CURRENT MONTH (March 2022)
Delaware Chancery Court Denies Plaintiff’s Motion to Dismiss Its Own Case, But Grants Defendant’s Motion to Dismiss on Other Grounds
By Yanna Banks, Reed Smith LLP
In what Chancellor Kathlaleen St. J. McCormick described as “a spin-off novella of the TransPerfect saga,” TransPerfect Global, Inc.’s legal malpractice claims against Ross Aronstam & Moritz LLP (“RAM”) have been dismissed, adding yet another “episode” to the ongoing story of corporate control.
In 2014, TransPerfect Global, Inc. (the “Company”), received a court order for the Company to be sold via modified auction (the “Sale Order”) and the appointment of Robert Pincus (“Custodian”) as custodian. In opposition to the sale, Shirley Shawe, one of the owners, brought two lawsuits against the Company, and both were dismissed. The Custodian obtained RAM to represent the Company in both actions.
In August 2020, the Company, now owned by Shawe, sued RAM and one of its partners (the “Defendants”), alleging that the Defendants acted improperly as a result of having been retained by and having taken directions from the Custodian, who was purported to be a conflicted agent for the Company (the “New York Action”). The Defendants moved to redirect the New York Action to the Court of Chancery of the State of Delaware (the “Court”) in accordance with the Sale Order’s exclusive jurisdictional provisions.
In January 2021, the Company amended the New York Action to drop its claims of equitable relief and later filed a nearly identical action in Delaware (the “Delaware Action”). Subsequently, the Defendants moved to dismiss the Delaware Action for failure to state a claim. In what the Court described as “a twist of Shyamalan-ian proportions,” the plaintiffs also moved to dismiss their own complaint, arguing that, because it was seeking only legal relief, the Court lacked subject matter jurisdiction.
Although neither party wished to proceed with the suit, the Court found it necessary to issue an opinion, as the legal basis for dismissing the Delaware Action could affect the New York Action. Under Delaware law, cases dismissed for lack of subject matter jurisdiction are not barred from later being asserted. However, a dismissal for failure to state a claim will typically be granted with prejudice to the dismissed claims.
With regard to the Plaintiff’s motion, the Court analyzed whether the Company’s claims fell within the Court’s inherent authority to enforce its own orders. This question happened to have been previously resolved in the affirmative by the Court in an earlier ruling. The Court held the New York Action violated the Sale Order, as the action directly implicated their supervisory authority with regard to custodians.
The Court then turned to the Defendant’s motion for failure to state a claim for legal malpractice. The Company asserted that the Defendants neglected their professional obligations by violating the Delaware Rules of Professional Conduct (the “Rules”) preventing a lawyer from representing a client if there is a concurrent conflict of interest, or in this case, the Custodian’s receipt of fees from the Company. The Court found that the Defendant’s actions fit squarely within the Sale Order, and therefore, it could not be reasonably conceived that the payment of the Custodian’s fees gave rise to a concurrent conflict under the Rules. Ultimately, the Court denied the Company’s motion while granting Defendant’s finding that the Company failed to establish that the Defendants neglected their professional obligations.
Delaware Chancery Court Preserves Common Stockholders’ Claims in Connection with Merger
By Luke Barbour, Reed Smith LLP
On March 1, 2022, the Delaware Court of Chancery (the “Court”) preserved the majority of claims brought by a group of common stockholders of WinView Inc. (“WinView”) arising out of a May 2020 merger (the “Merger”) of WinView with two Canadian companies.
WinView, a private company that primarily focused on sports betting, held an asset portfolio comprised largely of patents related to the gambling industry. Over the course of WinView’s existence, the company engaged in several funding rounds, including both Series A and Series B preferred equity offerings and several bridge loans. Simultaneously with these bridge financings, the Company also engaged in patent litigation in an attempt to monetize its patents.
