Corporate Opportunity Doctrine: Litigation Continues into 2020

Nate Emeritz is Of Counsel and Brian Currie is an associate at Wilson Sonsini Goodrich & Rosati. This post is based on their WSGR memorandum and is part of the Delaware law series; links to other posts in the series are available here.

In a short order from the Delaware Court of Chancery, Vice Chancellor Kathaleen McCormick held that a former director may have usurped a corporate opportunity by successfully bidding against his company for a contract to operate a local public access television channel. Leased Access Preservation Assoc. v. Thomas, C.A. No. 2019-0310-KSJM (Del. Ch. Jan 8, 2020) (ORDER). This decision addressed the scope of what constitutes a corporate opportunity and when a director is acting in a fiduciary capacity, each for purposes of the corporate opportunity doctrine. In doing so, this litigation picked up on issues also addressed in several cases in 2019 and suggests that the corporate opportunity doctrine may continue to be an important topic in Delaware corporate law in 2020.

Leased Access case

Leased Access, a case about a Delaware non-profit, non-stock corporation (Leased Access Preservation Association or “LAPA”) that had operated a local public access television channel on a yearly basis for five years, marks the first foray by the Court of Chancery into the corporate opportunity doctrine in 2020. In that case, when proposals were solicited for a new contract on the television channel, one of LAPA’s directors (who later claimed to have already resigned) secretly submitted a competing bid and allegedly disseminated negative information about LAPA’s operational practices, based on information he had learned as a director. An entity controlled by the director was ultimately awarded the contract. As described by the Delaware Supreme Court, the corporate opportunity doctrine “holds that a corporate officer or director may not take a business opportunity for his own if: (1) the corporation is financially able to exploit the opportunity; (2) the opportunity is within the corporation’s line of business; (3) the corporation has an interest or expectancy in the opportunity; and (4) by taking the opportunity for his own, the corporate fiduciary will thereby be placed in a position inimical to his duties to the corporation.” Broz v. Cellular Info. Sys., 673 A.2d 148 (Del. 1996).

On a motion to dismiss a claim against the former director, the court first held that this opportunity to submit a bid could have constituted a corporate opportunity. The court rejected a comparison of these facts to a case where the Court of Chancery had determined that the corporate opportunity doctrine did not extend to bidding opportunities where there was “virtually no certainty that the contractor would win.” Triton Construction Company v. Eastern Short Electrical Services, Inc., 2009 WL 1287115 (Del. Ch. May 18, 2009). In Leased Access, the court distinguished those precedent circumstances—i.e., “‘highly contingent . . . invitations to submit a bid’ in a state-wide market where ‘it is arguable whether any one contractor would have a reasonable expectancy that its bid would be accepted on any one job’”—from LAPA’s circumstances, where it was one of only two bidders competing for the contract that LAPA had held for the previous five years. The court stated, “Given the nature of this market and the limited pool of bidders, it is reasonably conceivable that LAPA had a reasonable expectation in obtaining the [contract]. This heightened probability strengthens the inference that the opportunity to be usurped was the actual awarding of the contract, not just the opportunity to bid.”

The court in Leased Access also determined that the corporate opportunity doctrine could bar the director from using corporate information to pursue the corporate opportunity, even though he had resigned as a director. The court explained that such a proscription extended to the director because he had allegedly begun working on his scheme and because he had obtained information in furtherance of that scheme while still a director: “‘A former director, of course, breaches his fiduciary duty if he engages in transactions that had their inception before the termination of the fiduciary relationship or were found on information acquired during the fiduciary relationship.’” Leased Access, at ¶ 14h n.21 quoting BelCom, Inc. v. Robb, 1998 WL 229527 (Del. Ch. Apr. 28, 1998).

Delaware Cases regarding the Corporate Opportunity Doctrine in 2019

Decisions addressing the corporate opportunity doctrine enjoy a long history in Delaware case law, see, e.g., Guth v. Loft, Inc., 5 A.2d 503 (Del. 1939), and have seen a notable increase in the Court of Chancery over the past year. Although not all of those recent cases have resulted in published opinions, the following three decisions provide important insight into the Delaware judiciary’s approach to these issues.

Personal Touch case

Early in 2019, Chancellor Andre Bouchard issued an opinion suggesting that the Court of Chancery may at times take a broad view of what counts as a “corporate opportunity” under the doctrine. Personal Touch Holding Corp. v. Glaubach, 2019 WL 937180 (Del. Ch. Feb. 25, 2019). In Personal Touch, the company’s business was home healthcare services, but the contested opportunity was the acquisition of a building in an area where the company had been seeking additional office space. Using information from the company’s property search, the president (who was also a director) worked in secret to acquire the building for himself, and immediately after purchasing the building, the president offered to lease it to the company.

