C.A. No. 4167-VCL (July 24, 2009) (Lamb, V.C.)
In this case, the Court of Chancery addressed the disclosure obligations of corporate insiders in connection with the insider’s purchase of shares from a stockholder. The Court granted in part and denied in part the defendants’ motion to dismiss the complaint, which alleged failure by the company and certain investors to inform the plaintiff-stockholder of a particular impending transaction when the stockholder sold its shares to the investors. The plaintiff-stockholder, Brett Stewart (“Stewart”), a founder and former CEO of Wayport, Inc. (“Wayport”), entered into a right of first refusal agreement (the “Agreement”) with Wayport and certain investors in Wayport, including Trellis Partners Opportunity Fund, LP (“Trellis”) and two affiliates of New Enterprise Associates (“NEA”). The Agreement restricted the transfer of all Wayport common stock held by Stewart and made those shares subject to a right of first refusal for the benefit of Wayport, and if Wayport did not exercise its right, the other investors, including Trellis and NEA.
In early 2006, Millennium Technology Ventures Partners, L.P. (“MTVP”) offered Stewart and other founders $3 per share for a portion of their Wayport shares. The holders of the rights of first refusal declined to exercise their rights when Stewart informed them of his potential transaction with MTVP. In connection with this transaction, Stewart requested that Wayport provide him information regarding the company, and Wayport complied to a limited extent, making available information about its financial results. In late 2006 and early 2007, Stewart and MTVP discussed a second set of sales transactions at $2.50 per share. Importantly, during this time, Chuck Williams (“Williams”), Wayport’s Senior Vice President, General Counsel, and Corporate Secretary, asked Stewart to make more shares available to company insiders. No Wayport director purchased shares from Stewart at this time, but Trellis and NEA purchased from Stewart 148,000 shares and 350,000 shares, respectively, between May 21, 2007 and October 1, 2007. During this time, both Trellis and NEA potentially had access to Wayport inside information through their board representatives. In response to Stewart’s concern that the parties were not on a level playing field with respect to information about Wayport’s business, Trellis’ managing partner stated that no one at Trellis was “aware of any bluebirds of happiness” with respect to Wayport.
Meanwhile, prior to May 2007, Wayport and its board became aware of an interest by Cisco System, Inc. (“Cisco”) in at least one of Wayport’s patents, which transaction Stewart alleged was near closing or already closed at the time Trellis’ managing partner disclaimed knowing of any “bluebirds of happiness.” On or about October 30, 2007, Stewart became aware of the Cisco transaction through a mention in Wayport’s financial statements, which prompted him to demand the inspection of books and records under Section 220 of the Delaware General Corporation Law, and Wayport provided him with limited additional information. On November 26, 2008, Wayport announced that it reached an agreement to sell the company to AT&T for $6.43 per common share, plus a $0.25 per common share pre-merger dividend and the right to receive a further “remainder dividend” about 18 months after the transaction closed.
Stewart, through Latesco, Inc., the entity through which Stewart beneficially-owned the Wayport stock (“Latesco,” and together with Stewart, the “plaintiffs”), asserted several claims against Wayport, Trellis, NEA, and directors of Wayport (collectively, the “defendants”), including breach of the fiduciary duty of disclosure (Count I), breach of the fiduciary duty of loyalty (Count II), fraudulent misrepresentation (Count III), civil conspiracy (Count IV), aiding and abetting breaches of fiduciary duty (Count V), unjust enrichment (Count VI), and breach of contract (Count VII). The defendants moved to dismiss the complaint for failure to state a claim upon which relief can be granted and for failure to plead fraud with particularity.
The Court held that, generally, the contours of an insider’s duty to a selling stockholder is defined by the terms of the right of first refusal itself and the normal prohibitions against fraud. However, because Williams had asked Stewart to make available to insiders a large number of additional shares, which ultimately led to the purchase by Trellis and NEA, the second set of transactions fell outside the right of first refusal. Therefore, that transaction should be evaluated under the standard of fraud as applied to transactions between corporate insiders and minority stockholders and not by the terms of the Agreement. This standard, the Court noted, is scienterbased and may include a duty to speak when, in purchasing or selling stock, the fiduciary is aware that material information is known to him, but not known to the counter party. The Court noted that this was not an instance of the fiduciary duty of disclosure, as it resulted from the corporation asking an individual stockholder to enter into a purchase or sale. A duty of disclosure claim, the Court noted, is only implicated when the company requests the stockholders collectively to take action (e.g., vote or tender their shares). Moreover, Delaware fiduciary law does not guarantee all stockholders identical rights to corporate information, and the Court suggested that the right of first refusal gives insiders such as Trellis and NEA an unconstrained right to buy shares when notice is given.
The Court further held that the complaint pled sufficient facts to support a claim that Trellis and NEA traded with Stewart in the second sales transactions while in possession of material undisclosed inside information. Therefore, the claim for breach of the duty of loyalty against Trellis and NEA could not be dismissed. Similarly, the complaint adequately pled a claim for breach of the duty of loyalty against Williams and Wayport, as Williams (as an officer and agent of Wayport) induced plaintiff to offer additional shares beyond those MTVP was prepared to buy while potentially in possession of inside information. The Court dismissed Count II as to the remaining director defendants, however, because there was no allegation of board action implicating a breach of the duty of loyalty. The Court further held that plaintiff adequately pled a claim against Trellis, NEA, Wayport, and Williams based on a theory of fraudulent misrepresentation, noting that they were likely subject to a duty to speak, allegedly sought to induce plaintiffs to sell at a lower price than they would have with full information, and that plaintiffs adequately pled that they were harmed by defendants.
The full opinion is available here.