DIRECT AND DERIVATIVE? CHANCERY COURT CERTIFIES INTERLOCUTORY APPEAL, ASKS SUPREME COURT TO CLARIFY DUAL CHARACTER STOCKHOLDER CLAIMS
By Scott E. Waxman and Cate H. Gelband
In In re Terraform Power, Inc. Stockholders Litigation, C.A. No. 2019-0757-SG (Del. Ch. November 24, 2020), the Delaware Court of Chancery (the “Court”) granted defendants’ Application for Certification of Interlocutory Appeal, giving the Delaware Supreme Court (the “Supreme Court”) an opportunity to clarify its decision in Gentile v. Rossette (“Gentile”) under which stockholders’ claims for a specific type of breach of fiduciary duty can have “dual character” as both derivative and direct. The Court relied on two factors under Delaware Supreme Court Rule 42 (“Rule 42”)—whether consideration of the appeal may end the litigation, and whether review of the appeal may serve considerations of justice—and held that the matter presented “a rare case” in which an interlocutory appeal was justified.
Plaintiffs are stockholders (“plaintiffs”) that brought a “purported[ly] direct action” against the corporate controller and certain directors of TerraForm Power, Inc. (“TerraForm”), a publicly traded Delaware corporation headquartered in New York (collectively “defendants”), for breach of fiduciary duty, alleging “that the controller caused the entity to issue it stock for inadequate value, diluting both the financial and voting interest of the minority stockholders.” Though plaintiffs initially asserted both direct and derivative claims, they ceased to be stockholders after TerraForm was acquired in a merger, which ended any derivative claims and left plaintiffs with only their direct claims to pursue.
Defendants moved to dismiss for lack of standing, arguing that dilution claims are derivative under Tooley v. Donaldson, Lufkin, & Jenrette, Inc. (“Tooley”), which sets out the test for determining whether a claim is derivative or direct. In response, plaintiffs argued their claims are “dual natured” under Gentile v. Rossette, and argued further that their complaint states direct claims under Tooley alone. The Court addressed plaintiffs’ second argument first and found that under Tooley, without relying on Gentile, plaintiffs’ complaint did not state direct claims, as claims of corporate overpayment are regarded as derivative. The Court then addressed plaintiffs’ Gentile argument. On that issue, defendants acknowledged that Gentile would apply to plaintiffs’ facts, but urged the Court to disregard it as precedent given that Gentile has been “both criticized and applied narrowly in a number of judicial opinions.”
In Gentile, the Delaware Supreme Court stated that there is a specific type of breach of fiduciary duty claim that is “both direct and derivative in character” where “(1) a stockholder having majority or effective control causes the corporation to issue ‘excessive’ shares of its stock in exchange for assets of the controlling stockholder that have a lesser value; and (2) the exchange causes an increase in the percentage of the outstanding shares owned by the controlling stockholder, and a corresponding decrease in the share percentage owned by the public (minority) shareholders.” In such cases, the corporation has a derivative claim, and in addition, the public shareholders have a direct claim. The direct claim is based on the “improper transfer—or expropriation—of economic value and voting power from the public shareholders to the majority or controlling stockholder,” the consequence of which is a “separate harm” that results “uniquely and individually, to the minority stockholders to the same extent that the controlling shareholder is (correspondingly) benefited.”
In its earlier opinion in the present case, the Court recognized that since Gentile was decided, its holding has been criticized and limited, including by the Supreme Court, and noted that Chief Justice Strine in his concurrence in El Paso Pipeline GP Co., L.L.C. v. Brinckerhoff stated that Gentile “cannot be reconciled with the strong weight of our precedent,” that it was inconsistent with Tooley, and that it was debatable whether Gentile is still good law. In addition, the Court discussed confusion among trial courts tasked with determining on what specific facts Gentile applies. Nevertheless, the Court concluded that it was bound by the Supreme Court’s decision in Gentile as controlling precedent, and plaintiffs’ complaint presented “the rare case that perfectly fits the narrow Gentile paradigm.” Consequently, the Court denied defendants’ motion to dismiss.
At issue in this opinion was the defendants’ Application for Certification of Interlocutory Appeal of the prior decision denying defendants’ motion to dismiss, discussed above. As a procedural matter at the outset, because the prior decision was not accompanied by an order, the Court filed an order consistent with that opinion and considered defendants’ Application for Certification to be addressed to that order.
Interlocutory appeals are governed by Delaware Supreme Court Rule 42. Rule 42 states that “[i]nterlocutory appeals should be exceptional, not routine,” and sets forth criteria in service of that principle. The Court acknowledged “the particularity with which the Supreme Court considers interlocutory appeals,” but found that the case nonetheless merited certification of the appeal based on two factors. First, the Court considered Rule 42(b)(3)(iii)(G) (“subsection (G)”), which involves whether review of the interlocutory order may terminate the litigation. The Court focused on defendants’ contention that the matter should be dismissed because the plaintiffs lack standing to pursue their complaint directly, rather than derivatively. The Court noted that if plaintiffs have standing, it would be under the Gentile doctrine, and again acknowledged that Gentile had been questioned, citing the Court’s own earlier discussion in its prior decision. That issue of Gentile’s continuing validity, the Court concluded, implicated the factor from subsection (G). The Court noted, however, that subsection (G) as applied here alone would unlikely be sufficient to sustain an interlocutory appeal.
Second, the Court looked to Rule 42(b)(3)(iii)(H) (“subsection (H)”). Subsection (H) asks whether review of the interlocutory order may serve considerations of justice. The Court again based its reasoning on “case law questioning the continued vitality of Gentile at the trial court level,” and “criticism at the Supreme Court level,” and found that an interlocutory appeal was in the interest of justice in this case. Moreover, the Court explained an interlocutory appeal was appropriate whether that appeal is successful or unsuccessful. The Court noted that a successful interlocutory appeal “will avoid substantial useless effort on behalf of litigation by parties who lack standing,” and an unsuccessful appeal “will still serve the interests of justice, by clarifying an area of law that appears to be in a state of flux.”
Plaintiffs argued that relying solely upon the last two factors in Rule 42(b)(3)(iii) was a “weak ground upon which to certify interlocutory appeal,” but the Court maintained that this matter presented a “rare exception” for which that is not the case, and noted that “if the Supreme Court disagrees, it need only decline to accept the appeal.” The Court therefore ordered certification of the interlocutory appeal.
In re Terraform Power, Inc. Stockholders Litigation, C.A. No. 2019-0757-SG (Del. Ch. November 24, 2020)