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London v. Tyrrell, C.A. No. 3321-CC (Del. Ch. Mar. 11, 2010) (Chandler, C.)

March 11, 2010

In this opinion, the Court denied a Special Litigation Committee’s (“SLC”) motion to dismiss, finding material questions of fact remained regarding the SLC’s independence, the good faith of the SLC’s investigation and the reasonableness of the grounds upon which the SLC recommended dismissal. Plaintiffs Craig London and James Hunt, co-founders of the government contracting firm iGov, brought this derivative suit against defendants Patrick Nevin, Walter Hupalo and Michael Tyrrell, alleging defendants breached their fiduciary duties by materially misrepresenting iGov’s business prospects to the company’s independent valuation firm for purposes of obtaining iGov stock at an artificially low price through the company’s equity incentive plan (the “2007 Plan”) and thereby entrenching themselves in their positions as directors and managers of iGov.

In securing new financing for the Company in August 2006, Tyrell sent iGov’s financier, Textron Financial, an updated FY07 forecast showing a projected EBITDA of roughly $3 million. At the same time, iGov hired Chessiecap Securities, Inc. (“Chessiecap”) to value iGov stock for purposes of setting the exercise price on the options under the 2007 Plan. After initially providing Chessiecap with the same $3 million EBITDA forecast given to Textron, Tyrrell insisted Chessiecap instead use a revised $1.8 million EBITDA forecast (“Revised Chessiecap Forecast”) which excluded revenue from three iGov contracts that had either not yet been formally awarded or which iGov would most likely close down before year-end. In December 2006, however, Tyrrell sent Textron an updated FY07 forecast showing an EBITDA of approximately $3.1 million. Using the Revised Chessiecap Forecast, Chessiecap certified its final valuation of iGov’s equity at $4.7 million.

Plaintiffs objected to iGov relying on Chessiecap’s final valuation for purposes of setting the exercise price on the options for the 2007 Plan, asserting that the Revised Chessiecap Forecast accounted only for recent negative developments and materially undervalued iGov’s total equity. In response, on January 19, 2007, Neven and Hupalo teamed up with iGov officer and shareholder Jack Pooley, the three of whom collectively owned 50.1% of iGov’s voting stock, and removed plaintiffs from the iGov board. Defendants then held a special meeting at which they adopted the 2007 Plan, set the exercise price on the options at $4.92 per share and awarded 80,000 options to Tyrrell along with 50,000 options to each of Neven and Hupalo. As a result, plaintiffs’ ownership interests fell to 40% while defendants’ increased to 54.1%.

Plaintiffs filed their complaint on October 31, 2007. After losing a motion to dismiss, defendants appointed a two member SLC comprised of newly elected board members Vincent Salvatori and John Vintner to consider plaintiffs’ derivative claims. After conducting its investigation, the SLC concluded that laintiffs’ duty of care and duty of loyalty claims should both not be pursued because any potential duty of care breach would be barred under iGov’s § 102(b)(7) provision and defendants employed a fair process and adopted a fair price in approving the 2007 Plan.

In reviewing the SLC’s findings, the Court applied the two-step Zapata analysis that requires the Court to review the independence of the SLC and consider whether the SLC conducted a good faith investigation of reasonable scope that yielded reasonable bases to support its conclusions. In the first part of its analysis, the Court found material questions of fact existed regarding the SLC’s independence given that Vintner’s wife was also Tyrrell’s cousin and that Salvatori had expressed deep gratitude to Tyrrell for Tyrrell’s help in securing a good price on the sale of Salvatori’s previous business venture.

The Court next turned its attention to the scope of the SLC’s investigation and the bases for its conclusions. The Court found that the SLC, in its investigation and analysis of plaintiffs’ duty of care claims, failed to consider the fact that plaintiffs’ requested relief was not limited to merely money damages and that, under Delaware law, exculpatory § 102(b)(7) provisions do not bar an award of equitable relief (such as an injunction or rescission) for duty of care claims. Thus, the Court found that it was unreasonable for the SLC to conclude that the duty of care claims should not go forward solely on the basis of iGov’s § 102(b)(7) provision. The Court also found that a series of material questions of fact remained regarding the SLC’s investigation and analysis of plaintiffs’ duty of loyalty claims. The Court identified numerous issues surrounding the process employed by defendants that the SLC failed to adequately explore prior to reaching its conclusions. Among those issues that the SLC failed to investigate were: 1) why Tyrrell provided Chessiecap with the original $3 million EBITDA forecast if he did not believe those projections were actually achievable; 2) why Tyrrell provided Textron with an updated $3.1 million EBITDA forecast after providing Chessiecap with the revised $1.8 million forecast; 3) why Tyrrell considered only negative developments that had occurred after July 31, 2006, in preparing the Revised Chessiecap Forecast; and 4) the timing of plaintiffs’ removal from the board. Given all of these concerns over the SLC’s investigation into both the duty of care and duty of loyalty claims in plaintiffs’ complaint, the Court refused to grant the SLC’s motion to dismiss.

The full opinion is available here