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

Nemec v. Shrader, No. 3878-CC, and Wittkemper v. Shrader, No. 3934-CC (consolidated cases)(Del. Ch., April 30, 2009), read opinion here.

The factual basis of this Chancery Court decision involves shareholders who had signed agreements that governed the redemption of their shares. They filed suit when their company had redeemed their shares shortly prior to the corporation being acquired.

The court dismissed claims that directors breached their fiduciary duty in connection with the redemption of shares, as well as dismissing unjust enrichment claims, based on the reasoning that formal contracts controlled the issues and that the directors were entitled by the terms of  the contract to redeem the shares involved. As the court  explained:

"... the relationship between plaintiffs and Directors is governed primarily by contract  under the Stock Plan. According to Delaware law where a dispute “relate[s] to obligations ‘expressly treated . . .’ by contract[, it] will be governed by contract principles.”  If the “fiduciary claims relate to obligations that are expressly treated” by contract then this Court will review those claims as breach of contract claims and any fiduciary claims will be dismissed."

By contrast, recent Chancery Court decisions summarized on this blog here and here, explain situations where both contract claims and torts claims may proceed (or fiduciary claims and contract claims may proceed),  in the same case, unlike the ruling in this matter.

Moreover, even if the court allowed the fiduciary claim, it would fail based on the court's reasoning that if the directors are acting in the best interests of all shareholders and the company, they are not liable simply because some shareholders fare better than others (citing Gilbert v. El Paso, 1988 WL 124325, at *10 (Del. Ch. Nov. 21, 1988), aff’d, 575 A.2d 1131 (Del. 1990)).

A claim based on the implied covenant of good faith and fair dealing was summarily dismissed based on the familiar reasoning of many Delaware cases that the court will not provide terms that the parties themselves failed to negotiate as part of their agreement.

In addition, the court cited settled Delaware law that rejects claims for unjust enrichment when the claims are covered by the express terms of a controlling agreement between the parties.

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Stevanov v. O’Connor, No. 3820-VCP(Del. Ch., April 21, 2009), read opinion here.

Kevin Brady, a highly respected Delaware litigator, provides us with the benefit of his summary of this Delaware Chancery Court decision as follows:

Vice Chancellor Parsons granted in part and denied in part defendant - ex-husband’s motion for summary judgment with respect to his ex-wife’s claims for equitable and compensatory relief based on causes of action relating to breach of fiduciary duty, conversion, unjust enrichment, and fraud. While on its face, this is not your typical Court of Chancery case, the devil and the jurisdictional basis are in the details of this 40-page opinion.

Since the facts are long, complicated and “fuzzy” to quote the Vice Chancellor, what follows is a relatively brief overview. The dispute between the former spouses arises out of two failed intertwined relationships grounded in statutes -- a marriage and a corporation. It’s a typical “boy meets girl, they get married, form a company,(he gets 80%, she gets 20% equity interest) they get divorced, and then they fight about splitting the assets and liabilities.”

The couple got married in 1990 and formed a corporation in 1992 to fabricate and manufacture air pollution equipment (the “Company”). The parties then bought land personally and leased it back to the Company. As a condition of some loans for the Company, the banks required guarantees and mortgages from the parties. Then, “things get fuzzy.” The ex-husband apparently arranged for a contract that the Company had with one of the Company’s major customer to be transferred to a new business run by the husband, but owned by his son from a different marriage (the Air Clear Contract”). In 2003, the parties got divorced. Two years later the Company was sued in federal court in South Dakota and a large default judgment was entered against the Company.

In January 2005, the Family Court entered an Order with a series of factual findings and legal determinations including approving the husband’s new business venture based on the apparent insolvency of the Company. The Family Court also awarded the wife 55% and the husband 45% of the marital assets. Thereafter, the husband terminated the lease agreement for the land, terminated the wife’s employment with the Company, and stopped paying debts of the Company including franchise taxes.

