Delaware Corporate and Commercial Litigation Blog : Delaware Litigation Lawyer & Attorney : Francis G. X. Pileggi : Corporate, Business, Commercial, Delaware Chancery Court

Whittington v. Dragon Group L.L.C., No. 2291-VCP (Feb. 15, 2010), read opinion here.

Previous decisions of the Delaware courts in the long line of cases involving this internecine warfare among family members fighting over their interests in various business entities, have been summarized on this blog and can be found here.

This latest iteration by the Delaware courts in this matter comes to us after remand by the Delaware Supreme Court involving an important High Court ruling that the applicable statute of limitations for claims on a contract “under seal” is 20-years. See summary of Delaware Supreme Court decision here.

In addition to defining laches and applying its elements such as “unreasonable delay,” the Court of Chancery in this decision concluded that laches would not bar a claim that was brought a little after 3-years from the date that “inquiry notice” was imputed, in light of the statute of limitations that was 20-years long.

Also helpful for litigators is the definition by the Court of Chancery of “inquiry notice” at page 11 of the slip opinion.

Also of practical use for future reference is the definition by the Court of Chancery of the doctrine called “law of the case” and how that compares and differs from the obligation of the trial court after remand by the Supreme Court to apply new rulings of law. See Slip Op. at 8 to 10.
 

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Whittington v. Dragon Group, L.L.C., No. 2291-VCP (Del. Ch., June 11, 2009), read opinion here.

Among the several prior decisions of the Chancery Court in this case, the two most recent have been summarized on this blog and are available here.

Overview

This Chancery Court decision is one in a series of Delaware decisions involving a dispute among family members of ownership in a Delaware business entity. The present case arises from the different interpretation of a court order entered over five years ago which attempted to resolve one of the intra-family squabbles. The defendants contend that the plaintiff is not a member of the entity, while the plaintiff seeks a judicial order to compel the defendants to recognize his interest in that entity. The court concluded that the plaintiff was barred by laches from seeking relief because he unreasonably delayed the filing of his complaint for over two years and during that period of time the entity involved extinguished liabilities and the defendants undertook certain risks that were not shared by the plaintiff.

The decision provides an extensive definition and rationale for the concept of laches and why the equitable defense of laches does apply in this case.

Examination of the Equitable Defense of Laches

Of particular note is the concept that laches can be applied to prevent a claim that is filed within the applicable statute of limitations when equitable relief is sought. For example, the court explained that where, as in this case, a claim for specific performance requiring a party to perform its contractual duties is filed, it invokes a “stricter requirement for prompt action by the plaintiff, and a plaintiff may not wait the full period of three years set forth in 10 Del. C. Section 8106 to seek such relief.” (See footnote 44. See also footnotes 42, 43 and 45.)

When applying a bar of laches to a claim that was filed within the statute of limitations, there must be either procedural prejudice, for example where a delay prevented a party from calling a crucial witness who has become unavailable; or substantive prejudice, such as when a party suffers a financial detriment by relying on the failure of the plaintiff to seek relief in a timely manner. (See footnotes 46 and 47.) The court also discussed the concept of “inquiry notice” which exists when a plaintiff becomes aware of “facts sufficient to put a person of ordinary intelligence and prudence on inquiry which, if pursued, would lead to the discovery of injury. A plaintiff is expected to act with alacrity once he has reason to suspect that his rights have been violated, and a statute of limitations runs from the point at which the plaintiff, by exercising reasonable diligence, should have discovered his injury.” (See footnotes 49 and 50.) The court found that even under several alternative findings of facts, that the plaintiff simply waited too long to pursue his claims and that it would be inequitable to permit such a delay even if the claim was filed within the applicable statute of limitations.

The court also rejected an argument that the alleged unclean hands of the defendants, based on the facts of this case, prevented the use of laches as a defense. (See footnote 54.)

In sum, the court emphasized that for the applicability of laches, “the length of delay may be less important than the reasons for it. . . . Additionally, the touchtone of the laches inquiry is whether an inexcusable delay leads to an adverse change in the conditions or relations of the property or parties.” (See footnotes 56 and 57.)

Conclusion

In closing, the court quoted the well known equitable maxim that: “equity aides the vigilant, not those who slumber on their rights.” After an exhaustive description of the facts, the court reasoned that the specific injunctive relief sought by the plaintiff required him to act with more alacrity than would apply if he were requesting monetary damages, and in this case it would be inequitable to ignore the “sluggishness in bringing his claims.”

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 Dubroff, et al. v. Wren Holdings, LLC, et al., Del. Ch., No. 3940-VCN (May 22, 2009), read opinion here.

Kevin Brady, a highly-respected Delaware litigator, provides us with the benefit of his following review of this Delaware Chancery Court decision.

