Shocking Technologies, Inc. v. Michael, C.A. No. 7164-VCN (Del. Ch. Oct. 1, 2012) (Noble, V.C.)
In this memorandum opinion, the Delaware Court of Chancery found defendant Simon J. Michael (“Michael”), a director of plaintiff Shocking Technologies, Inc. (“Shocking” or the “Company”), breached his fiduciary duty of loyalty to the Company by seeking to dissuade the Company’s only viable potential investor from investing in the Company and by sharing confidential Company information with that same investor. The Court, however, did not find that Michael’s conduct caused any material damage to the Company and also did not rise to the level of subjective bad faith that would warrant the shifting of fees.
Shocking is a privately held Delaware corporation that develops polymeric materials that provide electrostatic discharge protection for electronic devices. Michael is the manager of Balch Hill Capital, LLC which is the General Partner of Balch Hill Partners, L.P. (“BHP”). Michael was appointed to serve on Shocking’s board of directors as BHP’s Series B designee after BHP obtained the right to appoint a director through its participation in Shocking’s Series B round of financing in August 2009. The total number of directors constituting the Shocking board was six, but during the time period at issue (fall 2011 through April 2012), the board consisted only of Michael and three other directors, one of which was the Company’s CEO. Two other investors in the Company, ARCH Venture Partners (“ARCH”) and ATA Ventures (“ATA”), each had the right to designate a director, but each of their designees had resigned earlier in 2011, and neither selected a replacement during the relevant time period. By the summer of 2011, the Company was in a precarious cash position. Their best and only opportunity to solve their cash crisis was for one of their investors, Littlefuse, Inc., to exercise warrants it had acquired during the Company’s Series C round of financing that would generate an additional $3 million for the Company. Around the same time, however, Michael began expressing concerns about the Company’s corporate governance structure and the independence of the other board members. In particular, Michael was troubled by the fact that, despite providing approximately 60% of the Company’s contributed capital, the Series B/C investors were only entitled to designate one of the six board members. Michael also expressed concerns over the CEO’s compensation requests, wanting instead to tie his compensation to various performance triggers. Such an approach was not well-received by the other Shocking directors, and Michael viewed this unified hostility as evidence of a “control group” acting to advance their own self-interests at the expense of the Company.
Hostilities grew between Michael and the other three directors during the rest of the summer and early fall of 2011 and nearly boiled over during a particularly hostile set of board meetings on August 29 and September 2, 2011. Thereafter, Michael sought to alter the Company’s balance of power by finding a way to control an additional board seat and also convincing ARCH and ATA to each designate a director supportive of his views. To that end, Michael sent a letter to his fellow Board members acknowledging the Company’s need for cash infusions but asserting that the Company could not seek such additional funding until his issues with the Company’s corporate governance were addressed by the Board or communicated to existing and potential stockholders. After an October 20, 2011 board meeting failed to resolve his issues, Michael called a special meeting of stockholders to be held on November 28, 2011 to discuss his concerns. In the interim, the rest of the Shocking board attempted to address the Company’s cash needs by engaging in initial discussions with Littlefuse’s representative, Paul Dickinson, regarding the exercise of Littlefuse’s warrants. During those discussions, Dickinson indicated that Littlefuse would consider not only exercising its $3 million of warrants but also investing additional capital as well. As discussions with Littlefuse progressed, Michael, knowing Shocking’s survival likely depended upon Littlefuse’s investment, began lobbying Dickinson through a series of communications to hold off on any additional investment in Shocking until Littlefuse could secure better terms from the Company, including representation on the Shocking board. Michael also invited Dickinson to attend the November 28, 2011 stockholders meeting. During that stockholders meeting, Michael and the other three directors each gave presentations regarding Michael’s corporate governance concerns. After attending the meeting, Dickinson concluded that Michael did not raise any valid issues about compensation or director independence, but Dickinson did have concerns over Board strife. Finally, in a last ditch effort to dissuade Littlefuse from investing, Michael shared with Dickinson Shocking’s confidential business information that Littlefuse was, at that time, the only potential investor then at all likely to participate in the Company’s necessary fundraising. Ultimately, Dickinson recommended to Littlefuse that it should only exercise its $3 million of warrants and refrain from further capital contributions at that time. Littlefuse exercised its $3 million of warrants on December 5, 2011. Later, in April 2012, Littlefuse invested an additional $10 million in Shocking, but also obtained the additional concession of the right to designate a director to the Shocking board.
In bringing its action, Shocking asserted that Michael’s delivery of bargaining advice and confidential information to Littlefuse constituted a breach of his fiduciary duty of loyalty and caused the Company substantial damages through a reduced potential investment by Littlefuse in December 2011 and an additional investment in April 2012 on materially less favorable terms. By contrast, Michael contended that his actions were undertaken in good faith in an effort to better the corporate governance structure of Shocking and to reduce the domination of the CEO on the Company’s board. The Court started its analysis by noting that “[a] director acting in subjective good faith may, nevertheless, breach his duty of loyalty.” The Court found that the best interests of the Company were immediate and unmistakable – finding enough cash to survive. The potential short-term consequences of Michael’s actions, however, could have caused the demise of Shocking. The Court found that such “reasonably foreseeable outcomes cannot be reconciled with the exercise of fiduciary duty . . . a loyal director does not put the company in dire financial circumstances in order to obtain what he perceives as a benefit for himself and his associated directors. That there may be some theoretical improvement in ‘corporate governance’ to the director’s liking does not alter this conclusion.” The Court, therefore, concluded that, while reasonable minds may differ as to the nobility of Michael’s intentions, his improper means nevertheless constituted a breach of his fiduciary duty of loyalty to the Company.
The Court next turned to an assessment of damages. Shocking argued that Michael’s actions had damaged the Company in two ways – by convincing Littlefuse to not invest beyond its $3 million of warrants in December 2011 and by assisting Littlefuse in investing in April 2012 on terms materially less favorable to the Company. The Court found both arguments unpersuasive. As to the first point, the Court noted that it was Michael’s actions during the stockholders meeting in late November 2011 that gave Littlefuse concern over potential board strife and convinced Littlefuse to not make an additional investment beyond its $3 million of warrants in December 2011. In the Court’s mind, however, that conduct did not form the basis for its finding of disloyalty, but rather was a part of healthy stockholder debate. As to the second point, the Court noted that although Michael had revealed to Littlefuse that it was Shocking’s only option for fundraising in December 2011, Littlefuse waited an additional four months, until April 2012, before actually making an additional investment. During that four month window, Michael had no further contact with Littlefuse. The Court concluded that Littlefuse, even without the information Michael provided, would have been able to discern “Shocking’s difficult financial circumstances and, perhaps even more importantly, the absence of any other potential contributor of material amounts of capital.” Thus, the Court found that by April 2012, Littlefuse was likely not relying on anything Michael said in the fall of 2011, and that despite Michael breach, Shocking failed to prove it was entitled to an award of damages.
Finally, the Court addressed whether Shocking should be entitled to the attorney’s fees and expenses it incurred in pursuing its action against Michael. The Court concluded that “Michael’s litigation conduct should not be viewed as having reached the level required for changing the standard practice” of a litigant generally being responsible for its own fees and expenses. The Court noted that “[d]isloyalty alone does not require fee shifting” and that, here, “because of the range of considerations that Michael thought were influencing him and because the disloyal conduct caused relatively little, if any, harm, a departure from the American Rule is not justified.”