Not Plead Non-Exculpated Claims Against A Majority Of Directors
On November 7, 2017, Vice Chancellor Tamika Montgomery-Reeves of the Delaware Court of Chancery granted a motion to dismiss a derivative and putative class action brought by a minority stockholder of Erin Energy Corporation (“Erin”), challenging a series of transactions involving Erin, Allied Energy PLC (“Allied”)—an entity affiliated with Kase Lukman Lawal, Erin’s chairman, CEO, and controlling stockholder—and another party, Public Investment Corporation Limited (“PIC”). Lenois v. Lawal
, C.A. No. 11963 (Del. Ch. Nov. 7, 2017). Plaintiff alleged that the CEO—who together with an affiliated entity (Allied’s parent company) controlled nearly 60% of Erin’s shares—effectively stood on all sides of the challenged transactions and negotiated in his own self-interest. Plaintiff asserted derivative claims for breach of fiduciary duty against the CEO and the remaining directors. The Court found that plaintiff adequately pleaded that the CEO acted in bad faith, but dismissed the derivative claims because the complaint “failed to plead non-exculpated claims against a majority of the Erin Board” and, thus, demand on the board was not excused.
Texas Federal District Court Invalidates IRS Regulations Limiting Inversion Transactions
On September 29, 2017, the United States District Court for the Western District of Texas granted summary judgment in favor of the U.S. Chamber of Commerce and Texas Association of Business, holding that the Internal Revenue Service (“IRS”) and U.S. Treasury Department violated the Administrative Procedures Act (“APA”) when they promulgated an anti-inversion rule that ultimately inhibited the merger of Allergan PLC and Pfizer Inc. Chamber of Com. of the U.S., et al. v. Internal Revenue Service, et al.
, No. 1:16-CV-944-LY (W.D. Tex. Oct. 6, 2017) (Amended Order). Specifically, the Court found that the government agency defendants were required—but failed—to provide the public and affected parties adequate notice and an opportunity to comment on the proposed anti-inversion rule before enacting it. The ruling, which also held that plaintiffs had standing to challenge the rule (and that the government agencies had authority to implement it), creates an opening for other companies considering a possible inversion transaction.
Delaware Chancery Court Holds That Former Stockholders Lack Post-Merger Standing To Bring Mismanagement Claims
On May 4, 2017, Chancellor Andre G. Bouchard of the Delaware Court of Chancery dismissed for lack of post-merger standing an action by former stockholders of Massey Energy Company (“Massey”) against its former officers and directors for their alleged failure to act in good faith to ensure that Massey complied with mine safety regulations. In re Massey Energy Company Derivative and Class Action Litigation
, C.A. No. 5430-CB (Del. Ch. May 4, 2017). The plaintiffs, who were divested of their shares in connection with a merger of Massey while the litigation was pending, purported to assert two claims: (i) a breach of fiduciary duty derivative claim and (ii) “inseparable fraud,” styled as a “direct” claim. As to “inseparable fraud,” plaintiffs were relying on what Chancellor Bouchard described as “dictum” in the Delaware Supreme Court’s decision in Arkansas Teacher Retirement System v. Caiafa
, 996 A.2d 321, 322-32 (Del. 2010), which stated that “Delaware law recognizes a single, inseparable fraud when directors cover massive wrongdoing with an otherwise permissible merger.” But Chancellor Bouchard found that the misconduct alleged could only constitute a derivative claim, because the allegations “implicated” the directors’ “normal duty” to the corporation to manage its affairs and the allegations of harm—including the “prospect of . . . fines, penalties . . . and the like”—are “prototypical examples of corporate harm that can be pursued only derivatively.” The Court also concluded that plaintiffs’ allegations that the merger was “necessitated” by the misconduct were unavailing, because “inseparable fraud” is not an exception to the “continuous ownership rule for maintaining derivative standing.”
