Chancery Addresses Right to Direct Claim for Dilution of Minority Shareholders

Carsanaro v. Bloodhound Technologies, Inc., C.A. No. 7301-VCP (Del. Ch. March 15, 2013).

This 76-page Chancery decision addresses issues that include the following: (1) when a claim for dilution of minority shares can be pursued directly instead of, or in addition to, derivately; (2) restrictions imposed by DGCL Section 160 on the right to redeem shares; (3) prerequisites of DGCL Section 228 that allows for written consent in lieu of a shareholder meeting; (4) when equitable tolling due to fraudulent concealment will bar a laches defense; (5) what must be pled to overcome the BJR presumption; and (6) a reminder that there is no safe harbor where dual directorships present divided loyalties.

For the busy reader that is pressed for time and does not want a summary that approaches the 76-page length of this opinion, I offer a few bullet points.

  • One of the most noteworthy aspects of this opinion, that is chock-full of Delaware corporate law bedrock principles, is the discussion at pages 61 and 67 that addresses the important procedural nuance of when a claim against the board of directors for breach of fiduciary duty may be brought directly and/or derivately. The court acknowledges that the case law on this topic may not always be easy to apply in deciphering where the dividing line is for those matters that must  be brought derivately or directly–or which claims can be brought in either procedural posture.
  • The court explains that an individual claim challenging a self-interested stock issuance may be made when the allegations support an actionable claim for breach of the duty of loyalty, as in this case involving somewhat egregious dilution of the minority who were also co-founders. (However, it must be emphasized that this was a ruling on a motion to dismiss and no claims have been proven yet.) Other examples are also included.
  • A purported written consent of shareholders allegedly pursuant to DGCL Section 228 was not effective because the exhibit which was referred to in the consent was not provided for over a month after the consent was signed, despite a request. See Slip op. at 27-28.
  • A overview of basic principles of what must be pled to overcome the business judgment rule presumption is provided at pages 19 and 20 (e.g., at least half the board must be shown to be lacking in independence or disinterestedness), and a useful reminder is provided to explain when the burden of proof will shift to establish the entire fairness of an interested transaction.
  • The court emphasized that the right to redemption under DGCL Section 160 is not without limitation.
  • Another reminder in the opinion is that corporate actions will be “twice tested”: once by the strictures of the DGCL and again by the standards of equity.
  • There is much else to commend this scholarly work for its careful treatment of the issues referenced above. Aside: The court’s equitable heartstrings seem to have been struck based in part on the detailed factual allegations that demonstrated the unfair treatment of the minority whose interests in the company were rudely diluted.

SupplementMax Kennerly provides interesting commentary about this case and the more general situation where venture capitalist force-out or dilute the founders of a start-up, as well as the need for those founders to have their own lawyers at every step of the process dealing with venture capitalists.