On May 22, 2009, Vice Chancellor Noble granted in part and denied in part defendants’ motion to dismiss a class action involving a contested recapitalization plan that resulted in dilution of equity.

By way of background, the plaintiffs, two former minority shareholders of Nine Systems Corporation (“NSC”), brought a purported class action against NSC and other individuals and entities that included former directors and former shareholders, alleging breaches of fiduciary duties. During 2001 and early 2002, the entity defendants had made a series of loans to NSC. In August 2002, NSC carried out a recapitalization transaction (the “Recap”) by written consent of the holders of a majority of NSC’s stock (primarily the entity defendants) by which the entity defendants converted the preferred debt they each held into preferred stock. Before the Recap, the entity defendants collectively owned 56% of NSC’s stock and after the Recap their holdings increased to almost 80%. The other shareholders’ equity, including the plaintiffs’, decreased from approximately 44% to 22%.

Four years later in November 2006, Akami Technologies announced that it was acquiring NSC. In the NSC proxy statement there was a listing of NSC shareholders as well as the number of NSC shares each held. This was the first time that the plaintiffs became aware of their equity dilution. As a result, the plaintiffs filed suit alleging that the defendants breached fiduciary duties owed to the minority shareholders, and that the individual defendants aided and abetted breaches by the entity defendants. The defendants moved to dismiss the complaint arguing that: (i) the plaintiffs lacked standing to assert their claims because their claims are derivative and the plaintiffs were no longer stockholders of NSC; (ii) the defendants did not fail to disclose material facts; and (iii) the plaintiffs’ claims are barred by the doctrine of laches.

Plaintiffs’ Standing Issue —Direct, Derivative or Both

In his analysis, Vice Chancellor Noble noted that claims regarding corporate overpayment such as in the case of a recapitalization are normally derivative claims because the harm goes solely to the corporation. And under the Delaware Supreme Court’s decision in Lewis v. Anderson, 477 A.2d 1040, 1046 (Del. 1984), for a plaintiff to have standing to assert a derivative claim, the plaintiff must be a stockholder at the time of the alleged wrongdoing and must maintain his/her stockholder status in the corporate entity throughout the litigation. There is, however, an exception to the general rule.

In Gentile v. Rosette, 906 A.2d 91 (Del. 2006), the Delaware Supreme Court held that claims based upon equity dilution can be both direct and derivative in certain circumstances. Vice Chancellor Noble, in quoting Gentile and Tooley v. Donaldson, Lufkin & Jenrette, Inc., 845 A.2d 1031 (Del. 2004) noted that:

[a] breach of fiduciary duty claim having this dual nature arises where: (1) a stockholder having majority or effective control causes the corporation to issue “excessive” shares of its stock in exchange for assets of the controlling stockholder that have a lesser value; and (2) the exchange causes an increase in the percentage of the outstanding owned by the controlling stockholder, and a corresponding decrease in the share percentage owned by the public (minority) shareholders.

Thus, under Gentile and its progeny, “where a controlling shareholder causes the corporate entity to issue more equity to the controlling shareholder at the expense of the minority shareholders,” the shareholder’s claim can be both derivative and direct.

In this case, the plaintiffs lost their standing to bring derivative claims because they lost their stockholder status when NSC was acquired by Akami Technologies. In an effort to couch their claim as a direct claim under Gentile, the plaintiffs tried to show that the entity defendants collectively formed a controlling shareholder group. Unfortunately for the plaintiffs, the Court found that their claims under Gentile failed as a matter of law because “the Complaint states in conclusory fashion that the [e]ntity [d]efendants ‘controlled the NSC board of directors,’ but the Complaint is devoid of any facts demonstrating an agreement or that the [d]efendants were tied together in some legally significant way”. Moreover, in what might have been the death knell for plaintiffs on this issue, at the hearing on the motion to dismiss, “the plaintiffs conceded that there were no facts in the Complaint from which the Court could infer that an agreement existed”. As a result of a lack of standing to bring a direct claim, Vice Chancellor Noble granted defendants’ motion to dismiss the substantive claim regarding the Recap.

The Disclosure Claims

The plaintiffs also challenged the sufficiency of the notice sent to inform them of the Recap. Because the Recap was accomplished by written consent of the majority stockholders, there was neither a vote nor a solicitation of the plaintiffs’ approval. While the Court noted that “Delaware case law has not addressed the question of whether the notice required by 8 Del. C. § 228(e) triggers a fulsome disclosure akin to that required when stockholder approval is being solicited”, he did not need to address that issue here because the plaintiffs had stated a claim for breach of fiduciary duty so the motion to dismiss the disclosure claims was denied.

