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.
Vice Chancellor Joseph Slights recently ruled that Zhongpin Inc. shareholders have no standing to sue the food processors’ D&O insurer directly to collect a $41.3 million default judgement they won in their underlying Chancery Court challenge to Zhongpin’s allegedly unfairly-priced buyout in Rodriguez, et al. v. Great American Insurance Co., No. N21C-11—051-JRS opinion (Del. Super. Feb. 23, 2022).
In a February 23 opinion, the Vice Chancellor granted the Great American Insurance Company’s motion to dismiss the shareholder plaintiffs’ suit from the Delaware Superior Court, where he had transferred the D&O insurance dispute from the Chancery Court to assure proper jurisdiction on a question of law. He also decided the case when it arrived in the Delaware Superior Court after being specially appointed as a Superior Court Judge for this case only. He found that the shareholders lacked standing to sue under either common law or the terms of the D&O policy, noting that:
Under common law an injured third party may not bring a direct claim against a tortfeasor’s insurer unless there is an express assignment
Under the policy’s “No Action Clause” the insured Zhongpin’s controller and directors and officers failed to defend the underlying Chancery Court suit and have no basis to invoke subrogation, so coverage could not be available under any circumstances.
Considering the number of Delaware companies with parent corporations whose controllers, officers, directors and assets are in China, the decision is important because it appears to close the only door to recovery by shareholders who have won judgments in stock deals by allegedly faithless fiduciaries who have abandoned the litigation and fled to a nation that has a record of making it difficult to locate or serve defendants.
The litigation sprang from a 2012 squeeze-out of Zhongpin investors by Xianfu Zhu, the company’s de facto controlling stockholder. Zhu caused Zhongpin to enter a transaction with two of his wholly owned entities whereby the minority stockholders of Zhongpin were cashed out for inadequate consideration. That transaction prompted breach-of-duty claims against the Class Action Defendants that resulted in a default judgment after Zhu and his directors and officers stopped paying their defense firm, failed to hire a replacement, stopped defending the action and “disappeared” in China, the court said.
The insurance action
Following the default judgment, the plaintiff shareholders tried to collect from the D&O insurer on behalf of the company because it came in a derivative action and because Zhu, the directors and officers and company and its assets were in China and allegedly could not be located, let alone reached.
Vice Chancellor Slights decided that “this is fundamentally a breach of contract action for money damages, which is the traditional province of the Superior Court.” Transfer to Superior Court will not involve delay while another judge is forced to become familiar with a complex case, he said, because the insurance action is separate and new, and plays to the experience and strength of the Superior Court. Rodriguez, et al. v. Great American Insurance Co., No. 2020-0387-JRS letter opinion issued (Del. Ch. Oct. 20, 2021). (Notably, the Vice Chancellor, in the past, spent many years as a Superior Court Judge before being appointed to the Court of Chancery.)
The Superior Court opinion
In his February 23 Superior Court opinion on a renewed motion to dismiss, the Vice Chancellor noted that as of that date, plaintiffs have been unable to locate—much less execute the default judgment on any defendants “presumably because they all reside in China.”
He said in cases such as this the issue of standing is so closely related to the merits, a motion to dismiss is considered under Rule 12(b)(6) rather than Rule 12(b)(1). The Vice Chancellor noted three theories of standing where the third party:
- Has received a valid assignment of the claim from the inured,
- Is an intended third-party beneficiary of the insurance contract, or
- Qualifies for subrogation
There is no valid assignment of standing, he said.
As to third-party beneficiary standing, the Vice Chancellor ruled that “If the third party either accidentally or indirectly benefits from the promise, then the third party is deemed as incidental beneficiary and has no right to enforce the contract” and the Zhongpin insureds certainly never intended coverage to benefit the stockholder claimants.
As to subrogation standing, he said neither statutory nor equitable subrogation is available.
Finally, the fact that the Zhongpin insureds “failed to pay their lawyers…and then disappeared,” and when notified of plaintiffs’ intent to seek a default judgment in the underlying merger challenge, “they sat silent and, by their silence, acknowledged liability,” the court said.
“The insureds disappeared, leaving GAIC to hold the bag…a material breach of the of the GAIC policy,” the Vice Chancellor said in dismissing the coverage action.