Plaintiff’s Counsel Recovery in a Derivative Case Settling Under the Transitive Property Limited to Actual Benefit to Plaintiffs
By: Nicholas Froio and David Noll
In Baker v. Sadiq, C.A. No. 9464-VCL (Del. Ch. August 16, 2016), the Court held that the proper calculation of an attorney’s contingency fee for a derivative action settled using the transitive property is based upon the actual settlement value. Baker concerned fees owed to plaintiff’s counsel (“Counsel”) after the settlement of a derivative action by minority shareholders for misappropriation by the majority shareholder. The settlement of those claims was a buyout of the minority shareholders at a better pro rata value than could be expected from the derivative action. By holding that the appropriate measure of fees is based upon actual cash payments, Plaintiff’s counsel received approximately one ninth of its expected award to be collected from an entity with no assets.
The underlying action was a derivative action brought by minority shareholders (the “Shareholders”) on behalf of NavSeeker, Inc. (“NavSeeker”) to recover $25 million. The Shareholders retained Counsel on a contingency fee basis. The majority stakeholder of NavSeeker, HIMEX Limited and its affiliates (jointly, “Himex”), allegedly misappropriated the entirety of NavSeeker’s value, in the form of $25 million in technology assets. The Shareholders owned 10.75% of NavSeeker. Had the Shareholders gone to trial, NavSeeker would have recovered $25 million from Himex, or a $2,687,500 indirect benefit to the Shareholders.
The parties settled the case using the transitive property of entity litigation to change the entity-level award of a derivative action into a shareholder-level payment. Mathematically, the transitive property states that if A=B and B=C, then A=C. In shareholder litigation, this mathematical truism allows shareholders to directly receive the value equal to their indirect per share benefit from an entity-level recovery. While settlements often apply the transitive property to allow a shareholder-level recovery instead of one at the entity-level, courts rarely undertake such an action preferring the simplicity of an entity-level recovery.
Under the settlement, the Shareholders received $2.75 million plus a forgiveness of $500,000 of NavSeeker debt held by Himex in exchange for a buyout of their shares. This was a superior outcome to that anticipated at trial. The settlement failed to address the amount or source of Counsel’s fee. The parties agreed that the benefit conferred by Counsel was not less than $2.75 million and allowed Counsel to argue a greater benefit was conveyed. After the settlement, NavSeeker held no cash or assets and only received sufficient money from its controllers to meet its bills.
Counsel brought suit alleging its fee should be based upon the implied derivative action award of $25 million. Counsel claimed $6 million plus expenses, an award of 24% of the $25 million implied entity-level recovery. Counsel further claimed that this award should be payable jointly and severally between the defendants because each of them benefitted from the settlement.
Counsel’s primary argument for permitting this sort of recovery was policy based. First, Counsel noted it was bound by its fiduciary duty to the Shareholders in approving the settlement and not proceeding to trial. The settlement directly harmed Counsel by reducing the value of the award its fee was derived from and by removing any opportunity to develop facts that would permit recovery from Himex directly. Because courts rarely apply the transitive property to create shareholder-level rewards, Counsel could anticipate a fee based upon NavSeeker’s reward and not the benefit received by the Shareholders. Furthermore, Counsel stated that if the Court did not permit the recovery on the implied derivative action value then future plaintiffs’ counsels would be less likely to take cases of this nature. Both of Counsel’s requests were supported by case law only indirectly.
Vice Chancellor Laster stated that under current law there were no grounds to permit recovery on the implied derivative award or against any entity other than NavSeeker. The court assessed a value conferred of $3.25 million, representing the $2.75 million buyout plus the $500,000 of debt forgiveness. In determining the proper percentage assigned to Counsel, Vice Chancellor Laster noted that Counsel obtained a strong outcome in the settlement of the previous case. Counsel had also expended a good deal of effort on the case, even though the case settled before extensive discovery occurred. Finally, the Court recognized the complexity of the case, noting that some of the defendants in the preceding case were foreign and that the case had required interaction with a Department of Labor investigation into NavSeeker’s 401K plan. Therefore, the Court awarded Counsel a 20% contingency fee, or $650,000, to be collected solely from NavSeeker.
Counsel represented the Shareholders in a $25 million derivative action on contingency fee with the expectation of compensation commensurate with that claim. Counsel’s own records showed an as-billed fee of $390,000 for its work. Cases taken on contingency have the inherent risk of resulting in little or no recovery for the law firm; the potential loss leads firms to expect higher fees than those paid on an hourly basis. In the present case Counsel obtained a better than anticipated outcome for the Shareholders through a different structure than anticipated. Nonetheless, the Court in Baker made clear that structure of the outcome matters. Vice Chancellor Laster stated that just as the Court does not reduce a fee amount for an award at the entity-level to reflect the benefit to shareholders, nor will it multiply a fee at the shareholder-level to reflect the underlying entity claim.