Laches

Finally, the defendants claimed that the plaintiffs’ claims were barred by the doctrine of laches because they were on “inquiry notice” that interested parties converted their shares long before the plaintiffs brought their action. The Court rejected this argument, however, because the plaintiffs were not told that about the dilution until years after the notice was sent and the information that the plaintiffs did receive about the Recap informed them that “senior debt converted in the Recapitalization ‘was raised from existing investors.’” The defendants did not inform them that the “existing investors” were also members of NSC’s board of directors.

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Reid v. Spazio et al., Del. Supr., No. 199, 2008 (April 9, 2009), read opinion here.

Kevin Brady, a highly respected Delaware litigator, provides us with the benefit of his review of this decision.

Yesterday, the Delaware Supreme Court reversed and remanded the Court of Chancery’s dismissal of plaintiff’s complaint  in this matter on grounds that it was barred by the applicable statute of limitations and by laches. The claim was also saved by a procedural "safety net" known as the "Delaware Savings Statute".

International Joint Venture Dispute Goes to U. S. Supreme Court and Back

A joint venture was formed between U.S. Russian Telecommunications LLC (“USRT”), a Delaware limited liability company, and a group of Italian companies to assist Russia in replacing its obsolete commercial satellites. There were allegations that in late 1999, the Italian companies conspired to breach the joint venture agreement in order to seize this business opportunity for themselves, through the formation of a Delaware entity, USRT Holdings LLC (“Holdings”). Reid, a minority shareholder of both USRT and Holdings, brought suit on his own behalf and derivatively on behalf of the companies in May 2001 in federal court in the Southern District of Texas.  After his case was dismissed, Reid re-filed his claims in Texas state court and through a series of dismissals and appeals, Reid took his case literally to the United States Supreme Court (which denied his petition for certiorari) in October 2006.

On April 9, 2007, Reid filed suit in the Court of Chancery, against the Italian companies, who moved to dismiss the action as time-barred. The Court of Chancery granted the motion finding that: (i) the time during which Reid could file a timely action in Delaware expired on March 10, 2007; (ii) laches also barred Reid’s claim because it would have been barred by the statute of limitations and there were no mitigating circumstances; and (iii) the length of time between the challenged conduct and the filing of the action resulted in some prejudice to defendants’ ability to present a defense.

On appeal, Reid argued that: (i) his claim is preserved by the Delaware Savings Statute, 10 Del. C. § 8118(a); and (ii) his claim is not barred by laches. Since interpreting the Savings Statute was a question of law, the Delaware Supreme Court reviewed it de novo.

Are All Discretionary Appeals Encompassed Under the Delaware Savings Statute?

While Reid acknowledged that his complaint arises out of conduct that allegedly occurred in or around 1998 (well outside Delaware’s three-year statutory limitations period) he claimed that the action was still timely because it was preserved by the Delaware Savings Statute. That statute, which “reflects a public policy preference for deciding cases on their merits,” provides six exceptions to the applicable statute of limitations in certain instances where the plaintiff has filed a timely lawsuit, but is procedurally barred from obtaining a resolution on the merits.”

The dispute in this case focuses on whether all discretionary appeals are encompassed under the sixth prong of the statute which states: “if a judgment for the plaintiff is reversed on appeal or a writ of error; a new action may be commenced, for the same cause of action, at any time within one year after the abatement or other determination of the original action, or after the reversal of the judgment therein.” 10 Del. C. § 8118(a)

The Court of Chancery held that the statute was tolled during the time periods with respect to Reid’s discretionary appeals, but not the discretionary appeal to the United States Supreme Court. On appeal, Reid argued that “the grace period provided by Section 8118(a) should not commence until all appeals are resolved, including appeals as of right and those dependent upon a higher court’s discretion.” The defendants argued that “the grace period should be tolled only during the pendency of appeals as of right.”

The Supreme Court found that the Delaware Savings Statute applies to all discretionary appeals because: (i) it has a remedial purpose and is to be liberally construed; (ii) allowing a plaintiff to bring his case to a full resolution in one forum before starting the clock on his time to file in this State will discourage placeholder suits, thereby furthering judicial economy; and (iii) the prejudice to defendants is slight because in most cases, a defendant will be on notice that the plaintiff intends to press his claims.

As a result, the Supreme Court found that Reid’s claim, which was filed within six months of the conclusion of the Supreme Court appeal, was preserved and that the Court of Chancery erred in dismissing the complaint.

Laches v. Statute of Limitations

Reid also claimed that the Court of Chancery erred when it decided that his claims were barred by laches which requires: (i) knowledge by the claimant; (ii) unreasonable delay in bringing the claim; and (iii) resulting prejudice to the defendant. Although both laches and statutes of limitation operate as a time-bar to litigation, the Supreme Court noted that “[u]nder ordinary circumstances, a suit in equity will not be stayed for laches before, and will be stayed after, the time fixed by the analogous statute of limitations at law; but, if unusual conditions or extraordinary circumstances make it inequitable to allow the prosecution of a suit after a briefer period, or to forbid its maintenance after a longer period than that fixed by the statute, the [court] will not be bound by the statute, but will determine the extraordinary case in accordance with the equities which condition it.” (italics mine).

