In Corporate Property Associates 14 Inc. v. CHR Holding Corp., 2008 WL 963048 (Del.Ch., April 10, 2008), read opinion here, the court denied a Motion to Dismiss fraud and negligent misrepresentation claims against a company for disclosing misleadingly incomplete information to warrantholders that discouraged them from exercising their warrants just prior to a transaction that devalued them–even though the court held that they were not owed fiduciary duties.

The purpose of this blog is to summarize key decision from Delaware courts on corporate and commercial topics. Not infrequently the use of the English language in the courts’ opinions is so exemplary that it bears quoting verbatim instead of trying to summarize it, in order to get the full flavor. This is such opinion. It may be on the longer side as far as overviews go, but stick with it because it is worth the wait. The court introduces its opinion with a sketch of the factual and legal issues as well as its holding–with a memorable adage along the way.

The maxim silence is golden is not simply a goad to good manners at the local movie theater, it is good advice in many realms of life. For example, those are truly words of wisdom when you are not under a duty to speak and someone asks you a question that
potentially touches upon information that you would rather not divulge. Here, plaintiffs Corporate Property Associates 14 and Corporate Property Associates 15 (collectively “Corporate Property Associates”) held warrants in defendant CHR Holding Corporation, a wholly owned subsidiary of defendant “Platinum.” FN1  Those warrants did not require CHR to give Corporate Property Associates advance notice of cash dividends and did not protect the value of the warrants from being diluted through the payment of cash dividends. As such, CHR and Platinum had both the ability and the incentive to reduce the value of Corporate Property Associates’ warrants by issuing large cash dividends from CHR to Platinum. In 2006 and 2007, CHR recapitalized by undertaking two large debt issuances and using the proceeds of those debt issuances to pay two large cash dividends.

The court summarized its holding on the various issues as follows:

Corporate Property Associates asserts that CHR, Platinum, Kotzubei, and Eva M. Kalawski, CHR’s sole director, breached their fiduciary duties to Corporate Property Associates by not providing advance disclosure of the cash dividends. I dismiss those claims because warrantholders are not owed fiduciary duties. Likewise, I dismiss the claim that CHR breached its implied obligation of good faith and fair dealing in the warrants. It would be an error to imply an advance notice of cash dividends term in the warrant contracts because the sophisticated parties who negotiated those contracts included terms addressing similar issues and chose not to include a term addressing advance notice of cash dividends. On the other hand, I do not dismiss Corporate Property Associates’ fraud and negligent misrepresentation claims against CHR and Platinum to the extent those claims relate to the second dividend. At the motion to dismiss stage, viewing the facts alleged in the complaint in the light most favorable to Corporate Property Associates, CHR’s response to Corporate Property Associates’ question about “any significant changes/developments” was misleadingly incomplete. I do, however, dismiss the fraud and negligent misrepresentation claims against Kotzubei because I have dismissed the fiduciary duty claim and therefore this court cannot exercise personal jurisdiction over Kotzubei under Delaware’s director and officer consent statute, 10 Del. C. § 3114. (emphasis added).

For a helpful discussion of the implied duty of good faith and fair dealing, see page 6 of the Westlaw format of the opinion.

For a thorough analysis of the court’s finding of  "fraud by silence in the face of a duty to speak", see page 8 of the Westlaw format and the related bountiful footnotes.

Negligent misrepresentation (also known as equitable fraud or innocent misprepresentation) was addressed in detail starting at page 9, including the necessary elements to establish a claim, such as the first requirement that  "defendant had a pecuniary duty to provide accurate information…" That requirement limits the reach of the cause of action to "situations where the defendant makes a ‘representation in the course of a business or a transaction in which the defendant has a pecuniary interest.’" (copious citations in footnotes omitted, in which, inter alia,  recent Chancery Court opinions in H-M Wexford v. Encorp and Vague v. Bank One are distinguished to the extent they refer to the pecuniary interest requirement in dicta).

Finally, an essential insight into Section 3114 of Title 10 of the Delaware Code, regarding the imposition of Delaware jurisdiction over officers and directors of Delaware corporations, is discussed at page 14.  Section 3114 has been interpreted over the last 25 years by Delaware courts, to be limited to imposing jurisdiction only for claims involving violations of the DGCL; corporate charter or bylaws; and breaches of fiduciary duties owed to the company or to stockholders  (regardless of whether the statute potentially can be read to mean something else.) Thus,  because the only remaining claims were for fraud and negligent misrepresentation, Section 3114 could not be used to impose personal jurisdiction over the officer.