Case Financial, Inc. v. Alden, No. 1184-VCP (Del. Ch., Aug. 21, 2009),  read opinion here.

Two prior decisions by the Delaware Chancery Court in this case were previously reviewed on this blog and are available here.

Background

This Chancery Court opinion contains the findings of fact and conclusions of law based on a trial held in March 2009. The factual setting involves the sale of a company that provided financing for plaintiffs and plaintiffs’ attorneys through advances or high interest loans. The CEO of the old company remained in place at the new company for a period of time. At some point, the new company, Case Financial, formed a wholly-owned subsidiary called Case Capital. Eventually, individuals at the new company began to suspect that the CEO had committed fraud in the course of selling the old company and that he also committed various breaches of fiduciary duty after the acquisition.

Main Issues

The Court addressed three primary issues, only one of which was controlled by Delaware law. The main issue based on Delaware law was whether the new company had standing to assert claims in light of some of the wrongful conduct alleged to have occurred at the subsidiary level. In this 33-page opinion, the Court determined that the parent corporation did have standing to assert claims for breach of fiduciary duty against its former director for conduct he engaged in that breached the fiduciary duty owed to the parent, including any such conduct that also impacted the wholly-owned subsidiary, for which he also served as a director. The two issues controlled by California law which will not be addressed in this synopsis, dealt with the scope of a “crime exception” in a release, as well as the applicability of representations in the asset purchase agreement regarding fraud claims occurring after the closing. These are all interesting corporate litigation issues, but we will only focus on those governed by Delaware law in this case.

Piercing the Corporate Veil

One argument that was considered and rejected by the Court was that the parent and subsidiary were, in essence, alter egos of each other, and thus the unusual argument was advanced that the parent company should not be distinguished from the parent’s wholly-owned subsidiary for purposes of standing, and for purposes of allowing the parent to pursue claims against the CEO of the subsidiary. The court addressed the five customary factors to consider for an analysis of when the corporate veil can be pierced, in addition to fraud,  but the  Court concluded that the parent company in this case failed to carry its burden on these factors.

The Court emphasized that Delaware law takes the corporate form and corporate formalities very seriously, and will only disregard the corporate form in exceptional cases. See Sprint Nextel Corp. v. iPCS, Inc., 2008 WL 2737409, at * 11 (Del. Ch., July 14, 2008).

Direct  v. Derivative Claims

The Court then addressed the question about whether the claims for fraud and breach of fiduciary duty could be pursued directly by the parent corporation against the director of its subsidiary.
The Court discussed a procedural conundrum involved in this case, and explains the reasons why a parent corporation must still follow the "normal" requirements to sue a director of a subsidiary derivatively through its status as a shareholder of a subsidiary, and on behalf of a subsidiary. See, e.g., footnote 41. The Court , however, did not find it necessary to base its decision on those procedural distinctions, because the Court concluded that the parent corporation had standing to assert a fiduciary duty claim against Alden, who was also an officer and a director of the parent corporation, in addition to being an officer and director of the wholly-owned subsidiary.

Therefore, the Court reasoned that because Alden owed fiduciary duties directly to the parent as a director and officer, a direct claim could be pursued by the parent based on the duties that Alden owed to the parent as an officer and director of the parent corporation.  Nonetheless, as a director and officer of both entities, he obviously owed duties to both.

The Court reasoned that because Alden owed fiduciary duties to the parent corporation directly, the ability of the parent to pursue a suit against Alden directly would not depend on whether the entirety of the damage was sustained directly by the parent or derivatively through its wholly-owned subsidiary. Moreover, the Court demonstrated that the parent offered reasonable arguments why Alden may have violated his duties as a director of the parent by improperly misappropriating opportunities of the parent “by virtue of his actions” at the subsidiary.

Likewise, the parent alleged that it suffered a direct injury from the fraud caused by its former director which was not an injury suffered solely by virtue of the ownership stake of the parent in its subsidiary. Thus, the Court concluded that the parent corporation had direct claims against its former director for both fraud and fiduciary duty  breaches, and that it was not necessary that those claims be pursued on a derivative basis at the subsidiary level.  See generally  Anadarko Petroleum Corp. v. Panhandle E. Corp., 545 A.2d 1171, 1174 (Del. 1988) (cited at footnote 41 for the suggestion that shareholders of the parent corporation may have standing to sue the subsidiary “double derivatively” when the directors of a wholly-owned subsidiary do not fulfill their duty to maximize shareholder value in a wholly-owned subsidiary context.)
 

In Ruggiero v. FuturaGene, plc, et al., (Del. Ch., Feb. 1, 2008), read opinion here, the Chancery Court refused to exercise personal jurisdiction over the directors of a British corporation despite a merger agreement  which granted exclusive jurisdiction to Delaware courts over any issues arising out of the merger. The court acknowledged that because the plaintiff has the evidentiary burden to establish jurisdiction and is not limited in a Rule 12(b)(2) motion to the pleadings, discovery on the jurisdictional issue will be allowed absent a frivolous claim.  However, the court determined here that the claim for personal jurisdiction was frivolous (the court’s word), and thus, denied discovery. The familiar two-step approach to the analysis of personal jurisdiction was recited. First, one examines the Delaware long-arm statute, and then after establishing a statutory basis, one must satisfy the Due Process concerns under the Fourteenth  Amendment.

