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Seizing Control of a Dispute by Seeking Declaratory Judgment

September 24, 2011
Morris James LLP
Delaware Business Court Insider

For companies in disputes with third parties or insiders, filing a declaratory judgment action offers a way to seize control of a dispute and frame the contours of the litigation. Filing a declaratory judgment also provides a way to resolve uncertainty, such as when potential claims affect a business's ability to obtain financing. There can be a number of advantages to this approach, assuming the parties can satisfy the requirements for a declaratory judgment, versus waiting to see if the other side sues.

The advantages include "setting the table" for the litigation. The initiating party can tell the court its side of the story first, define the framework of the parties' dispute and introduce the key issues and players to its advantage. If there are bad facts for the initiating party, it can attempt to neutralize those bad facts by explaining why they are not actually bad or do not really matter. Such an approach can be preferable to defending bad facts after the other side initiates litigation and distorts the facts to its advantage. A defendant moving to dismiss a complaint for failure to state a claim cannot challenge the well-pleaded facts in the complaint. The court must accept the allegations as true in resolving the motion to dismiss.

Another potential advantage to initiating a declaratory judgment action is forum selection. Perhaps there are multiple jurisdictions that could hear the dispute and the parties did not select a forum. Or maybe there is some question as to the appropriate jurisdiction. Even if the parties have selected a forum, perhaps the other side is likely to file somewhere else.

Delaware courts move promptly and a party that initiates a declaratory judgment action in Delaware will at least have the opportunity to argue that Delaware is the appropriate forum. Like all courts, however, Delaware courts are critical of forum shopping, so filing a declaratory judgment action with a weak basis for jurisdiction in Delaware compared to a more convenient forum is unlikely to succeed.

A party can seek a declaratory judgment in the Superior Court or Court of Chancery. If a party chooses to file a declaratory judgment action in the Court of Chancery, then it will still need to establish a basis for the Court of Chancery to exercise its equitable jurisdiction. A declaratory judgment involving purely legal claims and remedies will not create equitable jurisdiction. A party may establish equitable jurisdiction by seeking equitable relief such as specific performance or a preliminary injunction or by asking the Court of Chancery to interpret Delaware organizational documents such as a charter or a merger agreement involving a Delaware company.

The Delaware Declaratory Judgment Act gives courts the "power to declare rights, status and other legal relations whether or not further relief is or could be claimed." (See 10 Del. C. § 6501.) A party cannot maintain a declaratory judgment action without an actual case or controversy between the parties. The Court of Chancery in August analyzed whether an actual case or controversy existed, focusing on whether the parties had real and adverse interests and a ripe dispute, in K & K Screw Products v. Emerick Capital Investments Inc.

In K & K, Vice Chancellor Donald F. Parsons Jr. explained that a defendant must have an interest adversely affected by the declaration sought by the plaintiff. Even though the defendant claimed it was not presently intending to assert certain claims against the plaintiff, it refused to waive its rights to assert those claims in the future. Accordingly, the Court of Chancery concluded that the parties had real and adverse interests.

The Court of Chancery also found the parties' dispute was ripe. As the court recognized, a declaratory judgment action is not ripe if it depends on a future, contingent event. If, however, the declaratory relief sought is based upon facts that have already occurred and not a future, contingent event, then the parties' dispute is ripe. The court rejected the defendant's argument that the parties' dispute was unripe because the defendant had not asserted or threatened to assert claims relating to the declarations sought by the plaintiff. The court emphasized that the parties' willingness to litigate is immaterial to a ripeness analysis.

Because the material facts giving rise to most of the plaintiff's declarations had occurred in the past and were static, the court found the parties' dispute was ripe. While arguably one contingent fact remained – whether the plaintiff would fully repay its loans - the repayment was expected to occur imminently. The court also noted that the plaintiff was suffering harm in its financing efforts as a result of the defendant's possible claims. Thus, the court was not inclined to delay review of the parties' disputes.

As this decision reflects, a company may assert a declaratory judgment action even if the other side has not threatened to assert claims. This decision also illustrates the understanding Delaware courts have for the potentially negative and paralyzing consequences uncertain legal rights can have upon a party. While instituting a declaratory judgment action will not be appropriate in all circumstances, companies should keep this option in mind as a way to take control of a dispute.