Earlier this year, the Chancery Court of Delaware denied approval of a proposed settlement of a derivative action based solely on a personal benefit the named plaintiff was to receive. Plaintiff Marvin Smollar brought a derivative action on behalf of VitalSpring Technologies, Inc. in an attempt to remedy certain alleged corporate governance failures. The parties reached a settlement of the litigation, and Smollar was able to achieve “much of, it not most of, the relief which he sought,” including a shareholder’s meeting, the appointment of two independent directors and a special review committee, and the hiring of an independent auditor. In addition to that relief, the settlement agreement also afforded Smollar the opportunity to sell back his VitalSpring shares at the price he paid for the stock. This was a unique and personal benefit not afforded to VitalSpring’s other shareholders, and it was especially beneficial to Smollar because there is little opportunity to trade in VitalSpring stock due to the federal securities laws and certain provisions in VitalSpring’s stock purchase agreement. In fact, counsel for neither party could identify a sale of VitalSpring stock within the last year.

Despite the fact that the settlement was recommended by the special review committee and the board of directors and generally supported by a majority of VitalSpring’s shareholders (eleven shareholders objected to Smollar’s personal benefit), the Chancery Court denied approval based on Smollar’s equity buy-back. The court explained that its task in assessing a proposed settlement is to determine whether the settlement is fair and reasonable and that an award of disparate benefits to the representative plaintiff, who owes a fiduciary duty to other shareholders, “will be closely scrutinized by the Court.” The court rejected Smollar’s argument that the settlement should be approved because the bulk of the settlement benefits were obtained through his efforts even before his equity buy-back was negotiated. Instead, the court characterized the buy-back as “self-dealing” that “drifts far from the conduct expected of a fiduciary” and distinguished a case where the named plaintiff’s personal benefit also resulted in a corporate benefit, unlike in this case. Even though the special committee and board of directors recommended the proposed settlement, the court believed that they did not properly assess how Smollar’s personal benefit discredited the fairness and reasonableness of the settlement and denied approval.

The case remains pending and illustrates the limitations on what benefits can be given to a named plaintiff who chooses to prosecute a derivative claim under Delaware law. Smollar v. Potarazu, C.A. No. 10287-VCN, 2016 Del. Ch. LEXIS 4 (Jan. 14, 2016