Genger v. TR Investors, LLC, et al., No. 592,2010 (Del. Supr. July 18, 2011)
In this letter opinion, the Court of Chancery declined to enjoin a negotiated acquisition of Orchid Cellmark. In this appeal, the Delaware Supreme Court affirmed two opinions and reversed one opinion of the Court of Chancery arising from a contest for control of Trans-Resources, Inc. The Court (i) affirmed the Court of Chancery’s judgment that defendant-below, Ari Genger (“Genger”), violated a status quo order by deleting files and permanently overwriting the unallocated free space on his computer hard drive and upheld a $3.2 million sanction imposed for that discovery misconduct (the “Spoliation Opinion”); (ii) affirmed the Court of Chancery’s decision that plaintiffs-appellees lawfully possessed a majority voting interest in Trans-Resources and the right to elect the majority of the board of directors (the “Merits Opinion”); and (iii) reversed on jurisdictional grounds the Court of Chancery’s holding that Genger and a trust for the benefit of his daughter were not beneficial owners of any Trans-Resources shares (the “Side Letter Opinion”).
All three opinions arose from an action by plaintiffs-appellees (collectively identified as the “Trump Group”) pursuant to 8 Del. C. § 225 to determine the rightful directors of Trans-Resources, a Delaware corporation that specializes in manufacturing fertilizer and producing chemicals for agricultural use. At its founding in 1985, Trans-Resources was wholly owned by TPR Investment Associates, Inc. (“TPR”), an entity that was in turn wholly owned by Genger, his wife, and two trusts for the benefit of Genger’s children (the “Orly Trust” and the “Sagi Trust”). In 2001, the Trump Group acquired a minority position in Trans-Resources pursuant to a Stockholders Agreement that provided them certain protections, including significant board representation, veto rights, and a restriction on the transfer of Trans-Resources shares to any persons other than those designated as “Permitted Transferees.” Moreover, if any party to the Stockholders Agreement wished to transfer its shares to a non-Permitted Transferee, the selling party was required to notify the other Trans-Resources shareholders, who had a right of first refusal. Any transfer that failed to comply with these restrictions and notice requirements was deemed invalid and void, and triggered the non-selling shareholders’ right to purchase the invalidly-transferred shares. The Stockholders Agreement also required that any shareholder undergoing a change of control notify the other Trans-Resources shareholders.
In the wake of the Gengers’ 2004 divorce, Genger purported to cause TPR to transfer its Trans-Resources shares to himself, the Sagi Trust, and the Orly Trust, and transferred his controlling interest in TPR to his ex-wife. (TPR subsequently came to be controlled by Sagi, Genger’s estranged son.) The trustees of the Trusts purported to give irrevocable lifetime proxies to Genger to vote the Trusts’ Trans-Resources shares. Because neither of the Trusts were Permitted Transferees, the Stockholders Agreement’s notice requirement and right of first refusal were triggered. The transfer of Genger’s controlling interest in TPR to his ex-wife triggered the notice requirement under the Stockholders Agreements’ change of control provision. Genger, however, did not notify the Trump Group of these transactions (the “2004 Transfers”).
In connection with a proposed financing in 2008, Genger notified the Trump Group of the 2004 Transfers. The Trump Group thereafter invoked its purchase rights to acquire all of the Trans-Resources shares covered by the 2004 Transfers. In response to Genger’s rejection of their Purchase Rights invocation, the Trump Group filed a lawsuit to enforce the Purchase Rights provision in the United States District Court for the Southern District of New York, which remains pending.
Mindful that the New York litigation could take years to resolve, the Trump Group entered into an agreement with Sagi to purchase the shares held by the Sagi Trust (the “2008 Purchase Agreement”), and entered into an agreement with TPR (the “Side Letter Agreement”) which gave the Trump Group an option to purchase the Trans-Resources shares purportedly transferred to Genger and the Orly Trust in 2004. The terms of the Side Letter Agreement provided that it would take effect only if the 2004 Transfers were eventually judicially determined to be void.
The 2008 Purchase Agreement gave the Trump Group a majority equity position in Trans-Resources, and the Trump Group promptly executed and delivered a shareholder consent removing Genger as a Trans-Resources director and appointing its own candidates to the Trans-Resources board.
Genger refused to recognize the Trump Group’s written consent, prompting the Trump Group to file suit in the Court of Chancery pursuant to 8 Del. C. § 225 (“Section 225”), for a determination that, as the Trans-Resources’ majority stockholder, it was entitled to designate and elect a majority of the Trans-Resources board. The parties quickly settled the dispute and entered into a Court-approved stipulated final judgment, which declared that the Trump Group’s designees constituted a lawful majority of the Trans-Resources board. Shortly thereafter, however, the Court of Chancery granted the Trump Group’s motion for relief from judgment and reopened the Section 225 proceeding, based on the Trump Group’s discovery that Genger had destroyed documents relevant to the Section 225 action in violation of a document preservation order entered by the Court (the “Status Quo Order”).