In litigation, the court determined that the opportunity to acquire the office building constituted a corporate opportunity. As part of that analysis, the court compared indications of the company’s strong financial position, such as its annual revenues, EBITDAE and cash on hand, with the lack of evidence that the company was financially unable to pay the purchase price. The court next found that the company had an interest or expectancy in the building, based on the parties’ stipulation that the company had been “particularly interested” in obtaining that office space, which was located next door to the offices of a key subsidiary.

Perhaps most interesting, however was the court’s holding with respect to the third Broz factor: whether the opportunity to purchase the building was within the company’s line of business. Although the company “historically had leased office space and . . . had owned a piece of real estate only once before,” the court commented that “the ‘line of business’ concept was intended to be applied flexibly” and that the building was “a rare opportunity to acquire a building with a highly desirable location.” The court further noted that the line of business test is irrelevant where (i) the company had a clear interest and expectancy and (ii) the opportunity presented concerns an operational decision about how to manage or expand an existing business. Personal Touch citing Kohls v. Duthie, 791 A.2d 772 (Del. Ch. 2000). Finally, the court found several indications that the director’s schemes to secretly divert the opportunity had placed him in a position inimical to his duties to the company. The court observed, for instance, that the director had learned of the available building in his capacity as a fiduciary of the company, made concerted efforts to conceal his efforts from the company until he had closed the deal, and allegedly used a company employee to assist him in his scheme.

Outlaw Beverage case

Later in 2019, Chancellor Bouchard provided guidance on where to draw the line between a “corporate opportunity” and a mere idea or concept that the corporation may want to further explore, as well as whether a director is acting in her fiduciary or individual capacity. Outlaw Beverage, Inc. v. Collins, C.A. No. 2019-0342-AGB (Del. Ch. June 18, 2019) (TRANSCRIPT). In that case, Outlaw (an energy drink manufacturer) alleged that its former director attended a meeting on behalf of the company where a retailer expressed interest in having a private-label energy drink developed for distribution and then the director hired various third parties to develop that drink. The parties in litigation disputed whether the director had undertaken these activities as a director for the purpose of developing an opportunity that belonged to the company, and the director pointed to a broad corporate opportunity waiver provision in Outlaw’s certificate of incorporation as an additional line of defense, the contours of which are discussed more fully below.

The court noted that what was presented at the meeting was not sufficiently well-formed to constitute a corporate opportunity, particularly because the retail partner later suggested that it had no interest in partnering with Outlaw to pursue the idea. The court stated that the opportunity “did not concern a tangible product, an actual business, or anything concrete in form. Rather the opportunity that was presented was little more than a general idea or concept.” Next, the court determined that the process by which the director had created and developed the beverage were undertaken in his individual capacity, not his role as a corporate fiduciary. To reach this conclusion, the court took thorough inventory of the branding, labeling, marketing, and resources around development of the drink: (1) with respect to the brand, there was no dispute that the director had come up with the name of the product (something that he historically did for his personal ventures as a leading figure in the beverage industry), his company applied for the relevant trademarks, and he paid for that work—no funds or resources of Outlaw were used; (2) regarding the labelling, the third-party contractor who was employed to do this work subjectively understood that he was working for the director, not Outlaw; and (3) with respect to the drink’s formula, Outlaw did not contend that any of its employees were involved in the formula’s creation or that any of its funds were used to pay for this work. Because the court concluded that the director had not developed the drink solely and exclusively in his capacity as a director of Outlaw, as required for the company to meet an exception to its corporate opportunity waiver, Outlaw could not sustain its claims against the director.

Armored Combat League case

One month after the Outlaw Beverage ruling, Vice Chancellor Morgan Zurn addressed similar issues, albeit in the context of a limited liability company that provided a competitive league for individuals who dress in medieval armor and fight in tournaments with blunted weapons. Armored Combat League, LLC v. Brooks, C.A. No. 2019-0463-MTZ (Del. Ch. July 2, 2019) (TRANSCRIPT) (the operating agreement of the relevant company in this case contained a provision stating that “the doctrine of corporate opportunity, or any analogous doctrine, shall not apply to any Covered Person”). The company managed its business largely by communicating with league participants on its website and social media. After a falling out among the founders, one of the company’s members began removing the other members’ administrative rights to the company’s social media pages and website, before making negative statements about the company and redesigning the website to redirect traffic to a competing entity that he had created.

In litigation, the competing member asserted that he was entitled to use the website as he saw fit because he owned it. The court rejected that position, noting that, for a temporary restraining order, “regardless of who owned the website, it is clear that the website was operated for the benefit of the company, and the defendant has tried to change that operational reality on his own.” Consequently, the court held that it was at least colorable that the defendant had done so wrongly. The court also explained that there is a difference between “competing with the company through a separate business” and “taking the company’s existing assets, including its website and social media accounts, and using them to divert current members,” or otherwise stated, a “distinction between competition and sabotage.”

