In Gentile v. Rossette, 906 A.2d 91 (Del. 2006), plaintiffs, former stockholders of SinglePoint Financial, Inc. (“SinglePoint”), appealed from a grant of summary judgment by the Delaware Court of Chancery which dismissed their claim for breach of fiduciary duty against SinglePoint’s former directors and its former Chief Executive Officer, Pasquale David Rossette, who also was SinglePoint’s controlling stockholder. Plaintiffs challenged an alleged selfdealing transaction in which Rossette forgave the corporation’s $3 million debt to him in exchange for stock of SinglePoint, which had a value that allegedly exceeded the value of the forgiven debt. The transaction, it was alleged, wrongfully reduced the cash-value and the voting power of the public stockholders’ minority interest in SinglePoint and increased the value and voting power of Rossette’s majority interest correspondingly. After the debt was forgiven and the stock was issued, SinglePoint was acquired by another company (“Cofiniti”) in a merger. Shortly after the merger, Cofiniti filed for bankruptcy and was liquidated.
Plaintiffs filed an action in the Delaware Court of Chancery seeking to recover the value that plaintiffs claimed to have been wrongfully deprived in connection with the forgiveness of debt and the is- Delaware Supreme Court Expands Upon Its Decision In Tooley And The Distinction Between A Direct And A Derivative Claim suance of stock to Rossette. The Court of Chancery granted defendants’ motion for summary judgment and dismissed the action on the basis that the claim alleged by plaintiffs was derivative, and, as a result of the merger with Cofiniti, plaintiffs lost standing to assert the claim on behalf of SinglePoint. In dismissing the action, the Court of Chancery relied upon the decision of the Delaware Supreme Court in Tooley v. Donaldson, Lufkin & Jenrette, Inc., 845 A.2d 1031 (Del. 2004), and stated that because the harm associated with plaintiffs’ claim was suffered only by the company, and because any remedy— either to cancel the “excess” shares issued to Rossette or to require Rossette to restore their fair value—would benefit only the company, the claim was derivative in nature. See Gentile v. Rossette, 2005 WL 2810683 (Del. Ch. Oct. 20, 2005).
In the appeal, the Delaware Supreme Court recognized that the issue presented by plaintiffs was “one purely of law: can SinglePoint’s former minority stockholders bring a direct claim against the fiduciaries responsible for the debt conversion transaction complained of, or is such a claim exclusively derivative?” After initially acknowledging that “[n]ormally, claims of corporate overpayment are treated as causing harm solely to the corporation and, thus, are regarded as derivative,” the Court then stated:
There is, however, at least one transactional paradigm – a species of corporate overpayment claim – that Delaware case law recognizes as being both derivative and direct in character. A breach of fiduciary duty claim having this dual character arises 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.
Such a transaction, the Delaware Supreme Court noted, (i) harms the corporation because of the “overpayment (or ‘over-issuance’) of shares” and the corporation “has a claim to compel the restoration of the value of the overpayment,” and (ii) harms the minority stockholders because the shares that represent the “overpayment” embody both economic value and voting power being transferred improperly “from the public shareholders to the majority or controlling stockholder” and the minority stockholders have a claim “to recover the value represented by that overpayment.”
The Delaware Supreme Court then stated (among other things) that this application of Delaware law “fits comfortably within the analytical framework mandated by Tooley,” and, “[h]ence, although under Tooley the claim could be brought derivatively or directly, as a practical matter, the only claim available after Cofiniti was liquidated is a direct action by plaintiffs.” In sum, the Delaware Supreme Court held that “[f]or these reasons, we conclude that the Court of Chancery committed reversible error in granting summary judgment dismissing plaintiffs’ debt conversion claim,” and the Court reversed the decision of the Court of Chancery and remanded the action “for proceedings consistent with this Opinion.”