Attorney Fees Awarded Notwithstanding Failure to Prove Damages for Breach
In In re Nine Systems Shareholders Litigation, (Del. Ch. May 7, 2015), the Delaware Court of Chancery faced the difficult task of deciding an appropriate fee award where the defendants engaged in disloyal, bad-faith conduct, but the plaintiffs failed to prove damages. The plaintiffs proved at trial that the defendants breached their duty of loyalty to plaintiffs by conducting a self-interested recapitalization. Among other things, the defendants "utterly failed" to understand their fiduciary relationship with the plaintiffs, employed a "grossly inadequate process" and sought to avoid full and fair communications with the company's stockholders. Based on this wrongdoing, the court found the defendants engaged in bad-faith pre-litigation conduct that warranted fee-shifting in the amount of $2 million.
The plaintiffs, who were minority stockholders, sought damages related to a 2002 recapitalization of the company (Streaming Media Corp., later known as Nine Systems) that increased the equity of certain defendants (officers and directors of the company) and correspondingly diluted the plaintiffs' equity. The plaintiffs alleged that, at the time of the recapitalization, the company was worth $30.89 million. In 2006, the company was sold for approximately $175 million, and the plaintiffs sought damages of over $130 million. Although, as noted above, the court found that the defendants breached their duty of loyalty to the plaintiffs, no damages were awarded, as the equity value of the company at the time of the recapitalization was $0.
After prevailing at trial, the plaintiffs were granted leave to "petition the court for an award of attorneys' fees and costs." The court granted leave based on "its inherent equitable power to shift attorneys' fees and its statutory authority to shift fees." Although acknowledging that equitable fee-shifting is "unusual relief" in light of the American rule, the court noted there are a number of well-established exceptions, including "cases where the underlying (pre-litigation) conduct of the losing party was so egregious as to justify an award of attorneys' fees as an element of damages." Known as the bad-faith exception, the court noted there is substantial authority indicating that it is "limited to cases of intentional misconduct." The court, however, found that its "equitable powers can be viewed more broadly as permitting fee-shifting 'where the situation or the equities dictate that such a burden should not fall on the prevailing party.'" The court also noted that the Delaware courts have considered a need "'to discourage outright acts of disloyalty' and to avoid penalizing plaintiffs 'for bringing a successful claim against the [defendant] for breach of their fiduciary duty of loyalty.'"
The court found the defendants' pre-litigation conduct warranted a shifting of fees. In particular, the court detailed the disloyal conduct of the defendants, including "knowingly excluding" a director representing minority shareholders from the decision-making process and conducting a "grossly inadequate process." Particularly troubling was the defendants' concealment of information related to the recapitalization until it was too late for the plaintiffs to take timely legal action. The defendants failed to disclose relevant information related to the recapitalization despite the fact that plaintiffs "held reasonable concerns" about it. The court concluded that "'bad faith' depends on context, and the court is satisfied that defendants' pre-litigation conduct qualifies."
With respect to the amount of the fee award, plaintiffs' lead counsel accrued fees and costs in the amount of about $11.4 million. The fees were accrued in filing two complaints, defending against motions to dismiss and for summary judgment and conducting an 11-day trial. Although the court did not question that the legal work at issue was performed, it found that the fees incurred were disproportionate to the benefit the litigation achieved and excessive in relation to a "plausible pretrial damages assessment." In determining an appropriate award, the court evaluated the fee request under the Sugarland factors and also projected a "reasonable pre-litigation recovery range." After considering the relevant factors, the court determined that a realistic estimate of plaintiffs' likely recovery was in the $7 million to $10 million range. Based on that range, the court awarded plaintiffs fees in the amount of $2 million.
Defendants often assume that, in the absence of intentional wrongful pre-litigation conduct and a recovery of damages, fee-shifting will not occur. The decision in Nine Systems is a reminder that the Court of Chancery has broad equitable powers that can be employed to discourage disloyal conduct by fiduciaries. Although the plaintiffs in Nine Systems only received a fraction of the attorney fees requested, the decision provides an example of the risks associated with acting in a disloyal manner and concealing relevant information from minority shareholders.