Monday, July 19, 2021

Fiduciary claim over derivative arbitration award can continue

By Mark S. Nelson, J.D.

The Chancery Court concluded that a company may pursue its breach of fiduciary duty and unjust enrichment claims against a group of former company directors who, in their capacity as derivative plaintiffs acting on behalf of their former company, had obtained a $6.8 million arbitral award which they allegedly withheld from the company due to their animosity towards certain shareholders involved with a prior attempt to remove the company’s CEO from the company’s board. As a result, the court rejected arguments that such claims are not recognized by Delaware while also declining to disturb the arbitrator’s award of attorney’s fees to counsel for the derivative plaintiffs/defendants. The court, however, cautioned that the company’s claims will need to be tested via further discovery (OptimisCorp v. Atkins, July 15, 2021, Zurn, M.).

Palace intrigue. Optimis sued a group of its former directors who, following an arbitration, won an award in a matter in which they asserted that the company’s former outside counsel engaged in legal malpractice and breached fiduciary duties owed to the company. The follow-on suit by Optimis alleged that the derivative plaintiffs (here defendants) breached their own fiduciary duty to Optimis by withholding payment of the arbitral award to Optimis out of animus for the company’s CEO and because they now worked for a company that directly competes with a key Optimis unit. Optimis further alleged the derivative plaintiffs had been unjustly enriched and sought a levy against Optimis at a time when Optimis was depending on the arbitral award to help smooth its financial prospects.

Derivative action benefits company. A key theme of the Chancery Court’s opinion is that derivative lawsuits are intended to benefit the company on whose behalf they are brought. The derivative plaintiffs/defendants in this case, however, sought to prevent selected Optimis shareholder/adversaries from benefitting from Optimis’s arbitration victory.

The Chancery Court, in part one of the bifurcated proceedings, granted partial judgment on the pleadings to Optimis regarding the question of whether its claim for payment of the arbitral award was derivative—the court said it was. That left for the court to address questions of whether the derivative plaintiffs/defendants breached fiduciary duties and were thus unjustly enriched.

Optimis argued that the derivative plaintiffs/defendants had a fiduciary duty to deliver the arbitral award to Optimis. The derivative plaintiffs/defendants, however, countered that: (1) whatever duties they owed were owed to fellow shareholders and not to Optimis; (2) in the derivative suit context, Delaware imposes no duty beyond the maintenance of the derivative suit; and (3) Delaware does not recognize a claim for money damages for a derivative suit plaintiff’s breach of fiduciary duty.

The Chancery Court rejected the derivative plaintiffs/defendants’ arguments because Delaware imposes fiduciary duties on those who bring suit on behalf of a corporation regarding corporate assets (i.e., the derivative claim). The court concluded that the derivative plaintiffs/defendants breached this duty and went on to explain why holding the derivative plaintiffs/defendants accountable would make sense.

Said the court: "While Defendants contend that allowing this action to go forward would ‘disincentivize stockholder representatives from pursuing this kind of derivative litigation,’ I disagree. Instead, it would disincentivize the kind of misconduct alleged here: the improper withholding of a derivative award for personal reasons and without regard for the authority of corporate decisionmakers" (footnote omitted).

As a result, Optimis had pleaded a claim for breach of fiduciary duty.

Unjust enrichment. The court next concluded that, for purposes of a motion to dismiss, Optimis had pleaded a claim for unjust enrichment. Such claims require a plaintiff to allege: (1) an enrichment; (2) an impoverishment; (3) a relation between the enrichment and the impoverishment; (4) that there is no justification; and (5) that there is no legal remedy.

The court reasoned that because of the withholding of the arbitral award, a subsequent levy, and competition by the former directors who are the derivative plaintiffs/defendants that Optimis had pleaded an enrichment. Optimis likewise pleaded an impoverishment arising from the timing of the withholding of the arbitral award at a time when Optimis was relying on the award to remain adequately capitalized. Optimis also pleaded there was no justification because the derivative plaintiffs/defendants’ animus (ostensibly to protect innocent shareholders but also based on reliance on an interpretation of the arbitral award) nevertheless resulted in a breach of fiduciary duty by them. As for the last element, the derivative plaintiffs/defendants had argued that the unjust enrichment claim was duplicative of Optimis’s breach of fiduciary duty claim, but the court concluded that these claims were separate claims.

As a result, at least at the pleading stage of the case, Optimis had pleaded a claim for unjust enrichment. However, the court noted that still more discovery was needed to prove the claim.

No additional attorney’s fees. The derivative plaintiffs/defendants also sought judgment on the pleadings regarding their counterclaim that their counsel during the underlying arbitration should receive additional attorney’s fees beyond the attorney’s fees awarded by the arbitrator, who had applied the lodestar method to calculate the amount of attorney’s fees. The basis for the ongoing dispute was the fact that the amount of attorney’s fees awarded by the arbitrator was roughly half the 30 percent contingency fees contemplated by the engagement agreement with the law firm.

The Chancery Court reiterated that arbitrators are entitled to deference and that the court lacks jurisdiction to review disputes that parties have opted to subject to arbitration. As a result, the request for additional attorney’s fees was denied.

The case is No. 2020-0183-MTZ.