The ex-wife filed her complaint in June 2008 alleging: (i) breach of fiduciary duty; (ii) conversion of jointly owned assets; (iii) unjust enrichment; and (iv) fraud. She also sought an accounting. The ex-husband counterclaimed seeking (i) damages; (ii) an accounting for lost income and property: (iii) a determination that her conduct has been in breach of  fiduciary duties, imposition of an equitable lien upon all interests in an entity he purchased after they were divorced as well as a constructive trust upon all assets improperly removed from the company by her, and all financial accounts into which any monies improperly removed from the company were deposited. Cross-motions for summary judgment were filed.

Vice Chancellor Parsons discussed in great detail a multitude of topics related to the allegations including direct vs. derivative claims, laches, statute of limitations, preclusion, collateral estoppel, fraud, and conversion. In the end, the Court granted summary judgment in favor of the ex-husband with respect to the breach of fiduciary duty claims based on actions that occurred before the Family Court entered its January 2005 Order or that occurred before the complaint was filed with respect to certain contracts mentioned in the Family Court Order. The Court also granted summary judgment on the claim for conversion for those portions of that count that were based on the use of the land purchased individually by the parties in September 1995, and on the fraud claim.
 

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Kuroda v. SPJS Holdings, L.L.C., Del. Ch., No. 4030-CC (April 15, 2009), read opinion here.

This case involves the following claims among members of an LLC, arising out of an LLC Agreement: (i) breach of contract; (ii) tortious interference with contract; (iii) tortious interference with prospective economic advantage; (iv) breach of the implied covenant of good faith and fair dealing; (v) conversion; (vi) unjust enrichment; and (vii) civil conspiracy. The court dismissed the foregoing claims against most of the defendants based on a motion to dismiss under Rule 12(b)(6). The discussion of this smorgasbord of claims serves as a useful reference to include in the toolbox of the business litigation lawyer.

Background

The factual background involves an intricate web of overlapping entities. The central fact that is key to this dispute is that a few investment management professionals formed several entities for the primary purpose of investing in Japanese companies. The plaintiff was the main "point man" in Japan. Eventually, the plaintiff and the other members of the LLC had disagreements that caused the plaintiff to want to leave. This litigation started when the negotiations for an amicable departure were unsuccessful. Among the problems that gave rise to the suit included the alleged failure of the defendants to provide full payment that the plaintiff thought he was owed, and the issuance to the plaintiff of a K-1 purporting to assign him $10 million in income that he apparently did not receive.

Breach of Contract Claim

Regarding the breach of contract claims relating to the LLC Agreement, the court denied the motion to dismiss against two of the defendants based on the familiar test for a Rule 12(b)(6) motion that the court cannot choose at such a preliminary stage the movant's view of the contract if it is "not the only reasonable interpretation". FN 9.

The opinion also includes discussion about whether the LLC members could be held liable "as members, solely by reason of them being members". Reference was made to Section 18-303(a) of the Delaware LLC Act, which addresses the liability of members to third-parties, but, the court explained, it "has no bearing on the liability between members." FN 13.

The court discussed the elements of a breach of contract claim (FN 15). The plaintiff, Kuroda, alleged that issuing him a K-1 that purported to assign him income that he never received. However, he still failed to allege the element of damages because as a Japanese citizen it was not clear that he would owe taxes  in the U.S., or suffer other damages as a result of an inaccurate K-1, though the court did allow the plaintiff to amend his complaint. [This conclusion should be compared with a decision from the Chancery Court of many years ago in an unaffiliated case that reached a different result on different facts but involved an arguably analogous issue. See   Litle v. Waters, 1992 WL 25758 at *8 (Del. Ch., Feb. 11, 1992)(finding that the plaintiff in that case stated a claim for oppression of a minority shareholder by failing to declare dividends in a subchapter S corporation where the plaintiff minority shareholder was incurring tax liability but receiving no income to pay the liability, while the Defendant was receiving loan repayments which he could use to pay his tax liability.)]

