Grunstein v. Silva, 2009 WL 4698541 (Dec. 8, 2009, Del. Ch.), read opinion here.

An associate in our Wilmington office prepared this synopsis.

The conflict in this Court of Chancery matter arose from the alleged breach of an oral partnership agreement which was formed to carry out the acquisition of a company. See id. at *1.  Compare generally, Olson v. Halverson, summarized here. (Delaware Supreme Court decision of December 2009 applying the statute of frauds to an oral LLC agreement.) Plaintiffs Grunstein and Dwyer alleged that they, together with Defendant Silva (the “Partners”), orally agreed to form a partnership for the purpose of acquiring a nursing home services company. See id.

Background

Plaintiffs alleged that they agreed to share profits and losses resulting from the acquisition and that “each partner would share in all the economic benefits received by any of them (or any entities controlled by them) resulting from the [acquisition].” See id. None of the terms, however, were ever memorialized in a written agreement signed by the parties. See id. at *2.

The Partners, initially through three business entities that were specifically created for the acquisition (“Acquiring Entities”), entered into a merger agreement with the target company. See id. Several amendments were made to the merger agreement, the third of which replaced the original Acquiring Entities with companies controlled by Defendant Silva (“Third Amendment”). See id. at *1. When the merger finally closed, the target company was owned solely by Silva’s companies. See id. at *4.

Central Focus of Claims

Plaintiffs asserted that Silva violated the partnership agreement by refusing to share the economic benefits of the acquisition with the Partners. See id. at *4. Silva maintained that no such partnership agreement existed and therefore he was not obligated to share distribution of the acquisition proceeds. See id. at *1.

Issues Addressed

The Plaintiffs asserted nine claims against Defendants. Defendants, in a motion to dismiss, challenged six of the causes of action including: breach of contract, breach of fiduciary duty, promissory estoppel, fraud, negligent misrepresentation, and tortious interference with contractual relations and business advantage. See id. at *5.

The following is a brief recap of the Court’s findings regarding Defendants’ motion to dismiss.

(a) Fiduciary duty: The Court dismissed the breach of fiduciary duty claims because Delaware law generally prohibits plaintiffs from asserting both a breach of contract and a breach of fiduciary duty claim under the same facts. See id. at *6. Plaintiffs argued that the claims should survive the motion to dismiss because they fell within the exception which allows assertion of fiduciary duty claims where “they depend on additional facts . . . are broader in scope, and involve different considerations in terms of a potential remedy.” See id. (quoting Schuss v. Pennfield Partners, L.P., 2008 WL 2433842 (Del Ch. 2008)). Rejecting Plaintiffs’ position, the Court held that the fiduciary duty claims were duplicative of the breach of contract claim because the establishment of any fiduciary relationship among the Partners was created by the partnership agreement which was also the source of the breach of contract claim.

(b) Promissory estoppel: The Court denied Defendants’ motion to dismiss the promissory estoppel claims. First, the Court held that the Third Amendment to the merger agreement, which assigned the rights of the original Acquiring Entities to the Silva-controlled companies, did not preclude a claim for promissory estoppel. See id. at *8. The Court acknowledged that the existence of a valid contract between the parties may, in some instances, preclude promissory estoppel claims. In this case, the Court found that the Third Amendment did not bar promissory estoppel because it did not directly involve the parties, nor did it relate to the agreement at issue in the pending litigation. See id. Second, the Court held that Plaintiffs’ failure to plead lack of consideration was not fatal to their claim for promissory estoppel. See id. at *10. Although recognizing that promissory estoppel historically functioned as a consideration substitute, the Court instead focused on the Delaware courts unwillingness to “apply strict contractual interpretation on what is, at base, an equitable remedy.” See id.

Finally, the Court held that Plaintiffs adequately pleaded reasonable reliance. See id. at *11. Invoking New York law, Defendants argued that, as a matter of law, Plaintiffs cannot reasonably rely on oral promises that directly conflict the terms of a written agreement, in this case the Third Amendment to the merger agreement. See id. at *10. Examining the case law, the Court found reliance was not precluded as a matter of law in this instance because the rule only applies where the oral promises flatly contradict the contractual terms. See id. The Court also held that the sophistication of the parties does not necessarily preclude reasonable reliance on oral promises where the parties had a pre-existing working relationship and repeatedly affirmed their business relationship. See id. at 12.

(c) Fraud: Defendants argued that Plaintiffs were improperly bootstrapping a fraud claim to a breach of contract claim by asserting that Defendants never intended to honor their agreement. See id. The Court found that Plaintiffs’ complaint adequately established “an intentionally false representation on which the Plaintiffs relied to their detriment” and denied Defendants’ motion to dismiss. See id. at *13. The Court noted, however, that in order to prevail on this issue Plaintiffs would have to rebut facts that contradict their theory that Silva intended to breach their partnership agreement from its inception. See id.

(d) Negligent Misrepresentation: The court dismissed the negligent misrepresentation claim based upon Defendants’ repudiation of the partnership agreement because “the promise to honor an agreement is only a misrepresentation if the promisor knows at the time of the promise that he will ultimately breach; such a misrepresentation cannot occur unknowingly or negligently.” See id. at *14.

(e) Breach of Contract: Asserting the statute of frauds, Defendants moved to dismiss the breach of contract claims regarding an underwriting contract related to the partnership’s acquisition of the nursing home company. See id. at *15. The Court held that the Plaintiffs’ obligations under the contract, which was for underwriting services with option to lend funding, fell outside Delaware’s statute of frauds. Denying the motion to dismiss, the Court refused to consider whether statute of fraud deficiencies could be cured by part performance or existence of a related writing. See id.

(f) Tortious Interference: The Court dismissed the claim for tortious interference because the non-Silva Defendants (Silva-controlled entities) were protected by the affiliate privilege. See id. at *17. Delaware law recognizes that a party to a contract cannot tortiuously interfere with that same contract. This “interference privilege” protects affiliates or entities under the control of that party as well. See id. at *16. Even nonparties to a contract may be protected so long as they “share a commonality of economic interests with one of the parties and act in furtherance of their share legitimate business interests.” See id. at *16 (quoting Sherin v. E.F. Hutton Group, Inc., 652 A.2d 578, 591 n14 (Del. Ch. 1994) (internal quotes omitted). Accordingly, the Court found that certain non-Silva Defendants were agents of Silva with regard to the partnership agreement and therefore fell within the scope of the interference privilege. See id. at *17.

(g) Claims against non-Silva Defendants: Defendants moved to dismiss all counts against non-Silva Defendants arguing inter alia that companies creates after the alleged partnership agreement cannot be bound by that agreement. See id. at *18. The Court recognized, however, under Delaware law a subsequently-formed entity may be subject to a pre-formation agreement by accepting the benefits of the agreement with knowledge of its terms. See id. (citations omitted). Further, corporations may be found to have imputed knowledge and to have implicitly adopted its agents contract where the agent is for all intents and purposes the alter ego of the corporation. See id. (citation omitted). The Court found that the complaint sufficiently alleged that Defendant business entities had knowledge of the partnership agreement, through Silva, and reaped the benefits of that agreement; and therefore was bound by the agreement. The motion to dismiss was denied. See id.