In late 2019, WinView’s board, which consisted of WinView’s largest stockholder and several secured noteholders, executed a term sheet in connection with the Merger. Notably, the terms of the Merger eliminated the Company’s common stock, and the common stockholders ultimately received no cash and no shares in the resulting entity. Rather, the common stockholders received a contractual right to 50% of any recoveries on successful resolutions of WinView’s patent litigation. By contrast, the preferred stockholders and the secured creditors of WinView received stock in the resulting entity, meaning that the Merger treated WinView’s common stockholders differently from the preferred stockholders and secured noteholders. The Merger closed in May of 2020, and for fourteen months thereafter, no patent lawsuits were filed. As a result, no payments were made to the former WinView common stockholders.
In their amended complaint against the directors, the plaintiffs brought suit for breaches of fiduciary duty, civil conspiracy, and unjust enrichment. The gist of their claim was that the directors, who were holders of preferred stock as well as debt instruments, sanctioned a transaction that benefited themselves to the detriment of the common stockholders. In response, the defendants maintained that WinView was insolvent, and that their actions were ultimately favorable to the common stockholders, who otherwise would have received nothing given WinView’s insolvency.
Writing for the Court, Vice Chancellor Sam Glasscock III concluded that the defenses proffered by the directors “may prove dispositive upon a fuller record, but [were] not sufficient at this plaintiff-friendly stage of the proceedings to support a dismissal.” The Court ultimately concluded that it was conceivable the director defendants had breached their duty of loyalty to WinView given the disparity in merger consideration, and that the plaintiffs’ claims should survive as a result. With respect to the defendants’ claim that WinView was insolvent, Vice Chancellor Glasscock pointed out that the plaintiffs’ amended complaint did not allege that WinView was insolvent, and so he concluded that “the question of WinView’s solvency is a factual issue that awaits a developed record.” The Court also preserved the plaintiffs’ unjust enrichment claim, although Vice Chancellor Glasscock expressed skepticism that the unjust enrichment claim would provide any relief separate and distinct from the breach of fiduciary claim. The Court did, however, toss out the civil conspiracy claims against the defendants, holding that a civil conspiracy claim does not apply to defendants who owe a direct fiduciary duty, which the director defendants in this case did.
Delaware Chancery Court Refuses to Apply Cleanup Doctrine to Enforce Release of Escrow Funds
By Neimann Gipson, Reed Smith LLP
On March 7, 2022, the Delaware Court of Chancery (the “Court”) declined to decide whether subject matter jurisdiction existed in a suit brought by Elavon, Inc., a credit card processing company (“Elavon”). The contractual suit was sought pursuant to a disputed asset purchase between Electronic Transaction Systems Corporation (“ETS”), Edward Vaughan, and Hadi Akkad (collectively, “Defendants”) valued at $180 million dollars, with $10 million dollars in escrow funds to satisfy indemnification claims. In connection with the asset purchase, Elavon alleged Defendants breached a contractual duty by attempting to defraud Elavon via the asset purchase agreement (“APA”), which was subject to post-closing adjustments. Particularly, Elavon sought tort and contractual damages, including rescissory, consequential, and expectation damages.
Elavon filed the complaint on May 18, 2021, and Defendants filed a motion to dismiss on July 8, 2021, pursuant to the Delaware Court of Chancery Rules 12(b)(1) and 12(b)(2). Defendants filed answers and counterclaims concurrently after filing the motion to dismiss. Elavon filed its reply shortly after, and briefing commenced July 2021. The Court heard oral arguments on November 22, 2021, and directed both parties to deliberate whether the Court had equitable jurisdiction over the matter before deciding on Defendants’ motion to dismiss. Defendants contend the Court should not exercise equitable jurisdiction.
The Court agreed with Defendants that it did not have equitable jurisdiction over the contractual dispute to release the full amount in the escrow funds. In determining whether equitable jurisdiction was appropriate, the Court reviewed the pleadings together with the case law provided by Elavon to support its claim for supplemental jurisdiction. The Court reasoned that the escrow agent was bound by a contractual duty to release the escrow funds under “joint directives by the parties or a final unappealable order,” and that there were no indications in the record that an order by the parties pursuant to a Superior Court decision would not result in release of the escrow funds by the escrow agent. Elavon contended that the Court had authority to issue an injunction directing the escrow agent to release all funds if it failed to do so, which would effectively invoke the “cleanup doctrine.”
