Delaware Chancery Court Upholds Claims by PSD Client Concerning Disloyal Equity Issuance
At a hearing on December 12, 2024, Vice Chancellor Laster denied a motion seeking the dismissal of claims by PSD’s client, FESI Holdings, Inc. Instead, the Court granted FESI’s motion for a stay pending the resolution of a related New York action.
As reflected in the transcript, the Court considered claims by FESI alleging that, in or about July 2020, defendants concealed the acquisition of a lucrative government contract to provide lead Covid testing services statewide, while proceeding with an equity issuance. The Vice Chancellor consider how these events impacted the value expectable in connection with later foreclosure efforts, stating “I’d increase the value you get based on the value of the company as of the foreclosure date. … you would be getting an amount of money that would reflect both your dilution and whatever the value of the company is as of the foreclosure date. So why can’t the New York court do that?”). When delivering its rulings, the Delaware court found likely value in FESI’s claims in that court, which could be factored into damages in favor of FESI in the related New York action: “I do think there’s likely good information-based claims relating to the equity issuance. I do think there’s likely a disclosure claim that would be grounded in the implied covenant of good faith and fair dealing. That claim would run against the company for the alleged failure to identify a material contract at the time you are requesting stockholder action. For similar reasons, I think there’s likely a breach of fiduciary duty claim that runs against the controller relating to that transaction. …So it was a request for members to make an investment decision. And it seems to me that there would be some type of disclosure obligation that applies in that setting either under the implied covenant running to the company or under fiduciary duty principles running against the controller.”
The Delaware court sided with PSD’s suggestion that the New York court resolve the entire dispute among the parties, if possible, and the Vice Chancellor explained, in the following pertinent excerpts, how any remaining claims by FESI would revert back to the Delaware action:
But if all that was really being transferred was the economic right to proceeds from the company and not also the litigation right, then you wouldn’t fully value the plaintiff’s interests. You would only be partially valuing the plaintiff’s interests. So I think that’s a critical question that I at least would be thinking about. Again, the New York court may have its own approach, and I’m not trying to step on my judicial colleague’s toes.
Now, if it is true that in New York the court would value both the economic interest in the entity and the value associated with the dilution claim, either assuming a successful challenge or discounting it for risk, then I don’t think there’s anything left for me to do. I think at that point the plaintiff would have received full relief. And because the plaintiff can’t get a double recovery, we’d be done. And as far as I’m concerned, that would be great.
But now let’s think about a different world where New York only values the sale of the economic interests and says that whether this dilution claim was problematic under Delaware law is something that the Delaware court ought to deal with. At that point, I think it would be incumbent on me to try to value this claim or to let the claim be litigated so that the result could be incorporated in the damages remedy. And the value would be allocated based on the interest that the plaintiff would have owned but for the dilutive transaction.
As I suggested during colloquy, if I was going to just cut to the chase on this and if the sale was not good, I’d start by looking back in time and seeing if there was an actionable claim in terms of the dilution. I tend to think there is because of disclosure issues I’ve already told you about. As a remedy for that, I would likely reallocate the ownership so that the plaintiff owned more. Let’s just stop with the concept of “more.” I would then value the company, and I would give the plaintiff his proportionate share of the value of the company based on the “more.”
Barry Pollack and John Yokow lead the representation of FESI Holdings.