The Court of Chancery found that Reid’s claim was barred because there were no extraordinary circumstances that warranted equitably extending the time to file. The Supreme Court disagreed and in examining the issue from the opposite point of view, found that Reid’s action would be barred by the doctrine of laches “only if unusual conditions or extraordinary circumstances make it inequitable to allow the prosecution of his claim within the time allowed by law.” Apart from the length of the Texas litigation, the Supreme Court found no conditions or circumstances that would make it inequitable to allow Reid to proceed. As a result, the Supreme Court found that the Court of Chancery erred in dismissing the complaint based on laches.
 

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In General Video Corp. v. Kertesz, et al., 2008 Del Ch. LEXIS 181 (Dec. 17, 2008), read opinion here, the Delaware Chancery Court  addresses in a 76-page decision, issues of practical importance to anyone interested in the sundry dilemmas that always arise in connection with the "break-up" of a closely-held business. As commonly happens, one of the "partners" of the failed business in this imbroglio claimed some interest in a new enterprise founded "on the ashes' by the other partner in the original venture. Other issues addressed related to what right, if any, each of the former partners had to restrict the other partner from competing in a new venture.

This decision should be required reading for anyone who plans to form a closely-held business in order to avoid typical traps for the unwary. A common omission that plagues such ventures is lack of appropriate documentation to memorialize understandings and failure to observe corporate formalities.

Two prior decisions (on mostly procedural issues) in this case were highlighted here.

Among the claims addressed by the court in this opinion, include:

1. breach of the fiduciary duty of loyalty to the entity;
2. usurpation of corporate opportunity;
3. misappropriation of trade secrets (12 Del. C. sec. 2001(4));
4. conversion of corporate property;
5. deceptive trade practices (6 Del. C. sec. 2532);
6. tortious interference with business relations;
7. breach of the fiduciary duty of the company's lawyer who allegedly assisted the former partner in establishing the new business.

Importantly, the court interpreted DGCL Sections 141(b) and 142(b) dealing with resignations by officers and directors, such that resignations do NOT need to be written, and when one party announced that he "wanted out", that was the effective date of his resignation (though it was later confirmed in writing).

The court also determined that neither the former partner nor the attorney acquired any confidential information that was used inappropriately.

An exclusive license agreement  for patented electronic equipment was also interpreted and the court noted that they are normally not assignable, but nevertheless it was found to have been terminated in this case.

An issue arose about whether an amount advanced to one partner should have been considered a loan. The determining factor in such a designation is the intention of the parties at the time. (See footnote  65). In the end, in this post-trial opinion, the court  dismissed all the plaintiff's claims.

UPDATE: The Wall Street Journal's  Law Page highlighted this post here.

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In Medek v. Medek, 2008 WL 4261017 (Del. Ch., Sept. 10, 2008), the Delaware Chancery Court described in great detail the limited scope of its subject matter jurisdiction, based in the distinction between the courts of  equity as they were separated in "merry old England" compared to what were described as the "law courts". Still today, the Chancery Court in Delaware is a separate court of equity as compared to the Delaware Superior Court which is a "law court" (and the trial court of general jurisdiction, i.e., basically everything that is not within Chancery's jurisdiction).

 This case describes the circumscribed prerequisites for invoking Chancery Court's jurisdiction as well as the "clean-up doctrine" which allows a court of equity to retain jurisdiction over matters that would otherwise be in the "law  court's" jurisdiction. See footnotes 25 to 40 and related text. Chancery will  retain that part of  the case that seeks only damages (as opposed to equitable relief) in order to "do complete justice" and to avoid "piecemeal litigation" involving the same basic dispute.

( Cf.  Recent Chancery Court decision within the last few days, summarized here, which allowed a case in Superior Court to go forward while the Chancery Court case between the same parties was stayed, in large part because the Chancery Court could not provide a jury trial on damages which is what the plaintiff in the related case had requested.)

The Court in this case noted that the claim based on the Uniform Fraudulent Transfer Act was one in which there might be concurrent  jurisdiction with the Superior Court but that it was well-settled that the Chancery Court had jurisdiction over such  claims and that under the "clean-up doctrine" it would also  retain jurisdiction for a related breach of contract claim.

 Also, procedurally, there was an instructive ruling that granted partial summary judgment for the plaintiff rejecting the affirmative defenses of laches and waiver that the defendant had asserted.

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