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Chancery Finds Plaintiffs Lost Direct and Derivative Standing After Sale of Shares

Urdan v. WR Capital Partners, LLC, C.A. No. 2018-0343-JTL (Del. Ch. Aug. 19, 2019).

It is well-settled Delaware law that the right to bring a derivative claim in the corporation’s name or a direct claim in the individual stockholder’s name is a property right associated with the ownership of shares and that those rights normally pass from a selling stockholder to the buyer.  Relatedly, Delaware law imposes two conditions for derivative standing: first, a contemporaneous ownership requirement, meaning the plaintiff must have been a stockholder at the time of the complained of wrong; and, second, a continuous ownership requirement, meaning the plaintiff must continue to be a stockholder to pursue its claims.  The rules are slightly different in the direct standing context.  In contrast to the continuous ownership requirement for derivative claims, a selling stockholder may retain the right to bring a direct claim by contract.  This decision explains and applies these concepts, finding certain stockholders lost both forms of standing when reaching a settlement, despite an apparent attempt to avoid that result in the relevant contracts.

Plaintiffs were shareholders of Energy Efficient Equity, Inc., a Delaware corporation operating in the property-assessed, clean-energy financing industry.  Plaintiffs alleged in their complaint that after loaning the Company some necessary funds and securing their representation on the board of directors, Defendants, a private equity fund based in New Jersey, cut off the Company’s other financing options and diluted the Plaintiffs through various interested transactions.  The Plaintiffs brought claims against the Defendants in the Delaware Court of Chancery for breaches of their fiduciary duties.

A few months after filing the complaint, Plaintiffs sold all of their shares back to the Company.  As part of that transaction, the Plaintiffs entered into Repurchase Agreements and a Settlement Agreement and Release with the Defendants and the Company.  The Settlement Agreement contained a release carveout clause generally covering any claims the Plaintiffs may have had against the Defendants.  In response to Defendants’ motion to dismiss for lack of standing based on the repurchase, Plaintiffs argued that they had done enough to preserve their claims through the Settlement Agreement’s carveout provision.  The Court of Chancery disagreed.

The Court reasoned that at the moment the Plaintiffs signed the Repurchase Agreements, they transferred all rights associated with the shares, with no carveouts.  The Repurchase Agreements clearly and unambiguously transferred all rights associated with the shares and did not exclude from the transfer any subset of rights associated with the shares.  Additionally, the Repurchase Agreements, which were effective first, did not incorporate the Settlement Agreement by reference and it was only the Settlement Agreement that contained a release carveout.  The Repurchase Agreements also contained an integration clause that provided that in the event of an inconsistency, the Repurchase Agreements would control.  Since Plaintiffs had no further interest in the claims and thus lacked standing to proceed under the circumstances, the dispute was non-justiciable and any decision on the merits would be an impermissible advisory opinion.