Tortious Interference with Contract

It was explained by the court as "well-settled that a party to a contract cannot be held liable for both breaching a contract and tortiously interfering with the same contract." FN 18. Moreover, the individual defendants were in control of the member entities, thus, as long as they were acting within the scope of their respective roles as managers of the member entities, they cannot be held liable for tortious interference with contract, based on the reasoning that they are the agents of the signatories to the contract. FN 20.

Tortious Interference with Prospective Economic Advantage

The elements of a claim for tortious interference with prospective economic advantage were recited (FN 31), but preliminarily, the court found that those claims were not direct claims that could be brought by the plaintiff, but rather were derivative claims that needed to be brought on behalf of the LLC through which he did business. See 6 Del. C. Section 18-1001 and FN 32.

Implied Covenant of Good Faith and Fair Dealing

An  explanation of this cause of action and a nuanced amplification of its limited scope in the opinion is the best way to  understand why this claim was dismissed, so I quote from page 24 of the slip opinion:

The implied covenant of good faith and fair dealing inheres in every contract and requires ‘a party in a contractual relationship to refrain from arbitrary or unreasonable conduct which has the effect of preventing the other party to the contract from receiving the fruits’ of the bargain.”38 The implied covenant cannot be invoked to override the express terms of the contract.39 Moreover, rather than constituting a free floating duty imposed on a contracting party, the implied covenant can only be used conservatively “to ensure the parties’ ‘reasonable expectations’ are fulfilled.”40 Thus, to state a claim for breach of the implied covenant, Kuroda “must allege a specific implied contractual obligation, a breach of that obligation by the defendant, and resulting damage to the plaintiff.”41 General allegations of bad faith conduct are not sufficient. Rather, the plaintiff must allege a specific implied contractual obligation and allege how the violation of that obligation denied the plaintiff the fruits of the contract. Consistent with its narrow purpose, the implied covenant is only rarely invoked successfully.42

Conversion

In connection with defining the elements of this claim (FN 49), the  court explains that when a claim arises out of a contract, such a cause of  action cannot be bootstrapped into a tort claim (FN 50). Moreover, the Court emphasized that there is a very narrow exception to the general prohibition against claims for the conversion of money. That is, the plaintiff, Kuroda, would have to establish a right to the money, separate from a contract right, that he asserts is being withheld improperly by the defendants. This he cannot do. FN 54.

Unjust Enrichment

After reciting the elements of this claim (FN 61), the reason given for why it was dismissed is as follows: such a claim is not available where, as here, there is a contract that governs the relationship between the parties. Thus, "when the complaint alleges an express, enforceable contract that controls the parties' relationship ... a claim for unjust enrichment will be dismissed." FN 63.  But cf. FN 65 that cites a case that refers to the limited circumstances in which the concept of "alternative pleading"  will allow both such claims to be pled in the same complaint.

Civil Conspiracy

The plaintiff failed to adequately allege the elements of an underlying claim, and thus this count in the complaint was dismissed because, as the court noted, civil conspiracy is not an independent claim. FNs 70 and 71. Moreover, the opinion cites to authority in footnote 74 for the position that unless a breach of contract constitutes an independent tort (which the excerpt above shows is hard to do), a breach of contract cannot constitute an underlying wrong on which a claim for civil conspiracy can be based.
 

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Addy v. Piedmonte, et al., Del. Ch., No. 3571-VCP (March 18, 2009), read opinion here.

Kevin Brady, a highly respected Wilmington lawyer, prepared the following review of this case:

In this Chancery Court decision, Vice Chancellor Parsons dismissed a claim for breach of fiduciary duty in a case with a complex fact pattern involving oil and gas exploration participation agreements, guarantees and notes.

The Court, in a 57-page opinion, addressed a multitude of issues raised by the eleven-count complaint against eleven defendants where the Court characterized the relationships among the parties under the various contracts as, “at best, murky.” In the pending motion, six of the defendants (the “Moving Defendants”) moved to dismiss eight claims for breach of contract, breach of guaranties, fraud and equitable fraud, breaches of fiduciary duty, promissory estoppel, unjust enrichment, and for equitable relief, including specific performance, an accounting, a constructive or resulting trust, and an equitable lien. The Court summed up the factual quagmire by noting “[this] dispute involves the interrelationship of several written contracts each purporting to integrate fully the agreement among the parties with the terms of notes that were described in summary fashion in informal documents, but never formally issued.”