Corporate Opportunity Waivers

An important corollary to the corporate opportunity doctrine is the corporate opportunity waiver authorized by Section 122(17) of the Delaware General Corporation Law. A corporation may “[r]enounce, in its certificate of incorporation or by action of its board of directors, any interest or expectancy of the corporation in, or in being offered an opportunity to participate in, specified business opportunities or specified classes or categories of business opportunities that are presented to the corporation or one or more officers, directors or stockholders.” 8 Del. C. § 122(17). Such waivers were present in some of these cases, and it has been suggested that the breadth of such provisions may present questions related to the validity of the company’s renunciation. See Alarm.com Holdings, Inc. v. ABS Capital Partners Inc., 2018 WL 3006118 (Del. Ch. June 15, 2018) (noting “this decision provides no opportunity to opine on the validity of a broad and general renunciation of corporate opportunities, as contrasted with a more tailored provision addressing a specified business opportunity or a well-defined class or category of business opportunities”).

In Alarm.com, the company had the following corporate opportunity waiver in its charter:

To the fullest extent permitted by the DGCL, the Corporation acknowledges that:

(i) each stockholder (subject to the proviso below) and each Preferred Director (each an “Exempted Person”) shall have no duty (contractual or otherwise) not to, directly or indirectly, engage in the same or similar business activities or lines of business as the Corporation or any of its subsidiaries, including those deemed to be competing with the Company or any of its subsidiaries; and

(ii) in the event that any Exempted Person acquires knowledge of a potential transaction or matter that may be a corporate opportunity for the Corporation, then such Exempted Person shall have no duty (contractual or otherwise) to communicate or present such corporate opportunity to the Company or any of its subsidiaries, as the case may be, and shall not be liable to the Company or its affiliates or stockholders for breach of any duty (contractual or otherwise) by reason of the fact that such Exempted Person, directly or indirectly, pursues or acquires such opportunity for itself, directs such opportunity to another person, or does not present such opportunity to the Company or any of its subsidiaries;

provided, however, that this Article 8 shall not apply to Backbone Partners, LLC or stockholders who are also officers or employees of the Corporation or any subsidiary of the Corporation (other than officers affiliated with any Preferred Director) or who are permitted transferees of any such person.

Since Vice Chancellor Travis Laster’s comment in Alarm.com, corporate opportunity waivers have been enforced in Outlaw Beverage and not enforced in Armored Combat League. For reference, the Outlaw Beverage corporate opportunity waiver read as follows:

[The Corporation] renounces any interest or expectancy . . . in, or in being offered an opportunity to participate in, an Excluded Opportunity. . . . [Excluded Opportunity is defined as] any matter, transaction or interest that is presented to, or acquired, created or developed by, or which otherwise comes into the possession of (i) any director of this corporation who is not an employee of this corporation . . . unless such matter, transaction or interest is presented to, or acquired, created or developed by, or otherwise comes into the possession of [the director] expressly and solely in such [person’s] capacity as a director of this corporation.

And the Armored Combat League corporate opportunity waiver read as follows:

Any [Manager or Member] may engage in or possess an interest in other profit-seeking or business ventures of any kind, nature or description, independently or with others, whether or not such ventures are competitive with the Company and the doctrine of corporate opportunity, or any analogous doctrine, shall not apply to any Covered Person.

Note that, in Armored Combat League, which was decided from the bench on a motion to dismiss, the company was a limited liability company with an unsigned operating agreement.

The Outlaw Beverage waiver renounced corporate opportunities except when an opportunity was “presented to, acquired, created or developed” by a director “expressly and solely” in her capacity as a director of the company. Because Outlaw was unable to demonstrate that its former director’s endeavors were confined to those narrow circumstances, he was not found to have usurped a corporate opportunity. In Armored Combat League, however, the court refused to enforce the corporate opportunity provision on a preliminary record, noting that “even if [it] did enforce that agreement . . . competing with the company through a separate business, as contemplated by [the agreement], is different than taking the company’s existing assets, including its website and social media accounts, and using them to divert current members.”

It is important to keep in mind the procedural and factual contexts surrounding each of these decisions, but the Court of Chancery’s approach to construing corporate opportunity waivers is also quite valuable to effective corporate planning and drafting, particularly because we would generally expect the language of those waivers to be closely examined in any litigation. As issues related to corporate opportunities continue to be litigated in 2020, see, e.g. HUMC Holdco, LLC v. MPT of Hoboken TRS, LLC, C.A. No. 2019-0973-KSJM (Del. Ch. Dec. 23, 2019) (TRANSCRIPT) (granting in part a temporary restraining order against a limited liability company manager who allegedly used company information to divert opportunities and compete with the company to acquire certain assets; although the claims were not styled as corporate opportunity claims, the HUMC plaintiffs alleged that the manager had breached his duty of good faith by using confidential information received in his capacity as a manager to engage in private meetings, interfere with the company’s ability to effect critical transactions and operations, and benefit himself), and the corporate opportunity doctrine and insights regarding corporate opportunity waiver provisions continue to evolve, we expect this to be an important issue for Delaware law.

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