Envo, Inc. v. Walters, No. 4156-VCP (Del. Ch., Dec. 30, 2009), read opinion here.
The Delaware Court of Chancery began this opinion by describing it as a case that “resembles a corporate version of a shell game.” The plaintiff alleged six causes of action against various combinations of the parties stemming from an Asset Purchase Agreement (“APA”) entered into in 2005 by the predecessor of Envo, called Environmental Solutions Group Inc. (“Old Environment”) and ESG, Inc. (“ESG”), a non-party. One of the defendants was a similarly named entity called E S G, Inc. (The nuanced difference in the name between these two entities is the space between the initials of the name.) Although the parties closed on the APA in 2005, Envo has yet to receive any payments for the assets it sold.
This case is before the Court of Chancery on a motion to dismiss the claim for reformation, as well as arguments based on laches and lack of subject matter jurisdiction.
Summary of Holding
This Court found that Envo did not state a claim for reformation but that Envo did demonstrate sufficient justification for a remedy that only equity can afford, and on the basis of that conclusion, as well as the “clean-up doctrine,” the Court determined that it had subject matter jurisdiction over this litigation.
The APA called for Old Environment and Envo, as its successor, to receive $300,000. Although the parties closed in 2005, as of the filing of the amended complaint, defendants have still not paid a single dollar towards the $300,000 purchase price specified in the APA. The first count sounds in fraud and alleges that defendants Walters and Aylor falsely represented that they owned ESG and that ESG would pay Envo the $300,000 purchase price called for in the APA knowing that they did not own ESG and lacked the authority to bind ESG to purchase the assets of Envo. Envo further alleges that Walters and Aylor intended for Envo’s representatives to rely on their representations and that Envo’s representatives reasonably did so rely.
Envo also alleges that because Walters and Aylor signed the Promissory Notes providing the consideration for the purchase of Envo’s assets on behalf of a corporation that was not in good standing and took possession of those assets, a contract for the purchase price should be implied between Walters and Aylor on one side, and Envo on the other.
The amended complaint also includes theories of quasi-contract, unjust enrichment and promissory estoppel based on allegations that Walters and Aylor took possession of and currently operate an environmental consulting business formerly run by Envo and that some or all of Envo’s assets have been transferred but Walters and Aylor have not paid anything for the environmental consulting business. Envo also seeks a constructive trust on the assets sold through the APA and the profits generated by these assets as a remedy for this claim.
The Court addressed the issue of subject matter jurisdiction under Rule 12(b)(1). The Court recited the truism that the Court of Chancery is a court of limited jurisdiction and can acquire subject matter jurisdiction over a case in three ways:
(1) the invocation of an equitable right; (2) a request for an equitable remedy when there is no adequate remedy at law; or (3) a statutory delegation of subject matter jurisdiction. See footnotes 10 to 13 for supporting authority.
The Court performs its analysis based on the substance of the complaint, therefore, if a legal remedy capable of affording to the plaintiff full, fair and complete relief is available, the Court will not accept jurisdiction even if some type of traditional equitable relief has been presented as a “kind of formulaic ‘open sesame’ to the Court of Chancery.”
Because the motion to dismiss for failure to state a claim of reformation is intertwined with the motion to dismiss for lack of subject matter jurisdiction, the Court addressed the reformation claim first.
The reformation claim was based on allegations of mutual mistake and as a result Envo bears the additional pleading burden under Rule 9(b), which requires the averments of fraud or mistake to be stated with particularity. The elements that must be satisfied for a successful complaint alleging reformation on grounds of mutual mistake include the following:
(1) the terms of an oral agreement between the parties; (2) the execution of a written agreement that was intended, but failed, to incorporate those terms; (3) the parties’ mutual – – but mistaken – – belief that the writing reflected their true agreement; and (4) the precise mistake.
The Court determined that Envo failed to meet at least the first two of the four elements and thus has not met Rule 9(b)’s requirement stating the circumstances constituting the alleged mistake with particularity.
The claims for equitable fraud or negligent misrepresentation were explained to differ from common law fraud in that the claimant need not show that the respondent acted knowingly or recklessly – – innocent or negligent misrepresentations or omissions suffice. See footnote 26.
However, the primary “policy trade-off” for the reduction in the state of mind required to recover for negligent misrepresentation is that the law “pares down the class of potentially liable defendants.” That is, in order for equitable fraud or negligent misrepresentation claims to prevail, there must be one of the following circumstances: (1) a special relationship between the parties over which equity takes jurisdiction, such as a fiduciary relationship; or (2) justification for a remedy that only equity can afford.
The constructive trust remedy was defined as one imposed by a Court of equity “as a remedy to correct the unlawful vesting, or assertion of, legal title,” and may be imposed “upon specific property or identifiable proceeds of specific property, and even money so long as it resides in an identifiable fund to which the plaintiff can trace equitable ownership,” but for purposes of conferring equity jurisdiction on the Court of Chancery, the request for a constructive trust will prevail “only if the plaintiff can show that full and fair relief requires a restoration of title to specific property or identifiable proceeds of specific property.” See footnotes 30 to 32.
The Court compared the damages available based on a common law claim of fraud, compared with the damages available on a negligent misrepresentation or equitable fraud claim. Citing to the Restatement (Second) of Torts, Section 549 (1977), the Court observed that damages for fraud include the benefits of the contract. By contrast, however, damages for negligent misrepresentation do not include the benefit of the plaintiff’s contract with the defendant. (citing Restatement (Second) of Torts, Section 552(B)(1977)).
The Court reiterated the truism that punitive damages are beyond the authority of the Court of Chancery to award, even under the ”clean-up doctrine.” See footnote 38. The Court also noted that there may be some limited situations not applicable here where the Court of Chancery may have authority to award exemplary or punitive damages by statute (citing as an example 6 Del. C. Section 2003(b)).
The Court also discussed the defense of laches in the context of a six-year statute of limitations when a cause of action arises from a promissory note. For such a claim there is a six-year timetable pursuant to Section 8109 of Title 10 of the Delaware Code. The doctrine of laches authorizes the Court of Chancery to permit a claim to proceed beyond the statute of limitations but it also permits the Court to hold a plaintiff to a shorter period if, based on equity, “the plaintiff should have acted with greater alacrity, and when the plaintiff’s failure to seek equitable relief with alacrity threatens prejudice to the other party.” See footnotes 46 and 47.
The Court also discussed the doctrine of fraudulent concealment which allows for a statute of limitations to be tolled when: “there was an affirmative act of concealment or some misrepresentation that was intended to put a plaintiff off the trail of inquiry, until such time as the plaintiff is put on inquiry notice.” See footnote 50.
The Court reasoned that the statute of limitations was tolled for at least two months which would mean that the timing of the complaint’s filing did not run afoul of the statute of limitations and there were no circumstances warranting a requirement that Envo should have acted with greater alacrity. Thus the motion to dismiss on the basis of laches was denied. In sum, other than the reformation claim, the motion to dismiss under Rules 12(b)(1) and 12(b)(6) for lack of subject matter jurisdiction and failure to state a claim, respectively, was denied.