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Chancery Reaffirms Narrowed Application of Gentile

In re Terraform Power, Inc. Stockholders Litigation, C.A. No. 2019-0757-SG (Del. Ch. Oct. 30, 2020)
In Terraform Power, the Court of Chancery declined the defendants’ invitation to disregard the rationale of Gentile v. Rossette—the seminal decision on dual-natured direct and derivative stockholder claims under Delaware law. On a motion to dismiss, the Court concluded that the plaintiffs adequately plead a direct claim for relief under Gentile against a controlling stockholder for executing a private placement that increased the controller’s voting power for an allegedly inadequate price and correspondingly decreased the minority ownership stake and voting power. In doing so, the Court reaffirmed the Gentile’s continued, albeit narrow, application, unless and until the Delaware Supreme Court holds otherwise. 

Despite having the debt capacity to fund most, if not all, of the necessary cash to acquire a Spanish onshore wind and solar business, the nominal defendant’s controlling stockholder caused the nominal defendant, through a private placement, to fund most of the purchase price with an equity offering backstopped by the controller. At the completion of the private placement, the controller increased its ownership interest from 51% to 65.3%. This percentage subsequently was reduced to 61.5% through a second private placement. Minority stockholders brought direct and derivative claims against the controller and its affiliates, the four board members appointed by the controller, and the nominal defendant’s CEO. After a merger consummated post-complaint, the plaintiffs lost standing to pursue their derivative claims leaving only the direct claims at issue. The defendants challenged the plaintiffs’ standing to bring the dilution claims arguing that such claims were exclusively derivative.

The plaintiffs argued that the complaint stated traditionally direct claims under Tooley and dual-natured claims under Gentile. The Court found the plaintiffs’ allegations of corporate overpayment and controlling stockholder entrenchment insufficient to satisfy the standard for direct claims under Tooley. Corporate overpayment claims are a quintessential derivative claim. And the Court concluded that the plaintiffs’ argument that the private placement allegedly entrenched the controller in circumstances relating to a subsequent public offering, thereby resulting in distinct harm to the minority stockholders, failed the reasonable conceivability standard of pleading.      

With respect to direct claims under Gentile, the Court found the facts of this case and those of Gentile “indistinguishable.” The transactional paradigm set forth in Gentile is a “species of corporate overpayment claim” whereby a controller causes the corporation to issue excessive shares of its stock to the controller for insufficient value and this exchange increases the percentage of outstanding shares owned by the controller and decreases the percentage owned by the minority in a corresponding amount. Because the shares representing the overpayment reflect both economic value and voting rights, the resulting harm to the minority stockholder is not exclusively derivative.  Here, the plaintiffs’ allegations fit within Gentile.      

Defendants conceded that Gentile applied but argued that the Court “need not follow Gentile because it was improperly decided” and criticized in subsequent authority. The Court acknowledged that trial court decisions have questioned Gentile’s reasoning. But, in the El Paso decision from 2016, the Delaware Supreme Court adopted a narrow application of Gentile that applied only when a stockholder already possessing a majority or effective control causes the corporation to issue more shares to it for inadequate consideration. Because El Paso limited, but did not overrule, Gentile, the Court declined defendants’ request to disregard it. The Court of Chancery subsequently certified an interlocutory appeal of its decision to the Delaware Supreme Court.     

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