Second Circuit Affirms Dismissal Of Shareholder Suit, Finding Subject Matter Jurisdiction Was Properly Exercised, Equity Dilution Claim Was Derivative, And Demand Futility Was Inadequately Pleaded
On April 26, 2017, the United States Court of Appeals for the Second Circuit affirmed the dismissal of a lawsuit brought by a shareholder of Star Bulk Carriers Corp. (“Star Bulk”) against its directors and entities affiliated with the director defendants. F5 Capital v. Pappas
, No. 16-530 (2d Cir. April 26, 2017). Challenging various transactions in which Star Bulk had engaged, plaintiff asserted derivative claims for breaches of fiduciary duty and waste, as well as a purported direct class-action claim for wrongful equity dilution. Affirming the dismissal of all claims, the Second Circuit held that (1) the equity dilution claim was not within the “limited circumstances involving controlling stockholders” to enable it to be considered a direct (rather than derivative) claim; (2) the district court nevertheless had and properly retained subject matter jurisdiction; and (3) plaintiff failed to plead demand futility, as required under Federal Rule of Civil Procedure 23.1 to maintain shareholder derivative claims.
Massachusetts Supreme Court Affirms Dismissal Of Shareholder Class Action And Clarifies That Directors Generally Owe Fiduciary Duties To The Corporation, And Not Its Shareholders
On March 6, 2017, in a decision authored by Justice Margot Botsford, the Massachusetts Supreme Judicial Court affirmed the dismissal of an action for breach of fiduciary duty brought by former shareholders of EMC Corporation against its directors in connection with its merger with Dell Inc., finding that the claims could only have been brought derivatively. Int’l Brotherhood of Electrical Workers Loc. No. 129 Benefit Fund v. Tucci
, SJC-12137 (Mass. Mar. 6, 2017). In its decision, the Court clarified that “the general rule of Massachusetts corporate law is that a director of a Massachusetts corporation owes a fiduciary duty to the corporation itself, and not its shareholders.” Further, the Court found that the injury alleged—the undervaluation of EMC in the transaction—“qualifies as a direct injury to the corporation” and “fit[s] squarely within the framework of a derivative action,” which plaintiffs as former shareholders did not—and could not—bring.
Delaware Chancery Court Holds That Former Stockholder Lacks Standing To Bring Section 220 Action For Inspection Of Books And Records
On February 27, 2017, Vice Chancellor Sam Glasscock III of the Delaware Court of Chancery dismissed for lack of standing a lawsuit for inspection of corporate books and records brought by a former stockholder squeezed out in a two-step merger. Weingarten v. Monster Worldwide Inc.
, C.A. No. 12931-VCG, 2017 WL 752179 (Del. Ch. Feb. 27, 2017). As noted by the Court, this case presented an issue of first impression: whether a plaintiff seeking corporate records under Section 220 of the Delaware General Corporation Law, 8 Del. C.
§ 220, must be a stockholder at the time the complaint is filed. Based on the language of the statute, the Court held that the former stockholder lacked standing to bring a Section 220 action because he no longer owned shares following the merger.
Delaware Chancery Applies Entire Fairness Standard, Denies Dismissal of Shareholder Suit Based on Claims that Directors Usurped Corporate Opportunity and Approved Merger to Avoid Liability
On July 28, 2016, Vice Chancellor Sam Glasscock III of the Delaware Chancery Court largely denied motions to dismiss a breach of fiduciary suit brought by former minority stockholders of Riverstone National, Inc. (“Riverstone”) against CAS Capital Ltd. (“CAS”), the majority stockholder of Riverstone, the Riverstone board (“Director Defendants”), and, nominally, Riverstone. In re Riverstone Nat’l, Inc. Stockholder Litig.
, Consol. C.A. No. 9796-VCG (Del. Ch. July 28, 2016). The Court applied the entire fairness standard to the merger because plaintiffs alleged that the Director Defendants usurped corporate opportunities and then caused Riverstone to enter into a merger with Greystar Real Estate Partners (“Greystar”) to extinguish said claims (the “Usurpation Claims”). Applying Delaware’s “reasonably conceivable” pleading standard, the Court held that plaintiffs adequately pleaded a claim for breach of loyalty in connection with the approval of the merger.