Chancery Allows Claims for Fraudulent Inducement and Unjust Enrichment but Not Implied Covenant of Good Faith

Narrowstep, Inc. v. Onstream Media Corporation, C.A. No. 5114-VCP (Del. Ch. Dec. 22, 2010), read 45-page opinion here.   

Issue Addressed

The Court of Chancery in this 45-page opinion granted a motion to dismiss a claim that was asserted based on the implied covenant of good faith and fair dealing but the Court denied the motion to dismiss claims relating to unjust enrichment and fraudulent inducement to enter into an agreement. Also noteworthy is the standard used by the Court to review a motion to dismiss, as referenced in more detail below.

Brief Overview of  Factual and Procedural Background

This case is based on a failed merger between Narrowstep and Onstream Media. In 2008 the parties entered into a Merger Agreement that required them to use their reasonable best efforts to close the merger expeditiously. As the Court explained: “Curiously, and in retrospect perhaps unwisely, Narrowstep agreed to terms in a Merger Agreement that required it to cede all operational control to Onstream well before closing in order to expedite the integration of the two companies. . . . [D]espite the shift in operational control, the merger never closed. After a number of months and multiple amendments to the agreement, Onstream walked away from the transaction. Thereafter, Narrowstep filed its complaint in this action . . ..” This decision was based on a motion to dismiss the complaint based on Rule 12(b)(6).

Bullet Points on Key Rulings of Court

● This is the first Chancery decision that I personally recall which has specifically relied on the relatively new standard announced by the United States Supreme Court in the Twombly case, as the Delaware standard applicable to motions to dismiss under Rule 12(b)(6). The federal standard announced in the Twombly decision requires that in order to avoid dismissal, a complaint must offer “sufficient facts to plausibly suggest that the plaintiff will ultimately be entitled to the relief she seeks.” See footnote 25 (citing Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 555-56 (2007) and Desimone v. Barrows, 924 A.2d 908-29 (Del. Ch. 2007)). There was much discussion on the federal level whether or not that applied to all federal complaints in all areas of the law. Though the Delaware rules of civil procedure are based on the federal rules, it has not yet been conclusively determined by the Delaware Supreme Court whether that federal standard will apply in all Delaware cases. In my reference above I carefully chose the words: "relied on", as opposed to merely "citing" the Twombly case.  I know that other Chancery cases have cited to Twombly. The federal standard is different than the more lenient and well-known "pre-Twombly" standard which provided that a motion to dismiss will not be granted unless there is no set of facts on which the plaintiff could prevail. The author of this opinion also cited to Twombly a few days later in an opinion available here. Although the Chancery decision in Desimone, supra, cited Twombly, there is no clear, controlling authority that definitely resolves the issue of whether Twombly represents the standard that will be used in Delaware on all Rule 12(b)(6) motions in all cases, as opposed to the "pre-Twombly" standard. Desimone was highlighted here on this blog. Compare, LeCrenier v. Central Oil Asphalt Corp., here at n. 33, a Chancery opinion issued on the same day as the instant opinion, but by a different vice chancellor, appearing to rely on the pre-Twombly standard. To paraphrase a popular media outlet: "We report, you decide".

● The Court also discusses the criteria by which it may consider the facts beyond the complaint; and that if a motion to dismiss is treated as a motion for summary judgment under Rule 56 then the Court must give the parties a reasonable opportunity to take discovery and to present material relevant to the summary judgment motion. See footnotes 29 and 32.

● A helpful discussion is provided for the claim based on the implied covenant of good faith and fair dealing, with an analysis of why the motion to dismiss that count alone was granted. The opinion includes an excellent summary of Delaware law on this important but amorphous and elusive concept. See page 26.

● The Court noted the instant case was similar in many respects to the Chancery decision in AQSR India Private, Ltd. v. Bureau Veritas Holdings, Inc., 2009 WL 1707910 (Del. Ch. June 16, 2009) (which was summarized on this blog here).

● The opinion explains the elements for common law fraud and equitable fraud, as well as the rule that detailed averments of fraud must be included with particularity as required by Court of Chancery Rule 9(b). See pages 31 and 32. The Court also explains why it rejected an argument under Rule 12(e) which sought a more definite statement of the claim.

● The Court explains the prohibition in Delaware law that prevents a party from “bootstrapping” a claim of breach of contract into a claim of fraud merely by alleging that a contracting party never intended to perform its obligations. See page 39. In this case, the Court reasoned that the complaint alleged sufficient facts which allowed the Court to infer that Onstream repeatedly lied to Narrowstep at many stages in the process in order to strip Narrowstep of its valuable assets with no intention of closing the merger. This is different than the unallowed attempt to simply add the words “fraudulently induced” to a complaint alleging that the defendant never intended to comply with an agreement when the parties entered into it. However, the facts of this case cannot fit into the category of a simple allegation that failure to comply with a contract equates with failure to disclose an intention to take actions inconsistent with that contract. That is, the agreement is not the source of the fraud claim but rather an instrument by which Onstream perpetrated its fraud and its broader scheme to loot Narrowstep.

● The last part of the opinion explains the elements of an unjust enrichment claim and why that claim was allowed to proceed.
 

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