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Chancery Decides Questions of First Impression Regarding Statutory Claims for Unlawful Dividends and Fraudulent Transfers

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August 5, 2019
K. Tyler O'Connell and Albert J. Carroll
Delaware Business Court Insider

Enforcement mechanisms available to creditors of Delaware corporations may include, inter alia, claims against directors to recover unlawful dividends under Section 174 of the Delaware General Corporation Law (8 Del. C. Section 174), and fraudulent transfer claims against the corporation and transferees including, where Delaware law applies, under Delaware’s Uniform Fraudulent Transfer Act, referred to as DUFTA (6 Del. C. Section 1301). In JPMorgan Chase Bank v. Ballard, C.A. No. 2018-0274-AGB (Del. Ch. July 11, 2019), Chancellor Andre G. Bouchard of the Delaware Court of Chancery addressed three important questions of first impression concerning standing and limitations periods issues under these statutes.

Background

Data Treasury Corp. (DTC) is a Delaware corporation whose primary business allegedly was suing financial institutions for infringement of check-imaging patents. DTC sued JPMorgan, and, in 2005, settled its claims in exchange for a $70 million licensing arrangement. The license agreement contained a “most-favored license provision,” providing that if DTC later licensed the patents to another party, JPMorgan would be entitled to notice and “the benefit of any and all more favorable terms.”

DTC allegedly soon began violating the agreement by entering into licensing agreements for the patents without informing JPMorgan or giving it the benefit of the more favorable terms. Among other such instances, DTC licensed the patents to a bank for just $250,000 in fall 2012.

Simultaneously, between 2006 and 2010, DTC allegedly issued more than $117 million in dividends to stockholders (the challenged dividends), when its directors knew or should have known that its business was in jeopardy due to the large refund owed to JPMorgan in accord with the most-favored license provision and the likely effects of patent litigation reform legislation.

Additionally, after JPMorgan first sued DTC outside of Delaware in connection with the most-favored license provision, DTC transferred nearly $14 million to certain insiders and affiliates, and loaned $1.5 million to an entity owned and controlled by its chairman, which was not repaid (the challenged transfers).

In 2015, JPMorgan obtained a ruling that it was retroactively entitled to the terms of DTC’s $250,000 license agreement, resulting in a roughly $69 million judgment against DTC. Thereafter, DTC allegedly resisted post-judgment discovery in aid of enforcement.

In mid-2018, JPMorgan filed this suit in Delaware against DTC, its directors during the relevant time period, and certain affiliates. JPMorgan alleged, among other things, that the challenged dividends were unlawful because the directors did not make them from net profits or surplus in violation of the DGCL; and the challenged dividends and challenged transfers were unlawful because the company made them with the intent to defraud creditors in violation of Section 1304(a)(1) of DUFTA. The defendants moved to dismiss on several grounds, including that JPMorgan lacked standing to bring its Section 174 claim, and that claims under both statutes were time-barred.

Chancery Resolves Three Questions of First Impression

The Chancellor first addressed the defendants’ motions to dismiss JPMorgan’s Section 174 claims for unlawful dividends. Briefly, Section 170 of the DGCL vests the responsibility to declare dividends in a corporation’s board of directors while also circumscribing that authority. At a high level, dividends are unlawful when not issued from surplus or net profits. In instances where the board declares unlawful dividends, Section 174 of the DGCL provides for personal liability of directors “to the corporation, and to its creditors in the event of [the corporation’s] dissolution or insolvency.”

The Court agreed with defendants that, to have standing to bring a claim under Section 174, JPMorgan must qualify as a “creditor” under the statute. This issue presented the initial question of first impression: to qualify as a “creditor” and thus have standing under Section 174, must a party have been a judgment creditor at the time of the challenged dividends?