The Chancery Court recognized that one may agree by contract to be subject to the personal jurisdiction of a particular court, in which case a minimum contact analysis is not required.

However, officers and directors are not parties to their corporation’s contract and generally are not liable on corporate contracts as long as it is clear that they did not sign in their individual capacities. Here, although their non-Delaware company agreed to the personal jurisdiction of Delaware courts, the officers and directors did not. Slip op. at 8-9 (citing Amaysing Tech. Corp. v. Cyberair Commc’ns, Inc. 2005 WL 578972, at *3 (Del. Ch., Mar. 2, 2005)). Although some of the individual defendants served on the board of a Delaware subsidiary and section 3114 of title 10 of the Delaware Code authorizes service over directors of a Delaware entity, it does so only when a cause of action is based on the breach of a duty to that corporation. None of the claims here related to the internal affairs or the corporate governance of the Delaware entity.

Plaintiffs also failed to establish that the officers and directors were subject to jurisdiction under section 3104(c) of title 10 of the Delaware Code. Namely, the court rejected the argument that their foreign corporation was their "agent" when it entered into a merger. A director or officer can only be said to use his corporation as his ‘agent" when it is proven to be his ‘alter ego" or the piercing of the corporate veil is warranted. (See n. 27.) Otherwise, the general rule applies that corporations can only act through their agents, and the actions of a corporation through its agents alone cannot satisfy the personal contacts needed for personal jurisdiction over those persons.

The Chancery Court in this decision also considered and rejected the argument that, based on the facts of this case, the civil conspiracy theory of personal jurisdiction applied. See here for article I co-wrote with my colleague Leslie Spoltore several years ago on the topic of the civil conspiracy basis of personal jurisdiction (which was written prior to the Chancery decision in CyberAir Tech. v. CyberAir Commc’ns, Inc., supra, on which the Ruggiero court relied heavily in the above opinion, and which has been cited in many other decisions. Ms. Spoltore and I represented the defendant in the CyberAir case.)

Finally, the court rejected the argument that "pendent jurisdiction" applied. Under Delaware law if personal jurisdiction is appropriate for a particular claim, Delaware courts may assert jurisdiction over the defending party where another claim is "sufficiently related" to the plaintiff’s independent claims. See n. 41 and 42.

In sum, the court refused to interpret the jurisdiction clause broadly and would not agree that the provision covered claims only tangentially related to the underlying contract.

Compare this decision to the very recent Chancery decision in Sample v. Morgan summarized here, that discussed similar legal issues in the context of very different facts and reached a different conclusion regarding personal jurisdiction over a company’s non-Delaware lawyer.

A recent Delaware Court of Chancery opinion explained the meaning of undefined terms in a limited partnership agreement which required the general partner in the Limited Partnership to use “best efforts” and “sound business practices.” In connection with claims that the general partner breached the agreement, the court in Wenske v. Blue Bell Creameries, Inc., C.A. No. 2017-0699-JRS (Del. Ch. July 6, 2018), explained that it would use dictionary definitions to help illustrate the meaning of those undefined terms. See page 25 and footnotes 91 to 93.

The court did not refer to the more common standard of “commercially reasonably efforts”, but that somewhat related contractual standard has been discussed in cases highlighted on these pages. Instead, the court’s application of dictionary definitions of the terms “best efforts” and “sound business practices” were applied to deny the motion to dismiss for breach of contract.The court also provided helpful contract interpretation principles in connection with how to define terms not defined in an agreement. See footnote 25.

Additional Noteworthy Principles Applicable to Commercial Litigation:

• The court reiterated the well-known Delaware principle that unless expressly disclaimed, alternate entities such as limited partnerships will be subject to default fiduciary duties. See footnote 3.
• The court explained that when fiduciary duties are disclaimed, and a new contractual standard is inserted to replace default fiduciary standards, the appropriate nomenclature for a claim for breach of that standard is a simple breach of contract, and not a breach of a “contractual fiduciary duty.” See pages 35 and 36.
• The court observed in passing what the elements of a claim for piercing the corporate veil are, and even though the plaintiffs did not use that terminology, that is how the court interpreted their claim. The court described why the elements for such a claim were not met. See pages 37 and 38.
• In connection with granting the motion to dismiss the claim for breach of fiduciary duties, the court discussed the well-recognized concept in Delaware that the controllers of a corporate general partner of a limited partnership may owe fiduciary duties to the limited partnership, if such persons exercise control over the limited partnership’s property—but that claim cannot be made if the limited partnership disclaims all fiduciary duties. See pages 42 and 43 and accompanying footnotes. The Delaware decision that articulated that cause of action against controllers of a corporate general partner of an L.P.is known as In re USA Cafes, L.P. Litigation, 6 A.2d 43 (Del. Ch. 1991).