This post was prepared by Frank Reynolds, who has been following Delaware corporate law, and writing about it for various legal publications, for over 30 years.
The Delaware Chancery Court recently decided OptimisCorp may be able to prove three ex-directors disloyally withheld from the struggling physical therapy company a $6.7 million award they had won in a derivative action against its former outside counsel for legal malpractice during a bitter board feud in OptimisCorp v. Atkins et al., No. 2020-0183-MTZ opinion issued (Del. Ch. July 15, 2021).
Vice Chancellor Morgan Zurn’s July 15 opinion denied the ex-directors’ motion to dismiss breach-of-duty and unjust enrichment charges because of evidence that as derivative suit plaintiffs, they put their own interests first by seeking to divide the award among their shareholder allies even when it became a company asset that Optimis badly needed.
Notably, the court likened the three directors’ duty to that of a trustee, especially when the derivative charges they brought against ex-Optimis counsel regarding his advice about the legality of their ‘ambush” ouster of CEO Alan Morelli resulted in an award to the company and all its investors. “The board may, and sometimes must, relinquish control over that asset to a stockholder representative in a derivative action,” the Vice Chancellor wrote. “Defendants’ position that they owed no duty to the company as derivative plaintiffs is inconsistent with Delaware law.”
She cautioned lawyers immersed in bitter contest-for-control litigation that “defendants’ disdain for Morelli and Sussman does not obviate their duties to them as stockholders, or to the other stockholders, or to Optimis” adding that per Delaware General Corporation Law, after the award, “the Optimis board should have regained its power under Section 141(a) to make decisions regarding the use of the benefits derived from corporate litigation.”
The three defendant directors — William Atkins, Gregory Smith and John Waite — had been in conflict with CEO and Chairman Alan Morelli since October 2012 when they purported to remove him from both positions in a surprise board meeting. The ex-Optimis counsel was drawn into the battle when the three directors charged him with malpractice for some of the legal positions he took during the many lawsuits spawned by the contest for control.
After the parties agreed to arbitrate the claims against the ex-lawyer for the company, an arbitrator found him liable to Optimis for legal malpractice and breach of duty in Sept. 2019 but despite the severe financial problems the company was experiencing at that time, the defendants did not turn the award over, the vice chancellor said. She found that it cost Optimis a total of $4 million counting loss of market share, referral sources, patients, payors, goodwill, and revenue, combined with the levy the defendants filed on Optimis operating unit’s accounts receivable funds, interfering with its business operations and Optimis’ cash flow and forcing it to borrow at a $1.4 million cost.
The defendants, who now hold positions with an Optimis competitor, turned over the full award only after the vice chancellor, in a June 19, 2020 bench ruling, found the award to be derivative and ordered them to comply, the court said.
Turning to the breach of duty and unjust enrichment charges, Vice Chancellor Zurn rejected as being “wrong under Delaware law,” defendants’ arguments that:
1. Any fiduciary role and duties they assumed as derivative plaintiffs prosecuting the arbitration was with respect to their fellow stockholders only, not to the corporation itself,
2. “[E]ven if Defendants owed fiduciary duties to Plaintiff, Delaware law does not impose upon them any obligation other than to maintain the derivative action for the benefit of the stockholders,” and therefore Plaintiff has not pled breach as a matter of law,” and
3. Delaware law does not recognize a claim for money damages for a derivative plaintiff’s breach of fiduciary duty.
In answer, the court ruled that:
1. “Defendants’ position that they owed no duty to the Company as derivative plaintiffs is inconsistent with Delaware law. Defendants owed fiduciary duties to the Company and its stockholders with respect to the corporate asset entrusted to them.”
2. “As a fiduciary, the representative plaintiff owes to those whose cause he advocates a duty of the finest loyalty… Any stockholder seeking to bring a derivative suit on behalf of the corporation has to act in the best interest of the corporation.”
3. “Optimis is not required to plead and prove damages in order to state a claim for breach of fiduciary duty, but has nonetheless done so by alleging that withholding the Award caused Optimis to take out unfavorable loans costing the Company approximately $1,500,000.”
Unjust enrichment claim may also proceed
The court said, “[b]y withholding the derivative proceeds from Optimis, Defendants unjustly enriched themselves with ill-gotten benefits to the detriment of Optimis, while also causing other direct and indirect harm to Optimis on a significant scale. Under Delaware law, “[u]njust enrichment is the unjust retention of a benefit to the loss of another, or the retention of money or property of another against the fundamental principles of justice or equity and good conscience.”