Delaware Chancery Court Grants ‘Unusual Relief,' Shifts Attorneys' Fees

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By Michael Greene

May 12 — The Delaware Chancery Court May 7 awarded $2 million in attorneys' fees and expenses as a result of a control group of investors breaching their duty of loyalty by conducting a self-interested recapitalization.

Vice Chancellor John W. Noble used the court's inherent equitable powers to shift fees despite declining, in a separate opinion, to award the plaintiffs monetary damages.

Noting that equitable fee-shifting is an “unusual relief,” Noble found that the plaintiffs were entitled to attorneys' fees in a scenario where a transaction is implemented at a fair price even though it resulted from unfair dealings.

“Such an award promotes meritorious litigation to address harm from disloyal acts and comports with equitable principles,” Noble opined.

Recapitalization

Last September, Vice Chancellor Noble issued an opinion concluding that three controlling stockholders of a start-up media streaming company eventually known as Nine Systems Corporation conducted a recapitalization that was not an entirely fair transaction because of “the grossly inadequate process employed by the Defendants”.

However, he declined to award the stockholder plaintiffs monetary damages because the recapitalization was conducted at a fair price. Instead, Vice Chancellor Noble granted the plaintiffs leave to petition the court for the purpose of determining whether the shifting of attorneys' fees and costs was warranted.

Fee-Shifting Warranted

After briefing and oral argument on the topic, the court concluded that the “bad faith” exception to the American Rule—under which each party pays its own attorneys' fees—was proper in this case.

Vice Chancellor Noble observed that the court is not limited to using its equitable powers to shift fees in cases of “intentional misconduct” and that it can do so “where the situation or the equities dictate that such a burden should not fall on the prevailing party.”

Noble concluded that the defendants pre-litigation conduct satisfied the bad-faith exception because of his earlier findings that the defendants clearly breached their duty of loyalty.

“The failure of the fiduciaries to follow a credible valuation process perhaps can be explained through consideration of the Company’s limited financial means at the time. No similar benefit of the doubt cloaks the failure to disclose the recapitalization and its consequences to the shareholders or the lack of information about the Company’s activities and relocation over several years,” he wrote.

He added that the unusual circumstances support equitable fee-shifting, namely that the defendants' concealment may have hindered pre-merger legal action.

The court also rejected an argument that the shifting of fees was not warranted because the plaintiffs did not “actually incur” any litigation expenses.

“The Plaintiffs did not incur any out-of-pocket obligation to pay attorneys’ fees because of the contingent nature of their fee agreement with counsel, but that does not necessarily equate [plaintiffs' counsel's] efforts to the functional equivalent of a charitable undertaking,” Noble wrote.

Troubling Case

Next, Vice Chancellor Noble addressed how much the plaintiffs should be awarded.

He observed that this was a difficult question because the plaintiffs' counsel accrued $11 million in fees and costs, which was much more than the reasonable pre-trial damage assessment of $3 to $4 million.

“This is a troubling case that tests the range of equity’s powers. Defendants’ conduct warrants a shifting of fees, but the shifting of fees cannot be in an amount grossly disproportionate to the benefit the litigation can achieve,” he wrote.

Ultimately, the court determined that the plaintiffs were entitled to an award of $2 million in attorneys' fees and expenses.

To contact the reporter on this story: Michael Greene in Washington at mgreene@bna.com

To contact the editor responsible for this story: Kristyn Hyland at khyland@bna.com

The opinion is available at http://www.bloomberglaw.com/public/document/In_re_Nine_Sys_Corp_Sholders_Litig_No_3940VCN_2015_BL_141648_Del_.