Crothall v. Zimmerman, C.A. No. 608, 2013 (Del. June 9, 2014)
In this unusual appeal, the Delaware Supreme Court reversed the Court of Chancery’s decision awarding a fee to the former counsel of a derivative plaintiff who had abandoned his claim before final judgment was entered, holding that the plaintiff did not create a corporate benefit that justified a fee award because the derivative plaintiff’s action rendered the Chancery Court’s decision moot.
The case arose out of a derivative suit initiated by Robert Zimmerman, a common unitholder and former CEO of Adhezion Biomedical, LLC (“Adhezion”). Zimmerman sued the directors of Adhezion and two Adhezion investors – Liberty Advisors, Inc. and Original Ventures, LLC – whom he alleged controlled Adhezion. Specifically, Zimmerman challenged certain financing and associated unit issuances by Adhezion on the grounds that (i) the financing transactions were substantively unfair and (ii) the unit issuances were made in violation of Adhezion’s Operating Agreement because the units issued had not been authorized by an amendment to the Operating Agreement approved by Adhezion’s common unitholders. The Court of Chancery rejected Zimmerman’s claim that the unit issuances were unfair, but held that the defendants had violated the Operating Agreement by not obtaining the necessary unitholder approval for the issuances. The Court awarded nominal damages of one dollar for the violation of the Operating Agreement.
Before the entry of a final judgment, Zimmerman announced that he was abandoning his lawsuit. Consequently, Zimmerman’s counsel filed a motion to withdraw as counsel and to intervene in the case to secure an award of attorneys’ fees from Adhezion. After Zimmerman sold all of his Adhezion units, the defendants filed a motion to dismiss the case in its entirety. Because Zimmerman lacked standing to continue prosecution of the case, and no other potential plaintiff was willing to pursue the derivative claim, the Court of Chancery dismissed the case. Therefore, an appealable final judgment on the merits of the case was never entered. In an interesting twist, the Court of Chancery awarded Zimmerman’s counsel $300,000 in attorneys’ fees for creating a corporate benefit. The Court determined that the corporate benefit that justified the fee award was its ruling that Adhezion’s Operating Agreement required a vote of the common unitholders to authorize an issuance of additional units.
On appeal, the Delaware Supreme Court expressed support for the defendants’ argument that the Court of Chancery incorrectly interpreted the Operating Agreement, and that, therefore, Zimmerman’s former counsel did not create a corporate benefit. The Supreme Court was, in fact, skeptical that Zimmerman’s litigation efforts produced any net benefit to Adhezion that justified a fee award. The Supreme Court did not rule on these issues, however. Instead, the Court held that Zimmerman’s counsel was not entitled to a fee because Zimmerman had abandoned the lawsuit and rendered his claim moot before entry of a final judgment. Because Zimmerman never obtained a binding interpretation of the Operating Agreement, no corporate benefit was created. Accordingly, there was no justification for the fee award.
In its analysis, the Supreme Court rejected the plaintiff’s reliance on In re First Insterstate Bancorp Consolidated Shareholder Litigation, in which the Supreme Court permitted the recovery of attorneys’ fees even though the claims in the case had been mooted before entry of a final judgment. The Supreme Court distinguished In re First Insterstate Bancorp and other cases in which the Court allowed attorneys’ fees, noting that in those cases the claims were rendered moot because of actions taken by the defendants that created the corporate benefit that the plaintiff had been seeking. The Court reasoned that awarding attorneys’ fees in cases in which the plaintiff himself rendered his claims moot would create perverse incentives for representative plaintiffs in an area of law already “fraught with the potential for conflicts of interest.”