In an opinion issued October 30, 2020, Vice Chancellor Sam Glasscock III refused to dismiss purported “direct” claims for breach of fiduciary duty brought by former minority stockholders of TerraForm Power, Inc. (TerraForm, or the Company) against its majority stockholder, Brookfield Asset Management Inc. (Brookfield); TerraForm’s CEO; and certain TerraForm directors in connection with a 2018 private placement with Brookfield of Company stock worth $650 million. See In re TerraForm Power, Inc. S’holder Litig., C.A. No. 2019-0757-SG (Del. Ch. Oct. 30, 2020). The opinion resolves the question of whether the plaintiffs adequately alleged direct claims which could survive the subsequent merger, eliminating the plaintiffs’ status as stockholders of the Company, or whether all of the plaintiffs’ claims were appropriately viewed as “derivative” and therefore must also be dismissed for lack of standing.
The contested stock issuance increased Brookfield’s stake in the Company from 51% to 65.3%. Not long after the issuance, the Company’s stock traded at a price more than 10% greater than the private placement price. Accordingly, the plaintiffs asserted derivative claims on behalf of the Company, alleging that the Company received too little in exchange for the issuance, and also purported direct claims on behalf of the Company’s minority stockholders, alleging that the issuance diluted their financial and voting interests in the Company.
In July 2020, after the suit was filed, Brookfield acquired the Company’s remaining shares in a merger. The merger ended any viable derivative claims for lack of standing, leaving the plaintiffs with only their purported direct claims to pursue. Defendants also moved to dismiss the purported direct claims, arguing that dilution claims, even when pled directly, are “quintessential derivative claims” that cannot be pursued by former stockholders. As noted by the defendants, the framework for distinguishing between derivative and direct claims was generally established in Tooley v. Donaldson, Lufkin & Jenrette, Inc., 845 A.2d 1031 (Del. 2004). That decision held that the determination “must turn solely on the following questions: (1) who suffered the alleged harm (the corporation or the suing stockholders, individually), and (2) who would receive the benefit of any recovery or other remedy (the corporation or the stockholders, individually)?” In order to plead a direct claim under Tooley, a “stockholder must demonstrate that the duty breached was owed to the stockholder and that he or she can prevail without showing an injury to the corporation.” According to the defendants, the remaining claims asserted only harm to TerraForm, and therefore the remaining claims must be dismissed as derivative. The plaintiffs countered that their claims were “dual natured” under the later-decided and more specific, albeit conflicting, rubric established by Gentile v. Rossette, 906 A.2d 91 (Del. 2006) and that their claims should survive.
The court ultimately sided with the plaintiffs. Applying Delaware Supreme Court “controlling precedent” Gentile v. Rossette, 906 A.2d 91 (Del. 2006), rather than Tooley, Vice Chancellor Glasscock determined that despite conflicting precedents, the plaintiffs had adequately alleged direct claims which survived the merger. Although the court acknowledged that the plaintiffs’ arguments for keeping their direct claims alive were “not reasonably conceivable” under the Tooley framework, it determined that the facts of the case were “strikingly similar to those of Gentile.” The court noted “ongoing uncertainty over whether Gentile remains good law” but that it remained “binding Delaware Supreme Court precedent, and thus controlling here.”
The court agreed with the defendants that corporate overpayment claims are typically “not regarded as direct” but rather “the quintessence of a claim belonging to an entity: that fiduciaries, acting in a way that breaches their duties, have caused the entity to exchange assets at a loss.” “This rationale extends even where a controlling stockholder allegedly causes a corporate overpayment [to itself] in stock and consequent dilution of the minority interest.” Therefore, under the “classic” Tooley framework, the claims alleged by the plaintiffs in this case would be derivative—rather than direct—and thus subject to dismissal for lack of standing. Nevertheless, the vice chancellor noted that the Delaware Supreme Court upheld nearly identical claims in Gentile, which was decided two years after Tooley. Specifically, in Gentile, the Delaware Supreme Court found that claims for breach of fiduciary duty arising from an issuance of stock to a controlling stockholder for allegedly inadequate value could be maintained by former stockholders as direct claims even though they no longer had standing to assert derivative claims.
Vice Chancellor Glasscock conceded that efforts to reconcile Gentile and Tooley are “as a matter of doctrine, unsatisfying.” The opinion notes that Gentile has been criticized by many, including by former Delaware Chief Justice Leo Strine, who described Gentile as “a confusing decision, which muddies the clarity of our law in an important context.” Confusion notwithstanding, Vice Chancellor Glasscock concluded that he was “not free to decide cases in a way that deviates from binding [Delaware] Supreme Court precedent.”
This opinion is an important reminder of the constraints imposed on trial courts and the possibility that certain types of claims may survive as direct despite the well-established principles of Tooley. This opinion, like Gentile, stands in stark contrast to Delaware’s generally well-developed and consistent body of binding precedents. As advocated by former Delaware Chief Justice Leo Strine, Gentile arguably should be overruled to the extent that it somewhat arbitrarily allows for a direct claim in dilution cases with a controlling stockholder.
On November 24, 2020, Vice Chancellor Glasscock certified the ruling memorialized in his October 30 opinion for interlocutory appeal to the Delaware Supreme Court.