However, the Court determined a decision pertaining to the escrow funds would effectively act as a “reverse cleanup doctrine,” since the cleanup doctrine is typically only applied after an equitable matter has been revolved. By contrast, if the Court grants Elavon’s request, its decision would determine the “conditions for the release of the escrow funds, in what amounts and to whom, as required by the contract.” Consequently, the Court determined that since there was nothing in the record indicating a post-decision order by the Superior Court would not be upheld, Elavon was requesting relief for a hypothetical and unexpected subsequent breach by the escrow agent upon refusal to release escrow funds. The Court thus concluded that because it lacked subject matter jurisdiction over the dispute, the matter was dismissed subject to transfer to the Superior Court.
Delaware Chancery Court Grants Partial Summary Judgment in Favor of Former Delaware Corporation Director and CEO Regarding Expenses Incurred in Responding to SEC Subpoenas and Litigation Defenses
By Cam Viney, Reed Smith LLP
On March 7, 2022, the Court of Chancery of the State of Delaware (the “Court”) held that 180 Life Sciences Corporation, a biotech company that engages in developing new therapeutics for inflammation (the “Company”), which entered into a business combination with KBL Merger Corp. (“KBL”), Katexco Pharmaceuticals Corp., and CannBioRx (the “Business Combination”), must advance former director and Chief Executive Officer (“CEO”) Marlene Krauss, MD, the fees and expenses incurred in connection (i) to a subpoena response from the Securities and Exchange Commission (“SEC”), and (ii) with certain defenses pertaining to litigation in the Court.
Krauss commenced an action against the Company with regard to its handling of the advancement of Krauss’s fees incurred in relation to her duties as a director and officer of KBL. The Company’s original Certificate of Incorporation (the “Charter”) provided for advancement of legal fees incurred by those who were acting as directors or officers of the Company in their official duties. Later, the Company amended its Charter providing that approval by the Company’s board of directors (the “Board”) was required for advancement of proceedings initiated by officers or directors. The Court, however, held that unlike the advancement right established by the Charter, its original and amended and restated bylaws (the “Bylaws”) did not require Board approval for advancement of expenses relating to certain types of proceedings.
In April 2021, the SEC served Krauss with four subpoenas in connection with its investigation regarding the Business Combination, one of which directed Krauss to produce documents (the “Krauss Subpoena”). Also, in April 2021, the Company initiated litigation against Tyche Capital, LLC (the “Tyche lawsuit”) in New York state court alleging breach of contract, and it asserted third-party claims and served Krauss with a third-party summons. Lastly, in September 2021, the Company filed a complaint against Krauss in the Court (the “Direct Action”) alleging breach of fiduciary duty and that Krauss intentionally failed to disclose information that rendered certain KBL disclosures materially false and misleading.
First, Krauss argued that the SEC subpoenas served on her arose out of the Business Combination and her former role as a director and officer of KBL. Second, she asserted her entitlement for advancement with respect to the Tyche lawsuit because she was named as a third-party defendant as a result of her position as an officer and director of KBL. Lastly, she sought advancement of all expenses related to her affirmative defenses, counterclaims, and third-party claims regarding the Direct Action.
On the other hand, the Company argued that Krauss was not entitled to advancement for her affirmative defenses because she caused unauthorized transfers of Company funds after her resignation from KBL. Also, although the Company conceded advancement for portions of the Company’s complaint against Krauss, it disagreed with advancement related to Krauss’s defenses, counterclaims, and third-party claims.
The Court granted summary judgment to Krauss for her claim regarding the SEC subpoenas because it found that a causal nexus existed between the SEC’s investigation and Krauss’s former role as a director and officer of KBL. Further, it held that Krauss was not entitled to advancement with respect to the Tyche lawsuit where she was a third-party defendant because the Company had not conceded that there were no material facts in dispute, and if Krauss wanted to continue to press for advancement in connection with the Tyche lawsuit, the matter of her entitlement must be resolved at trial. Finally, the Court held that because Krauss was owed advancement in connection with her defenses, including affirmative defenses, and the singular counterclaim in the Direct Action, summary judgment was appropriate.