The Court discussed the language of the Participation Agreements and issues related to them including the parties’ intentions, extrinsic evidence, the parol evidence rule and the concept of integration.

The Concept of Integration in Contract Law

With respect to arguments about integration of the contracts in this case, the Court noted:

Clauses indicating that the contract is an expression of the parties’ final intentions generally create a presumption of integration. Courts, however, may consider extrinsic evidence to discern if the contract is completely or partially integrated. Furthermore, in determining whether a contract is fully integrated, the Court focuses on whether it is carefully and formally drafted, whether it addresses the questions that would naturally arise out of the subject matter, and whether it expresses the final intentions of the parties.

With respect to the only claim that was dismissed by the Court (Count VIII Breach of Fiduciary Duty), the Court noted that in early 2006, two defendants, Piedmonte and Stover offered, at approximately the same time, separate investment opportunities to plaintiff. Within three months, the plaintiff, a sophisticated investor, contributed cash to the two investments in an aggregate amount exceeding $3 million. Pursuant to agreements with two of the defendant LLCs, the plaintiff directly provided money to those defendants, which undertook to purchase participation units in the investments from two of the Westside defendants in exchange for notes. The $3 million eventually found its way to two entities, each of which are owned 50% by an entity controlled by Piedmonte and 50% by an entity controlled by Stover.

Creation of Fiduciary Relationship Alleged

In Count VIII, the plaintiff claimed that Stover breached a fiduciary duty with respect to these commercial contracts by inducing his participation in those investments and engaging in self-dealing by retaining a portion of the plaintiff’s cash contribution. On this point, Vice Chancellor Parsons noted:

Under Delaware law, a fiduciary relationship arises where one person places special trust in another or where one person has a special duty to protect the interests of another. Generally, the fiduciary enjoys a position of superiority in knowledge or expertise upon which the other person relies. A fiduciary relationship requires confidence reposed by one side and domination and influence exercised by the other.

Based upon the above, the Court found that Stover did not owe a fiduciary duty to the plaintiff because the Participation Agreements included provisions under which the plaintiff represented that he conducted an independent investigation into Westside, including its business and financial welfare, and that he did not rely on any statements made or investigations performed by other entities.

Fiduciary Relationships v. Commercial Relationships

The Court also discussed the concerns of extending the fiduciary duty doctrine to ordinary commercial transactions:

[I]t is vitally important that the exacting standards of fiduciary duties not be extended to quotidian commercial relationships. This is true both to protect participants in such normal market activities from unexpected sources of liability against which they were unable to protect themselves and, perhaps more important, to prevent an erosion of the exacting standards applied by courts of equity to persons found to stand in a fiduciary relationship to others.

Bargained-for commercial relationships between sophisticated parties do not give rise to fiduciary duties. In addition, this Court is chary of expanding the scope of fiduciary duty to a broad set of commercial relationships which traditionally has been regulated by normal market conditions, rather than the scrupulous concerns of equity for persons in special relationships of trust and confidence.

The Court found that the plaintiff entered into an agreement to purchase participation units in the two projects at issue after he had ample opportunity to review their terms and negotiate new terms if required before contributing any money. Thus, the plaintiff’s claim that Stover breached his fiduciary duties was without merit, and as a result, it was dismissed.

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In Metcap Securities LLC ,et al. v. Pearl Senior Care, Inc., et al., Del. Ch., No. 2129-VCN (Feb. 27, 2009), the Chancery Court granted summary judgment in a case involving a dispute about the payment of a $20 million fee for a financial advisor to a merger deal.  Prior decisions in this case were summarized here.

Kevin Brady, a highly respected Delaware litigator,  prepared the following review of this case.

