Parent Corporation May Sue Directly Even if Harm to Sub, Delaware Clarifies

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By Michael Greene

June 25 — Answering a certified question, the Delaware Supreme Court June 24 concluded that a parent corporation may sue to enforce its own contractual rights directly, even if the harm from the alleged breach is to its subsidiary.

The state's high court clarified that commercial contract actions are not subject to derivative lawsuit requirements under its ruling in Tooley v. Donaldson Lufkin & Jenrette Inc., 845 A.2d 1031 (Del. 2004).

Writing for the court, Delaware Supreme Court Chief Justice Leo E. Strine Jr. opined: “Reading Tooley to convert direct claims belonging to a plaintiff into something belonging to another party would, we confess, be alien to our understanding of what was at stake in that case.”

Failed Merger

In the underlying case, the plaintiff NAF Holdings LLC created two subsidiaries to effectuate a merger with Hampshire Group Ltd. To facilitate the deal, the parent corporation contracted with defendant Li & Fung (Trading) Ltd. to serve as sourcing agent for Hampshire.

However, the merger between the NAF subsidiaries and Hampshire fell apart once Trading allegedly repudiated its deal with NAF. While Hampshire and the subsidiaries eventually resolved their differences by entering into a settlement agreement, NAF proceeded with claims for breach of contract against Trading in the U.S. District Court of the Southern District of New York.

Specifically, NAF sued Trading for $30 million in damages that allegedly resulted from a diminution of NAF's subsidiaries' stock

District Court Ruling

Applying Delaware law, the district court dismissed NAF's breach of contract claims because it had not met the pleading requirements of a derivative lawsuit. Basing its decision on language in Tooley that states that a stockholder-plaintiff is required to establish it “can prevail without showing an injury to the corporation” to bring a direct claim, the district court held that NAF could only proceed with its claims derivatively.

As a result of the lower court's decision, NAF filed an appeal to the U.S. Court of Appeals of the Second Circuit, arguing that Tooley did not apply to its commercial contract claims. 

Seeking guidance on the issue, the Second Circuit certified a question to the Delaware Supreme Court on the application of Tooley.

‘Tooley' Clarified

In answering the certified question, the state court concluded that NAF could bring its claims directly, without proceeding by way of a derivative action. The court held that NAF does not need have to proceed derivatively with contractual claims that it possesses, regardless of whether the harm was suffered by its subsidiary.

Writing for the court, Chief Justice Strine found that the district court had applied Tooley “in a decontextualized manner that is inconsistent with Delaware law.”

He opined that consistent with fundamental Delaware law contract principles, parties seeking to enforce their own commercial contracts should not be subjected to the burdensome demand excusal process.

In reaching its decision, however, the court clarified that its decision did not address the merits of NAF's claims, including the effect of its subsidiaries' settlement, which included a broad release of claims.

“[W]e simply answer the question posed by our learned friends by holding that a suit by a party to a commercial contract to enforce its own contractual rights is not a derivative action under Delaware law,” Strine wrote.

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