Delaware Business Litigation Report

District Court Denies Motion to Dismiss, Allows Duty of Care, Loyalty and Fraud Claims to Proceed

Ad Hoc Comm. of Equity Holders of Tectonic Network, Inc. v. Wolford, 2008 WL 212 7464 (D. Del. May 21, 2008)

The District Court recently allowed claims for breach of the duties of care and loyalty against former directors and officers of Tectonic Network, Inc. (the “Company”) to go forward, rejecting Defendants’ jurisdiction, standing and insufficient claim arguments. Plaintiff, an Ad Hoc Committee of Equity Holders in the Company, sued Defendants for purportedly improper conduct in connection with the acquisition of three businesses and the resulting sale of one of the Company’s subsidiaries. Plaintiff alleged that Defendant Officers (Officer #1 and Officer #2) committed fraud related to the Company’s actions, and all Defendants breached their fiduciary duties. Specifically, Plaintiff alleged that the Defendants breached their fiduciary duties in recommending and/or approving the acquisition of the three businesses, all of which Officer #1 had a majority interest in. Plaintiff also alleged that the Defendant Officers committed fraud in making material misrepresentations to the board regarding the profitability of the acquired businesses and the prospective profitability of a future business plan that resulted in the sale of the Company’s subsidiary. Subsequent to acquisitions and sales, the Company’s financial picture worsened, and it filed for voluntary Chapter 11 bankruptcy. The Bankruptcy Court lifted the stay to allow Plaintiff to press its claims outside of the bankruptcy proceedings.

The Court first found that although a factual dispute existed as to whether the Court had diversity jurisdiction, jurisdiction was warranted because Plaintiff’s state law-based claims had a close nexus to the bankruptcy plan. The Court next rejected Defendants’ claims that Plaintiff lacked standing, finding the claims were not abandoned in the bankruptcy proceeding, and Defendants’ argument that Plaintiff lacked standing because it never held shares in the Company in its own name lacked merit. Also rejected was the argument that the claims were a class claim. With respect to Defendants’ argument that the Complaint pled insufficient facts to overcome the presumption of the business judgment rule, the Court distinguished between the Delaware state courts’ more stringent application of the specific factual pleading requirement of Rule 8 and the federal courts’ more lenient notice pleading standard. The Court noted that the business judgment rule was in the nature of an affirmative defense, and under the federal standard specific factual pleading was not required to overcome it. Considering Plaintiff’s fiduciary duty claims, the Court found that sufficient facts were pled to support a conclusion that Defendants lacked independence in recommending and/or approving the transactions, such that they breached their duty of loyalty. The Court also rejected Defendants’ argument that the exculpation provision in the Company’s certificate of incorporation required dismissal of the duty of care claims, finding that it also was in the nature of an affirmative defense that could not serve as the basis for a motion to dismiss under Rule 12(b)(6). Finally, the Court found that while Plaintiff alleged specific facts to support a fraud claim against Officer #1 in connection with certain representations to the board, the remaining fraud allegations against the Defendant Officers did not meet the particularity requirement under Rule 9. 

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