The Spoliation Opinion. After a trial on the spoliation allegations, the Court of Chancery found that Genger had violated, and was in contempt of, the Status Quo Order, because he had caused the deletion of files stored on his work computer at Trans-Resources, and had directed an employee to use special software to wipe the unallocated free space on both his computer’s hard drive and on a Trans-Resources computer server, making it impossible to recover any deleted files that were stored in those computers’ unallocated free space. In addition to other sanctions, the Court of Chancery awarded the Trump Group $750,000 of the attorneys’ fees incurred to investigate and litigate Genger’s spoliation of evidence, and $3.2 million for expert fees, technology consultant fees, special master fees, and other unreimbursed expenses incurred in investigating and litigating Genger’s spoliation of evidence.
On appeal, the Delaware Supreme Court rejected Genger’s arguments that the record evidence was insufficient to establish that he had destroyed relevant documents, or that the Trump Group was thereby prejudiced. Genger argued that because computer operating systems constantly overwrite unallocated free space by creating and deleting temporary files, a requirement that a party-litigant must preserve a computer’s unallocated free space whenever a document-retention policy is in place would impossibly burden a company-litigant by effectively requiring the company to refrain from using its computers entirely. The Court rejected this argument, noting that its holding only applies where a party intentionally takes affirmative steps to destroy or conceal information to prevent its discovery at a time that party is under an affirmative obligation to preserve that information. The Court also noted that Trans-Resources’ electronic data retention and deletion procedures did not include the routine use of special software to overwrite its unallocated free space. To avoid the “unallocated free space” issue in the future, the Court suggested that parties and courts address the question before a document retention and preservation order is entered.
Because Genger expressly waived his right to challenge the reasonableness of the $3.2 million fee sanction in the Court of Chancery’s stipulated final judgment, the Delaware Supreme Court held that issue was not properly preserved for appeal, and so reviewed it for plain error. The Court found no plain error because the $3.2 million figure was the result of the parties’ compromise.
The Merits Opinion. After a separate trial on the merits of the Section 225 action, the Court of Chancery concluded that the Trump Group held a majority of the voting stock of Trans-Resources, and that its written consent installing its board designees was valid. Genger appealed the trial court’s findings that (i) the Trump Group did not ratify the 2004 Transfer to the Sagi Trust, and that (ii) the irrevocable proxy associated with the Sagi Trust shares was invalid, and in any event, the proxy did not run with the Sagi Trust shares after those shares were sold to the Trump Group. The Delaware Supreme Court affirmed the finding that the Trump Group did not acquiesce or ratify the 2004 Transfers either expressly or implicitly by its conduct, and specifically noted that in the 2008 Agreement, Sagi and TPR expressly conveyed only such interest as they may have had in the disputed Trans-Resources shares, and agreed on a mechanism to protect the Trump Group’s acquisition if the 2004 Transfers were determined to be void. The Court declined to hear Genger’s new argument that the irrevocable proxy associated with the Sagi Trust was valid under the applicable New York statute, as Genger’s argument was never fully and fairly presented to the trial court. The Court upheld the Court of Chancery’s finding that the proxy’s plain language provides that it only applied to Trans-Resources shares owned by the Sagi Trust. Accordingly, because the proxy did not purport to bind any subsequent owner of the shares, the Trump Group was free to vote the shares.
The Side Letter Opinion. In a separate opinion arising from the trial on the merits of the Section 225 action, the Court of Chancery invalided the 2004 Transfers of Trans-Resources shares from TPR to the Orly Trust and to Genger, and ruled that the Trump Group was the lawful record and beneficial owner of those transferred shares. Although Genger had sought to have the Court of Chancery declare the rightful owner of the Genger and Orly Trust shares, on appeal, Genger argued that the trial court lacked in personam jurisdiction over the Orly Trust and TPR, because neither stockholder was made a party to the Section 225 action in any capacity.
The Delaware Supreme Court agreed with this argument and reversed, finding that the Court of Chancery crossed a jurisdictional line by adjudicating questions of ultimate beneficial ownership, and exceeded its powers under Section 225. The Court explained that a Section 225 proceeding is not an in personam action, but rather is in the nature of an in rem proceeding, wherein respondents are invited to litigate their claims to the res (here, the disputed corporate office) or forever be barred from doing so. Although the Court of Chancery may adjudicate claims that a director obtained the office through fraud, deceit, or breach of contract in a Section 225 action, it may do so only for the limited purpose of determining the corporation’s de jure directors and officers. The Court cited Shaffer v. Heitner, 433 U.S. 186, 213 (1977) to note that the Court of Chancery could not exercise personal jurisdiction over TPR or the Orly Trust based on their mere ownership of stock in a Delaware corporation.