In Longoria v. Somers and LC Therapeutics, Inc., C.A. No. 2018-0190-JTL (Del. Ch. May 28, 2019), the Delaware Court of Chancery examined its authority to tax the costs of receivership against the stockholder of an insolvent corporation. The Court’s decision highlights an exception to the general principle that stockholders of a properly maintained corporation are not responsible for costs incurred by the corporation and illustrates a scenario where stockholders may be held liable for a corporation’s obligations.
Plaintiff James Longoria (“Longoria”) and Defendant Charles Somers (in his capacity as trustee of a living trust, referred to here for simplicity as “Somers”) formed LC Therapeutics, Inc. (the “Company”) in 2013 to develop and exploit certain intellectual property (the “Patents”). With Longoria and Somers each owning 50% of Company, the two parties deadlocked on various matters, including on how to fund the Company. After judicial intervention, in late 2018, the parties agreed to hire a third-party receiver (the “Receiver”) to oversee the Company’s dissolution. When the parties were unable to agree on (i) the scope of the Receiver’s authority; (ii) the process the Receiver should follow; and (iii) the amount of the Receiver’s compensation, the Court entered an order providing that the parties would equally pay the Receiver’s unpaid fees and expenses as costs in the event proceeds from the Company’s dissolution were otherwise insufficient.
After the Receiver engaged several third-party professional firms to handle the sale of the Patents and complete the Company’s unfiled tax returns, Longoria protested the incurrence of additional expenses related to the Patents, asserting that the Patents were worthless. With Somers agreeing to pay for one-half of the Receiver’s expenses (and providing 100% of an advance retainer to cover immediate costs), the Receiver petitioned the Court for a ruling on whether he could tax the remaining half of expenses on Longoria.
Noting the general rule that funds for a receiver’s compensation and expenses can typically only be sourced from available “funds in his hands” and not from the pockets of the appointing part(ies), the Court provided that an exception exists when there are either no funds or insufficient funds out of which expenses can otherwise be paid. In such a scenario, the Court has discretion to apportion expenses equitably between the parties.
Maintaining that his status as a stockholder of the Company precluded him from being compelled to provide additional funds to support the Company’s continued operation, Longoria claimed that the Receiver lacked authority to compel his payment of the Company’s expenses. Vice Chancellor Laster agreed with Longoria’s logic but not his conclusion. Focusing on Longoria’s status as a stockholder, he distinguished between the general expenses of a corporation—which would generally not be imposed upon a stockholder—and the expenses of a corporation incurred by virtue of a stockholder’s decision to litigate. When a stockholder makes a decision to litigate, he can be held liable as a litigant for expenses associated with the proceeding, even when those expenses would generally be considered debts of the corporation. The Court accordingly reasoned that Longoria’s status as both a litigant and the petitioner who sought the receivership warranted imposition of the expenses of receivership.
The Court also rejected a number of other arguments proffered by Longoria. In response to his reasoning that he cannot have liabilities imposed on him simply because he is a director, the Court countered that no liabilities were imposed on him in that capacity. Longoria offered additional arguments against having to bear the expenses, grounded in the existence of alleged contractual claims against Somers, Longoria’s proposed plan of dissolution (which by having himself serve as trustee, would have eliminated the need for third-party fees), and ongoing litigation in an alternate forum. Rejecting each of Longoria’s arguments, the Court maintained that contractual claims could be presented as part of the receivership process, the proposed plan of dissolution was unlikely to be acceptable to Somers and third-party receivership costs were foreseeable expenses, and ongoing litigation in a separate forum had no bearing on the receivership proceeding.
Deeming Longoria responsible for half of the fees of receivership, the Court required Longoria to reimburse Somers for one half of the expenses already incurred relating to the receivership and further stipulated that Longoria would remain responsible for half of receivership-related costs throughout the duration of the receivership process.