No. 436, 2010 (Del. June 20, 2011)
In this decision of the Supreme Court sitting en banc, Chief Justice Steele reversed the Court of Chancery’s judgment of dismissal with respect to the shareholder-plaintiffs’ derivative claims concerning alleged breaches of fiduciary duty, and remanded the case for further proceedings. In so ruling, the Supreme Court clarified the required elements of a derivative claim for a corporate injury caused by a fiduciary’s breach of the duty of loyalty through insider trading, as set forth in Brophy v. Cities Serv. Co., 70 A.2d 5 (Del. Ch. 1949), and its progeny (hereinafter, a “Brophy claim”).
By way of background, in Pfeiffer v. Toll, 989 A.2d 683 (Del. Ch. 2010), Vice Chancellor Laster affirmed the continuing vitality of Brophy claims and recited the well-established elements thereof: (i) “the corporate fiduciary possessed material, nonpublic company information;” and (ii) “the corporate fiduciary used that information improperly by making trades because she was motivated, in whole or in part, by the substance of that information.” In Pfeiffer, Vice Chancellor Laster further held that the purpose of a Brophy claim is to “remedy harm to the corporation,” and that disgorgement is not an available remedy in the absence of actual corporate harm.
In Kahn, captioned below as In re Primedia, Inc. Derivative Litigation, C.A. No. 1808-VCL, two shareholders of Primedia, Inc. (“Primedia”) asserted various derivative claims against Kohlberg Kravis Roberts & Co. L.P. (“KKR”), which controlled approximately 60% of Primedia’s outstanding stock, and Primedia’s current and former directors. The plaintiffs’ claims included, in relevant part, a Brophy claim against KKR based upon its alleged improper use of insider information. Primedia formed a Special Litigation Committee (“SLC”), which moved to dismiss the plaintiffs’ claims in their entirety following the completion of its own investigation of the claims. On June 14, 2010, ruling from the bench and applying the standard set forth in Zapata Corp. v. Maldonado, 430 A.2d 779 (Del. 1981), Vice Chancellor Laster dismissed the plaintiffs’ claims with prejudice, holding under Zapata that (i) the SLC’s decision had been based upon an independently thorough investigation of the claims’ merits and a cost-benefit analysis of pursuing such claims; and (ii) the Brophy claim against KKR might otherwise survive dismissal for failure to state a claim, but that Primedia had suffered no harm and therefore disgorgement was not available under Pfeiffer.
On appeal, the Supreme Court reviewed the first prong of the Court of Chancery’s Zapata analysis de novo and affirmed that the SLC acted in good faith and had a reasonable basis for its conclusion. As to the second prong, which entails the sustainability of claims which the SLC has declined to pursue, the Supreme Court reviewed the Court of Chancery’s business judgment for abuse of discretion.
The Supreme Court’s analysis centered upon the actual harm requirement set forth in Pfeiffer, which “is not a correct statement of our law.” The Supreme Court “decline[d] to adopt Pfeiffer’s thoughtful, but unduly narrow, interpretation of Brophy and its progeny,” and clarified that a Brophy claim focuses not upon the harm to the corporation, but rather the prevention of a fiduciary wrongdoer’s unjust enrichment. Moreover, no reasonable public policy ground favored restricting the scope of the disgorgement remedy with respect to Brophy claims. Accordingly, “actual harm to the corporation is not required for a plaintiff to state a claim under Brophy.”
The Supreme Court could not ascertain from the record below whether the Court of Chancery had relied upon the incorrect holding of Pfeiffer in applying Zapata’s second prong and granting dismissal, and therefore reversed and remanded with instructions to analyze the Brophy claim without any requirement that the plaintiffs establish harm to the corporation.
As a side issue, the SLC contended that the parties’ dispute was moot because an imminent transaction involving Primedia would divest the plaintiffs of standing to pursue their claims. The Supreme Court held that this case falls within an exception to the mootness doctrine for “matters of public importance that are capable of repetition yet may evade review.” Indeed, the Supreme Court noted that the Pfeiffer litigation had been stayed pending the outcome of this appellate decision.
The full opinion is available here.