In Clark v. Davenport, C.A. No. 2017-0839-JTL (Del. Ch. July 18, 2019), the Delaware Court of Chancery ruled on a motion to dismiss claims brought by Plaintiff Kenneth Clark (“Clark” or “Plaintiff”) against former officers, directors, and controlling stockholders of a now-defunct Basho Technologies Inc. (“Basho”) by an investor, who accused defendants of violating their fiduciary duties and committing fraud by inducing plaintiff to invest millions in what defendants knew was a failing enterprise. The motions to dismiss were granted in part and denied in part dependent on the involvement of the particular defendant in the scheme.
Defendant Georgetown Basho Investors (“Georgetown”), a private equity firm was run by Defendant Chester Davenport (“Chester”). Defendant Corey Davenport (“Corey”) is Chester’s son. Chester, through Georgetown, made an investment in Basho, a company specialized in distributed systems database software. Through its investments, Georgetown obtained the right to designate two members of Basho’s board, along with a grant of blocking rights that prevented Basho from raising capital without Georgetown’s consent. Chester wanted to force a near-term sale of Basho and used Georgetown’s blocking rights to stop Basho from pursuing attractive third-party financing options. Having cut off Bash’s other financing options and with loans made by Georgetown to Basho coming due, Georgetown presented Basho with an offer to lead a round of financing. The terms of the financing were egregious and gave Georgetown control over 65% of Basho’s voting power and the right to designate four of seven directors. Without other options Basho accepted. Chester was appointed executive chairman of an executive committee that was established with the power to exercise all of the Basho board’s authority. Its members were Chester and Robert Reisly (an associate of Chester’s) and Adam Wray. Adam Wray (“Wray”) was hired as Basho’s CEO. Wray also became a director and member of the executive committee of Basho. Wray was underqualified to lead Basho.
By October 2014, Basho desperately needed money and Chester called Plaintiff about investing in Basho. Chester knew Clark was in the process of selling his company and would have cash to invest. Chester misrepresented Basho’s investment history and financial condition, inflated its prospects, and did not disclose that it was distressed. Plaintiff also alleged that, based on these conversations with Chester and Wray, it decided to invest millions in Basho, relying on years of friendship with and trust in Chester.
Basho was ultimately placed into receivership and its equity rendered worthless. As a result Clark brought this action, alleging breach of fiduciary duty, common law fraud, negligent misrepresentation, and claims of aiding and abetting against Chester and other defendants in connection with such causes of action arising from information that Plaintiff received before investing in Basho. Three defendants failed to respond to the complaint and default judgment was entered against them. Plaintiff reached a settlement with two other defendants. The remaining defendants, Wray and Corey, moved to dismiss the complaint for failure to state a claim. Corey, additionally moved to dismiss the complaint for lack of personal jurisdiction.
The Court noted that a private stock sale transaction between corporate fiduciaries and a stockholder could be subject to the “special facts doctrine” (imposes a duty of disclosure on a director when he possesses special knowledge of the business of the company and deliberately misleads an unknowing stockholder). Plaintiff and defendants contended that the director disclosure requirements provided under Malone v. Brincat apply when directors speak outside of the context of seeking stockholder action and result in liability only when a director as a fiduciary “knowingly disseminates false information.” To prevail on a claim for common law fraud a plaintiff can show reckless indifference but Malone v. Brincat requires a standard of knowing misconduct. If a plaintiff cannot successfully plead a common law fraud claim then the same facts cannot give rise to a claim under Malone v. Brincat based on a breach of fiduciary duties.
Also Corey argued that Plaintiff cannot assert any claims for fraud because the agreements that governed his investments in Basho contained anti-reliance provisions. The Court noted that a plaintiff’s fraud claim will only be dismissed as a result of a contractual anti-reliance clause if the language clearly articulates a plaintiff’s agreement that he did not rely upon statements outside the four corners of the contract. Standard integration clauses alone or anti-reliance provisions will not bar a plaintiff from later asserting a fraud claim.
The court found that Plaintiff had failed to plead fraud with particularity with respect to Corey’s involvement in Plaintiff’s first investment in Basho but sufficiently pled fraud as to Wray with respect to Plaintiff’s second investment in Basho. The Court found that Wray had a significant financial stake in keeping Basho solvent, that Basho was his sole source of income, and that Wray stood to personally and professional gain from keeping Basho afloat. The Court noted that Wray made specific false representations to Plaintiff about Basho’s fundraising efforts, future prospects, and strategic partnerships with others. The intent to deceive was adequately supported to survive a motion to dismiss. The Court also found that Plaintiff had sufficiently pled a claim for aiding and abetting against Wray.
Finally, the Court held that it could exercise personal jurisdiction over Corey under the conspiracy theory test. The theory “is based on the legal principle that one conspirator’s acts are attributable to the other conspirators.” That is, if the purposeful acts of one conspirator are of a nature that would subject the actor to the jurisdiction of the court, all of the conspirators are subject to the jurisdiction of the court. The Court held that Plaintiff had pled a viable aiding and abetting claim against Corey in connection with Plaintiff’s second investment. The Court held that Corey had reason to know that Plaintiff’s second investment involved the filing of a restated certificate of incorporation and the formation of a Delaware entity. As a result the Court held that there was a Delaware nexus given the investment’s formation of a Delaware entity that subjected Corey to the jurisdiction for purposes of litigation.