On June 25, 2018, the Delaware Court of Chancery denied a motion to dismiss, finding that when a controller uses his control to extract a special benefit in a stock sale, at the expense of the company’s minority stockholders, the latter may sue directly. In addition, the transfer of corporate assets for “a manifestly unfair price” is sufficient to state a claim for breach of fiduciary duties.

Generally, “When the controller of a company improperly uses his control to enter a transaction with the company at the expense of the minority, the resulting cause of action for breach of fiduciary duty is an asset of the company, which stockholders typically can pursue only derivatively. When the company is sold, the litigation asset, like the other assets, passes to the purchaser.”

However, when a controller improperly uses her control to extract a special benefit in the sale itself, the former stockholders may sue directly.

Here, a holding company was for sale. It was subject to a fine which would be levied by the federal government upon sale of assets.

The directors, concerned that the value of the indemnification right could not be adequately monetized through the sale of the company, opted to put the indemnification claim into a litigation trust, the benefit of which would be received by stockholders—along with the consideration paid by the buyer—when the claim ripened upon the sale of the company.

The stockholders alleged that the controller used his control to purchase the indemnification asset for a price manifestly unfair. After the sale, $614 million of the consideration was diverted to pay the fine, but the company only received around $10 million from the controller for release of the claim.

The stockholders sued the controller, and others, directly for breach of fiduciary duties.

Defendants argued that this was a classic derivative claim where the cause of action passed to the purchaser, and the claim of the former stockholders had to be dismissed.

The Court, however, disagreed with Defendants and deemed the stockholders’ claim direct. The transfer of the indemnification claim to the controller was “sufficiently intertwined with the sale of the company and the assets received by stockholders” to state a claim that the sales transaction was unfair. The indemnification right did not fully ripen until the sale, and the leverage used by the controller included a threat to nix the transaction unless corporate assets were first transferred to his affiliates for a manifestly unfair price.

In re Straight Path Communications Inc. Consol. S’holder Litig., C.A. No. 2017-0486-SG (Del. Ch. June 25, 2018), is available at https://courts.delaware.gov…