Case Financial, Inc. v. Alden, No. 1184-VCP (Del. Ch., Aug. 21, 2009), read opinion here.
Two prior decisions by the Delaware Chancery Court in this case were previously reviewed on this blog and are available here.
This Chancery Court opinion contains the findings of fact and conclusions of law based on a trial held in March 2009. The factual setting involves the sale of a company that provided financing for plaintiffs and plaintiffs’ attorneys through advances or high interest loans. The CEO of the old company remained in place at the new company for a period of time. At some point, the new company, Case Financial, formed a wholly-owned subsidiary called Case Capital. Eventually, individuals at the new company began to suspect that the CEO had committed fraud in the course of selling the old company and that he also committed various breaches of fiduciary duty after the acquisition.
The Court addressed three primary issues, only one of which was controlled by Delaware law. The main issue based on Delaware law was whether the new company had standing to assert claims in light of some of the wrongful conduct alleged to have occurred at the subsidiary level. In this 33-page opinion, the Court determined that the parent corporation did have standing to assert claims for breach of fiduciary duty against its former director for conduct he engaged in that breached the fiduciary duty owed to the parent, including any such conduct that also impacted the wholly-owned subsidiary, for which he also served as a director. The two issues controlled by California law which will not be addressed in this synopsis, dealt with the scope of a “crime exception” in a release, as well as the applicability of representations in the asset purchase agreement regarding fraud claims occurring after the closing. These are all interesting corporate litigation issues, but we will only focus on those governed by Delaware law in this case.
Piercing the Corporate Veil
One argument that was considered and rejected by the Court was that the parent and subsidiary were, in essence, alter egos of each other, and thus the unusual argument was advanced that the parent company should not be distinguished from the parent’s wholly-owned subsidiary for purposes of standing, and for purposes of allowing the parent to pursue claims against the CEO of the subsidiary. The court addressed the five customary factors to consider for an analysis of when the corporate veil can be pierced, in addition to fraud, but the Court concluded that the parent company in this case failed to carry its burden on these factors.
The Court emphasized that Delaware law takes the corporate form and corporate formalities very seriously, and will only disregard the corporate form in exceptional cases. See Sprint Nextel Corp. v. iPCS, Inc., 2008 WL 2737409, at * 11 (Del. Ch., July 14, 2008).
Direct v. Derivative Claims
The Court then addressed the question about whether the claims for fraud and breach of fiduciary duty could be pursued directly by the parent corporation against the director of its subsidiary.
The Court discussed a procedural conundrum involved in this case, and explains the reasons why a parent corporation must still follow the "normal" requirements to sue a director of a subsidiary derivatively through its status as a shareholder of a subsidiary, and on behalf of a subsidiary. See, e.g., footnote 41. The Court , however, did not find it necessary to base its decision on those procedural distinctions, because the Court concluded that the parent corporation had standing to assert a fiduciary duty claim against Alden, who was also an officer and a director of the parent corporation, in addition to being an officer and director of the wholly-owned subsidiary.
Therefore, the Court reasoned that because Alden owed fiduciary duties directly to the parent as a director and officer, a direct claim could be pursued by the parent based on the duties that Alden owed to the parent as an officer and director of the parent corporation. Nonetheless, as a director and officer of both entities, he obviously owed duties to both.
The Court reasoned that because Alden owed fiduciary duties to the parent corporation directly, the ability of the parent to pursue a suit against Alden directly would not depend on whether the entirety of the damage was sustained directly by the parent or derivatively through its wholly-owned subsidiary. Moreover, the Court demonstrated that the parent offered reasonable arguments why Alden may have violated his duties as a director of the parent by improperly misappropriating opportunities of the parent “by virtue of his actions” at the subsidiary.
Likewise, the parent alleged that it suffered a direct injury from the fraud caused by its former director which was not an injury suffered solely by virtue of the ownership stake of the parent in its subsidiary. Thus, the Court concluded that the parent corporation had direct claims against its former director for both fraud and fiduciary duty breaches, and that it was not necessary that those claims be pursued on a derivative basis at the subsidiary level. See generally Anadarko Petroleum Corp. v. Panhandle E. Corp., 545 A.2d 1171, 1174 (Del. 1988) (cited at footnote 41 for the suggestion that shareholders of the parent corporation may have standing to sue the subsidiary “double derivatively” when the directors of a wholly-owned subsidiary do not fulfill their duty to maximize shareholder value in a wholly-owned subsidiary context.)