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Court of Chancery Dismisses De Facto Dividend Claim Because Disguised as Improperly Pled Claim of Self-Dealing

Horbal v. Three Rivers Holdings, Inc., C.A. No. 1273-N, 2006 WL 668542 (Del. Ch. Mar. 10, 2006). Plaintiffs, founders of a Health Management Organization, alleged that their co-investors abused their positions by siphoning off tens of millions of dollars from the HMO in the form of disguised salaries and corporate perquisites; plaintiffs call these "de facto dividends." The Court of Chancery granted defendants' motion to dismiss because plaintiffs did not adequately allege self-dealing, the center of a de facto dividend claim.

Plaintiffs' de facto dividend claim was centered on allegations of director self-dealing. Plaintiffs alleged that the director defendants used wholly-owned subsidiaries under their control to siphon off millions of dollars in the forms of excessive salaries, bonuses, and corporate perquisites. Plaintiffs asked the court to treat this excessive compensation as constructive or de facto dividends to which plaintiffs, as shareholders, had a right to share in equally. The Court of Chancery noted that no Delaware court has ever recast executive compensation as a constructive dividend nor has any Delaware court recognized such a cause of action to exist for the benefit of shareholders of a corporation. The court dismissed plaintiffs' claims because they neither alleged fraud nor adequately pled a breach of fiduciary duty. Plaintiffs did not directly challenge the management agreements, or the payments thereunder, on duty of loyalty grounds. Authored by: Fotini Antonia Skouvakis 302.888.5202 fskouvakis@morrisjames.com