Delaware case law is well-established regarding the aspect of the fiduciary duty of loyalty that prohibits a corporate director from usurping a corporate opportunity. A recent decision from the Delaware Court of Chancery applies that well-settled prohibition in a flexible manner to a set of facts that have apparently not been squarely addressed in prior precedent. In Personal Touch Holding Corp. v. Glaubach, C.A. No. 11199-CB (Del. Ch. Feb. 25, 2019), the court awarded damages for the breach of this subset of fiduciary duty, as well as for other breaches of fiduciary duty.
Basic Background Facts:
This case involved a co-founder who also served as a president and director of a New York-based provider of healthcare services. He was removed when the company discovered various transgressions. The former director purchased an office building in his individual capacity–secretly–even though the court found that the former director had been aware that the company was interested for several years in purchasing a similar building for its own use. The former director then offered to lease the building back to the company at what the court found to be above-market rental rates.
Key Principles of Law:
This short blog post assumes that readers are familiar with the basic principles involved with the usurpation of corporate opportunities, and will merely highlight some of the key statements of law and the court’s reasoning in this 84-page opinion.
The well-known elements of a claim based on the corporate opportunity doctrine have been stated frequently in prior Delaware cases. Those familiar with corporate litigation will recognize the following four elements of a claim for usurpation of corporate opportunity:
“(1) The corporation is financially able to exploit the opportunity;
(2) The opportunity is within the corporation’s line of business;
(3) The corporation has an interest or expectancy in the opportunity;
(4) By taking the opportunity for his own, the corporate fiduciary will thereby be placed in a position inimicable to his duties to the corporation.”
Slip op. at 36-38.
The court explained that Delaware Supreme Court decisions have referred to some of these elements in the disjunctive even though they are often quoted as being conjunctive. Specifically, proof of either the third element or the fourth element would sustain a corporate opportunity claim.
Moreover, the court decides the viability of a corporate opportunity claim by weighing the four factors in a holistic fashion and no one factor is dispositive. Id.
Key Reasoning of the Court:
- The court rejected the argument that the purchase of the office building was not in the line of business of the healthcare company involved, which historically leased office space, because the “line of business factor” was in either inapplicable or was satisfied because the company had a clear “interest and expectancy” in the opportunity. In addition to that factor having a flexible meaning, the court explained that latitude should be allowed for development and expansion of a business, and the Delaware courts have broadly interpreted the nature of the corporation’s business when determining whether a corporation had an interest in a opportunity.
- Regardless, the court found that the line of business test was not relevant where, as here, the company had a clear interest and expectancy in acquiring the building, and the opportunity presented related to an operational decision about how to expand the business as opposed to an opportunity to acquire a new business.
- The court further reasoned that even if the opportunity was not within the existing line of business, it was sufficient that the company had a “clear interest and expectancy” at the time the opportunity arose. Id. at 44-47.
- Regarding the fourth factor, the court instructed that a corporate officer or director was prohibited from taking an opportunity for his own “if the corporate fiduciary will thereby be placed in a position inimicable to his duties to the corporation.”
- The court elaborated by observing that the corporate opportunity doctrine is implicated where the fiduciary’s seizure of an opportunity results in a conflict between the fiduciary’s duties to the corporation and the self-interest of the director as actualized by the exploitation of the opportunity.” Id. at 47-49.
- The court also rejected an argument that the employment agreement of the former director allowed him to pursue other business interests outside of the company, and to devote a material portion of his time to other business interests. The court found that contractual defense to be unavailing in part because that provision did not allow the defendant to compete with the company for opportunities in which the company had an interest or expectancy. In addition, the employment agreement also prohibited the former director and president from engaging in activities which were “competitive with” the business of the company.
- The court applied the entire fairness test because the former director was on both sides of the transaction involving a lease of the building to the company, and also because the director received a personal benefit from the transaction that was not received by the shareholders generally. Id. at 53.
- The court also explained that charging the company an above-market rate for rent was unfair self-dealing and a breach of the duty of loyalty–regardless of whether the former director acted in subjective good faith.
As a side note, the court also found a separate breach of fiduciary duty as a result of the former director engaging in a “letter-writing campaign” over a several month period in which the former director sent harassing and disturbing anonymous letters to board members, employees and the lender of the company which caused harm to the company by hurting morale and causing distraction–in addition to attempting to sabotage the company’s relationship with its primary lender. Slip op. at 76-83.