This post was prepared by Chauna A. Abner, an associate in the Delaware office of Lewis Brisbois.
Invoking the principles articulated in USA Cafes, the Court of Chancery recently held that a controller cannot use its control over an entity to advantage himself at the expense of the controlled entity. 77 Charters, Inc. v. Gould, C.A. No. 2019-0127-JRS (Del. Ch. May 18, 2020).
The plaintiff in this case was an investor with a non-preferred ownership in a mall. Defendant, Jonathan D. Gould also invested in the mall and held a similar non-preferred interest. A non-party, Kimco, possessed preferred interests in the mall. Unbeknownst to 77 Charters, Gould acquired Kimco’s interest. Gould then amended the operating entity’s governing documents to advantage the mall’s preferred investors (i.e., himself) before selling part of Kimco’s interests to a third party for the same price he paid for the whole interest. Gould retained “a slice of the preferred stake for himself.” Id. at *2.
77 Charters filed suit against Gould alleging a multitude of claims, including a claim that Gould breached his fiduciary duties by acquiring Kimco’s interest, amending the operating agreement of the controlling entity and then selling the mall at a time and in such a manner where he derived a personal benefit while 77 Charters was left with nothing. Id. at *3.
In a 65-page opinion granting in part and denying in part the defendants’ motion to dismiss, the Court held that “[w]hile the scope of USA Cafes-type liability is limited, ‘it surely entails the duty not to use control over [an entity] to advantage the [controller] at the expense of’ the controlled-entity” and the plaintiff well pled such a circumstance. Id. at *40 (internal citations omitted).
In USA Cafes, L.P. Litigation, 6 A.2d 43 (Del. Ch. 1991), highlighted in many other decisions summarized on these pages, Chancellor Allen held that “remote ‘controllers’ of an alternative entity may owe limited fiduciary duties, the ‘full scope’ of which the court did not ‘delineate.’” 77 Charters, Inc., C.A. No. 2019-0127-JRS, at **3-4 (citing USA Cafes, 6 A.2d at 49).
In 77 Charters, Inc., the plaintiff plead that Gould, the LLC’s ultimate controller: “(i) acquired the Preferred Interest, (ii) executed the Amended CRA to increase the Preferred Interest’s economic value at 77 Charters’ expense and (iii) sold a slice of the augmented Preferred Interest to Eightfold while retaining a piece for himself.” Id. at ** 40-41.
The Court held that Gould, as the LLC’s ultimate controller, conceivably owed “USA Cafes-type” fiduciary duties and that Gould conceivably breached those duties by amending an agreement that governed the LLC’s operating company to enrich himself. Id. The Court found the plaintiff’s allegations to be well-plead and thus denied the defendants’ motion to dismiss with respect to this count. Id.
In addition to a host of other claims, the Court also analyzed 77 Charters’ aiding and abetting and civil conspiracy claims against Eightfold, an entity that was unaffiliated with the other defendants. Id. at **57-62. In doing so, the Court recited the four basic elements of a claim for aiding and abetting breach of fiduciary duty: “(1) the existence of a fiduciary relationship, (2) a breach of fiduciary duty, (3) defendant’s knowing participation in that breach and (4) damages proximately caused by the breach.”Id. at *57.
After finding that 77 Charters failed to satisfy these elements, the Court dismissed this count of the complaint and turned to 77 Charters’ civil conspiracy claim. The Court held that the conspiracy claim, “as pled, [was] functionally the same as 77 Charters’ aiding and abetting claim.” Id. at *60. After recognizing the “functional identity” of the two claims,” id. at *60, n. 242, the Court iterated “[t]he elements for civil conspiracy under Delaware law . . . (1) a confederation or combination of two or more person[s]; (2) an unlawful act done in furtherance of the conspiracy; and (3) actual damage.” Id. at **60-61. The Court then also dismissed this count of the complaint.
Although the decision provides a lengthy analysis on several principles of Delaware corporate law, I highlight the following key takeaway: a controller cannot use its control over an entity to advantage himself at the expense of the controlled entity by, for example, amending an agreement to waive the duty of care. See id. at *40, n. 162. This implicates the fiduciary duty of loyalty and its variant, usurpation of corporate opportunity.