Brookfield Asset Management, Inc., et al. v. Rosson, et al., No. 406, 2020 (Del. Sept. 20, 2021)
In this unanimous en Banc opinion, the Delaware Supreme Court overturned its oft-criticized decision in Gentile v. Rosette, 906 A.2d 91 (Del. 2006) (“Gentile”). Gentile held that a stockholder who allegedly suffers dilution as a result of a controlling stockholder increasing its holdings had standing to pursue a direct claim because a corporate dilution/overpayment claim was “dual-natured” (i.e., direct and derivative). Gentile, however, stood in tension with the Court’s earlier decision in Tooley v. Donaldson, Lufkin & Jenrette, Inc., 845 A.2d 1031 (Del. 2004) (“Tooley”), in which the Court articulated a two-part test for determining whether a stockholder’s claim is direct or derivative. The Brookfield Court put to rest the Gentile dual-natured exception in favor of Tooley and thereby made clear that stockholder plaintiffs will now need to contend with the demand requirement under Court of Chancery Rule 23.1 in controller dilution cases.
This case arose from a June 2018 private placement in which Brookfield Asset Management, Inc. (“Brookfield”) acquired $650 million shares of TerraForm Power, Inc. (“TerraForm” or the “Company”) increasing Brookfield’s interest in TerraForm from 51% to 65.3% (the “Private Placement”). Stockholder plaintiffs sued, alleging that TerraForm issued stock for insufficient value in the Private Placement, diluting the minority stockholders’ economic and voting interests. Plaintiffs asserted their claims both directly and derivatively, but in July 2020, Brookfield affiliates acquired all outstanding stock of the Company not already owned by Brookfield, and plaintiffs lost standing to pursue the derivative claims.
Defendants moved to dismiss the plaintiffs’ remaining direct claims, arguing they are exclusively derivative under Tooley. In October 2020, the Court of Chancery found that plaintiffs’ overpayment claims were derivative under Tooley and were also direct under Gentile’s dilution claim exception to Tooley. Defendants moved for interlocutory appeal of that decision, which application was granted in light of earlier criticism from the Delaware Supreme Court questioning the continued validity of Gentile.
In this decision, the Delaware Supreme Court identified doctrinal, practical, and policy reasons for overturning Gentile. The Court acknowledged three ways in which Gentile was in tension with Tooley.
First, the Court found tension in Gentile’s conclusion that economic and voting dilution was an injury to stockholders independent of the corporation. The Court stated that the basis for plaintiffs’ claims was that the Private Placement allegedly harmed the Company by issuing shares to Brookfield for an unfairly low price, resulting in the plaintiffs suffering harm through the reduction in economic and voting power in proportion to their shareholdings, and the harm was therefore indirect.
Second, the Court found that Gentile’s explicit reliance on In re Tri-Star Pictures, Inc. Litig., 643 A.2d 319 (Del. 1993) (“Tri-Star”) created tension with Tooley because Tri-Star relied on opinions applying the “special injury” test that Tooley expressly rejected. Gentile stated that it was applying both Tooley and Tri-Star, which the Court found inconsistent with Tooley’s clear rejection of the “special injury” test.
Third, the Court noted that Gentile’s reliance on the presence of a controlling stockholder conflicted with the Tooley test, which solely focuses on who suffered harm and who would recover rather than the nature of the wrongdoer.
The Court then identified practical concerns with Gentile. First, the carve-out for dual-natured claims in Gentile was unnecessary because there are other avenues through which stockholders may assert fiduciary duty claims in change-of-control transactions or challenge the fairness of a merger. Second, because both the corporation and stockholders could recover for harm under Gentile, there was a risk of double recovery.
Next, the Court explained why stare decisis did not prevent overturning Gentile. The opinion held that fifteen years grappling with Gentile was sufficient to determine that the difficulties that it created were unworkable and that Gentile was a substantial departure from Tooley. The Court also found that the Supreme Court’s statements casting doubt on the continued viability of Gentile in El Paso Pipeline GP Co. v. Brinckerhoff, 152 A.3d 1248, 1256 (Del. 2016), meant that parties could anticipate that Gentile’s status was in jeopardy.
While Gentile was limited to dilution claims, the decision to overturn it is a continued endorsement of the simplified direct versus derivative analysis established by Tooley. This decision provides more certainty for litigants and the courts regarding the applicable pleading standards to assert a dilution claim (i.e., it must meet the Rule 23.1 pleading standard for derivative claims) and the standing of stockholders to bring a dilution claim (i.e., they must be continuous owners of the nominal defendant corporation’s stock).