The Chancellor answered that question in the negative. Construing the term “creditor” broadly, the Court held that, to qualify as a “creditor” and have standing under Section 174, it is sufficient that a party have a claim against the corporation at the time of the challenged dividends, whether or not reduced to a judgment. In reaching this conclusion, the Court cited the one Delaware Supreme Court decision “touching” on the issue, Johnston v. Wolf, 487 A.2d 1132 (Del. 1985), finding it “tacitly suggested” this result. The Court also found its reading in harmony with Delaware precedent concerning other remedies available to “creditors.” Specifically, the Court cited case law interpreting the predecessor to Section 291 of the DGCL, which permits creditors of insolvent corporations to seek the appointment of a receiver, and DUFTA itself, which recognizes that having a “right to payment” suffices to make one a creditor whether or not it has been reduced to a judgment. Applying this interpretation, the Court declined to dismiss JPMorgan’s Section 174 claims on standing grounds, as its claim against DTC concerning the license existed at the time of the challenged dividends.

The Court, however, went on to find that JPMorgan’s Section 174 claims were time-barred. Section 174 provides for director liability “at any time within six years after paying such unlawful dividend.” This issue presented the next question of first impression: is the six-year time period set forth in Section 174 a statute of limitations subject to tolling doctrines or, alternatively, a statute of repose not subject to tolling doctrines?

The Court found it to be the latter. In concluding the six-year time period was a statute of repose, the Court cited the fact that period ran from a specific act (i.e., the payment of the dividends), rather than the accrual of a cause of action. The Court also relied on the statute’s legislative history. Section 174’s six-year time period was present since the late 1800s. Just prior to 1900, the General Assembly added that the statute could be enforced through “an action on the case,” which was a type of proceeding governed by a three-year statute of limitations. The Court inferred that Section 174’s six-year time period thus was understood to be a statute of repose, imposing a maximum outside date for bringing a claim, complementing the shorter three-year statute of limitations period. Otherwise, the amendment would have created two inconsistent limitations periods. The Court buttressed this reading citing precedent supporting that statutes of repose may work in tandem with statutes of limitations. Applying this reading, because JPMorgan did not bring its Section 174 claims within six years of the challenged dividends, the Court found them to be time-barred.

However, the Court upheld JPMorgan’s fraudulent transfer claims. Section 1309(1) of DUFTA provides that claims for transfers made with intent to defraud under Section 1304(a)(1) must be brought within four years of the transfer or, if later, “within one year after the transfer … was or could reasonably have been discovered by the claimant.” This issue presented the final question of first impression: does DUFTA’s one-year period for claims under Section 1304(a)(1) start when the mere existence of the transfer was or could reasonably have been discovered or, alternatively, when the fraudulent nature of the transfer was or reasonably could have been discovered?

Recognizing there was no “clear” Delaware authority on this issue, the Court found the existing authority supported the latter interpretation. According to the Court, authority supporting that the one-year period relates to discovery of the transfer’s fraudulent nature rather than its existence included a Delaware bankruptcy court decision, a treatise on the Uniform Fraudulent Transfer Act (upon which Delaware based DUFTA), as well as precedent outside of Delaware. Applying this interpretation, the Court found that JPMorgan could not reasonably have discovered the alleged fraudulent nature of DTC’s transfers more than a year before its complaint, largely due to alleged obstructionist discovery tactics in prior litigation, such as DTC allowing its corporate records to be destroyed and its witnesses’ refusal to answer questions about DTC’s assets, financial health and the amount of the dividends at-issue. Since JPMorgan filed suit within a year of learning sufficient information to discover their alleged fraudulent nature, the Court declined to dismiss its DUFTA claims concerning the challenged dividends and challenged transfers on statute of limitations grounds.

Key Takeaways

Under Ballard, claimants at the time dividends are declared, not just judgement creditors, have standing to pursue unlawful dividend liability against directors under Section 174 of the DGCL. Further, a director’s potential liability under Section 174 ends six years after the challenged dividends. However, claims for fraudulent transfers under Section 1304(a)(1) of DUFTA extend potentially longer, up to a year after the alleged fraudulent nature of the transfer was or reasonably could have been discovered. In short, Ballard is a mixed bag for directors who approve dividends and the creditors of corporations. Being the first Delaware trial court to address these questions of first impression, it is possible for others to answer them differently.

Delaware Business Court Insider, July 31, 2019

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