One of the Plaintiffs, North American Senior Care, Inc. (“NASC”), a Delaware corporation formed solely for the purpose of acquiring Defendant Beverly Enterprises, Inc. (“Beverly”), entered into a merger agreement on August 16, 2005, pursuant to which Beverly would be acquired for $2 billion. Leonard Grunstein, a partner at the law firm of Troutman Sanders LLP, was a principal of NASC and a principal of the other plaintiff MetCap Securities LLC. Before the merger agreement between NASC and Beverly, MetCap had entered into an Advisory Agreement with NASC to act as NASC’s financial advisor in connection with the Beverly transaction. Under the Advisory Agreement, MetCap was to receive a $20 million fee for its services upon closing of that transaction. However, as the negotiations to finalize the merger documents were winding down, a change was made to the merger agreement by a law partner of Grunstein which in effect deleted the language that permitted MetCap to get the $20 million fee for the transaction.

NASC and MetCap filed this action to recover the $20 million fee from the Defendants. The Defendants moved for summary judgment on two issues: (1) whether NASC can reform the merger agreement and return to the earlier version of the agreement which acknowledged a potential right to compensation regarding MetCap; and (2) whether the Defendants were unjustly enriched by work performed by MetCap after the amendment to the merger agreement.

In discussing the issues, Vice Chancellor Noble went through a very detailed analysis of the plaintiff’s claim for reformation of the merger agreement. There is an interesting discussion about the role of “deal counsel” and whether Grunstein’s law partner (who made the final changes to the merger agreement, deleting the references to MetCap getting the fee), was a “dual or common” agent and thus “conflicted’ thereby having no authority to bind his principal by agreeing to the deletion. The Court decided that he was not conflicted.

The Court also went through a very detailed analysis of the Plaintiffs’ claim for unjust enrichment, including discussions about an “unclean hands” defense and whether MetCap conferred a benefit on the Defendants after the amended merger agreement. In a prior decision, the Court had determined that before the amendment to the merger agreement, MetCap’s relationship to the Beverly transaction was governed by the Advisory Agreement which would preclude an unjust enrichment claim. Vice Chancellor Noble concluded that any work done by MetCap after the amendment did not benefit the Defendants, so MetCap was not entitled to any recovery for that work.

The Defendants also argued that if MetCap had conferred a benefit upon the Defendants, it did so officiously and therefore the Defendants’ retention of the benefit was not unjust. The Court, in agreeing with the Defendants, stated that because there was no “mistake, coercion, or request” as required by the Restatement of Restitution § 112 (which Delaware has expressly adopted), any benefit which MetCap may have conferred upon the Defendants was done so officiously. As a result, the Court granted the Defendants’ motion for summary judgment on the reformation issue and the unjust enrichment claim.

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 In Winner Acceptance Corp. v. Return of Capital Corp., (Del. Ch., Dec. 23, 2008), read  44-page opinion here, the Chancery Court decided that it had equitable jurisdiction (where it raised the issue sua sponte), over whether the allegations in this case were within its limited parameters. Importantly, there was no specific allegation or request for relief that mentioned the phrase "piercing the corporate veil" but the court noted that no special talismanic words were needed to invoke its jurisdiction and that instead it looks to the essence of the claims made and the relief sought. 

The gist of the complaint was that the individual shareholders should be held personally liable for their fraudulent activities despite the conventional protection of the corporate shield.
The court described the criteria that it will apply to determine whether a claim for "piercing the corporate  veil" will be allowed to proceed, as it was in this case. See footnotes 24, 27 & 29.

 Also addressed were the following claims and issues:

• Under certain circumstances, the requirement pursuant to Chancery Rule 3(aa) that  all complaints be verified can be satisfied by the attorney as agent for the plaintiff, though in this case the original complaint was amended with the verification of the party being added shortly after the original filing;
• fraud v. equitable fraud (footnote 56);
• unjust enrichment;
• statute of limitations for the above claims; and
• Indispensable parties pursuant to Chancery Rules 19 and 12(b)(7).

UPDATE: The Wall Street Journal online today highlighted this post here.

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