In a recent ruling destined to be referred to often, the Delaware Court of Chancery provided the analysis used, in the context of a closely-held company, to determine an award of attorneys’ fees in representative corporate litigation. It is most notable for its discussion of the infrequently discussed concept of the “transitive property of entity litigation.” In the end, in Baker v. Sadiq, C.A. No. 9464-VCL (Del. Ch. Aug. 16, 2016), the court awarded typical fees based on the payment of settlement proceeds directly to the minority stockholder. Also included is a useful recitation of the typical range of fees awarded by the court based on a sliding scale percentage of settlement funds created.
The court explained that the transitive property of entity litigation recognizes that a derivative action that asserts claims for breaches of fiduciary duty and an investor class action that asserts similar theories may be conceptually distinct and doctrinally separate, but can be functionally equivalent and, therefore, substitutes.
The court described the concept of transitive property in mathematics as providing that if A = B, and B = C, then A = C. In the world of entity litigation, the transitive property recognizes that an entity-level recovery can be the equivalent of an investor-level recovery and vice versa. This concept calls to mind a comparison with the syllogistic logic or Aristotelian logic exemplified by the following syllogism:
Major premise: All humans are mortal.
Minor premise: All Greeks are humans.
Conclusion: All Greeks are mortal.
The court gave the following example of the transitive property concept: Consider a minority investor suing derivatively on behalf of the entity. If the plaintiff prevails entirely the typical remedy would provide a monetary recovery payable to the entity. The entity-level of monetary recovery benefits all the investors indirectly, including the controller who was found liable for breaches of fiduciary duty. The indirect benefit to the minority investor is equal to her percentage interest in the entity multiplied by the amount of the entity-level recovery.
In light of this reality, the controller could make the minority investors whole through a direct cash payment equal to their proportionate share of the entity-level recovery. This, of course, would typically apply in the context of a closely-held company with a small number of stockholders.
The court provided several examples of transcript rulings in which the Delaware Court of Chancery employed the transitive property concept to settle derivative actions using investor-level relief.
The court also discussed the legal principles and the public policy basis involved. The benefits of using the transitive property to settle derivative litigation with an investor-level recovery provides an advantage to the plaintiff who gets actual cash rather an indirect benefit. It also benefits the defendant who pays a much lower net settlement amount.
The court referred to the endowment effect in which humans value items that they own or control more highly than items of equal value that they do not own or control.
Direct recovery also incentivizes investors who are not enthusiastic about providing an entity-level recovery to fiduciaries who have a history of defalcation and who present the risk of repeated bad behavior.
Basis for Attorneys’ Fees
The downside for plaintiffs’ lawyers in this situation is that the award of attorneys’ fees for representative litigation is usually based on the total fund created for the settlement. In this context, a direct payment to a minority investor is of course much lower than would be the case in the typical entity-level settlement.
Although counsel for plaintiffs in this case sought a recovery based on a hypothetical entity-level recovery of $25 million on which they based their request for $6 million in attorneys’ fees, the court could find no legal basis for applying a percentage to anything other than the $3.2 million direct benefit to the minority stockholder.
Percentage of Fees Based on Settlement Amount and Stage of Case
The court observed that the customary percentages for fee awards are 10% to 15% of the monetary benefit conferred if a “case settles early.” If a case settles after the plaintiffs have “engaged in meaningful litigation efforts, typically including multiple depositions and some level of motion practice,” fees awards in the Court of Chancery range from 15% to 20% of the monetary benefits conferred. Higher percentages up to 33% at the top range are warranted when cases progress to a post-trial adjudication.
In this case, the court awarded 20% of $3.25 million or $650,000. The court found that this was not excessive based on the amount of $390,000 which the plaintiffs would have billed if this were done on an hourly basis. Especially when compared to the billings by defense counsel of over $2 million, the court found the fee award to be on the low end of the scale, but the most appropriate amount based on the facts of this case.
There are many other gems of legal analysis and public policy reasoning to commend the reader to carefully examine the entire court decision in this matter, which should be required reading for anyone interested in the latest iteration of Delaware law on this topic.