Delaware Supreme Court Overrules Gentile, Resolving Tension in Legal Test To Determine Whether a Claim Is Direct or Derivative
Brookfield Asset Mgmt., Inc. v. Rosson, No. 406, 2020 (Del. Sept. 20, 2021)
Seeking to bring clarity to the issue of whether a claim is direct or derivative—a potentially outcome-determinative issue—the Delaware Supreme Court overturned its own precedent in Gentile v. Rossette, 906 A.2d 91 (Del. 2006).
A controlling stockholder of a public company steered it to make an acquisition funded with equity financing provided by the controller. The transaction enabled the controller to increase its ownership from 51 percent to more than 65 percent, at a discount to fair value. Plaintiffs filed derivative and direct class action complaints. Defendants moved to dismiss the direct claims on the basis that the claims were entirely derivative. The Court of Chancery expressed doctrinal concerns with the existing derivative claim legal test, but denied the motion to dismiss, reasoning that the dilution claims against the controller were direct claims under Gentile.
The Supreme Court accepted an interlocutory appeal and determined that tension in the law justified overruling Gentile despite Delaware’s commitment to stare decisis. In Tooley v. Donaldson, Lufkin & Jennette, Inc., 845 A.2d 1031 (Del. 2004), the Supreme Court had sought to create a simple test to distinguish direct and derivative claims, based on who suffered harm and who would benefit from recovery or remedy between the company and the stockholders, individually. Two years later, the Supreme Court decided Gentile, carving out an exception to Tooley by which a plaintiff could assert a direct claim against a controller for corporate dilution or overpayment, characterized as a dual-natured direct and derivative claim. After Gentile, practical and doctrinal difficulties arose from its inherent tension with Tooley, including Gentile’s focus on who was the wrongdoer.
In Brookfield Asset Management, Inc., the Delaware Supreme Court reasoned that a logical, consistent framework when no change in control was involved was that a corporate overpayment or dilution claim was solely derivative under Tooley—thus overruling Gentile and its carve-out. The Supreme Court reasoned that a departure from stare decisis was warranted because sufficient time had passed since Gentile to reveal its flaws, but not so much time to create “antiquity” status. Judicial decisions subsequent to Gentile had brought to light that Gentile’s continued viability was questionable, which had already resulted in diminished reliance on that case. The Supreme Court’s decision was unanimous in overruling Gentile.Share