Zimmerman v. Crothall, C.A. No. 6001-VCP (Del. Ch. Oct. 14, 2013) (Parsons, V.C.)

This memorandum opinion addressed several post-trial motions in a derivative action pursuant to which the plaintiff and unitholder, Zimmerman, sued nominal defendant, Adhezion Biomedical, LLC (“Adhezion”), certain of Adhezion’s directors, and other investors in Adhezion, for breach of contract and breach of fiduciary duty in connection with a series of financing transactions entered into by Adhezion (the “Challenged Transactions”). In earlier proceedings, the Court of Chancery granted summary judgment for the defendants on the duty of care claims, but the claims for breach of contract, breach of the duty of loyalty, and aiding and abetting survived and continued to trial. In a post-trial opinion on January 31, 2013, the Court held that the defendants had breached Adhezion’s limited liability company agreement by failing to have the Class A Common unitholders approve the issuance of additional units in connection with the Challenged Transactions, however, because the Challenged Transactions were found to be entirely fair, the individual defendants did not breach their fiduciary duties and only nominal damages were awarded. The parties were then directed to confer and submit a proposed form of final judgment.

Approximately two months later, the plaintiff moved for entry of a final, post-trial order. Shortly thereafter, the plaintiff divested all of his membership interests in Adhezion to a third party. Following the sale, the plaintiff’s former law firm, The Williford Firm LLC (“TWF”), moved to withdraw as plaintiff’s counsel and intervene in the action for purposes of securing attorneys’ fees and the defendants moved to dismiss the derivative action for the plaintiff’s lack of standing.  In this opinion, Vice Chancellor Parsons granted the defendants’ motion to dismiss and awarded $300,000 in attorneys’ fees to TWF, payable by Adhezion, and denied the plaintiff’s motion to enter final judgment on the merits of the underlying dispute.

In support of their argument for dismissal, the defendants requested that the Court apply, by analogy, the “continuous ownership rule” applicable to derivative claims against Delaware corporations.  Subject to narrow exceptions, the continuous ownership rule requires that a plaintiff-stockholder purporting to sue derivatively on behalf of a corporation own stock in such corporation throughout the duration of the applicable litigation. Applying this rule to limited liability companies, the defendants contended that the Court should dismiss the plaintiff’s derivative action because the plaintiff sold all of his units in Adhezion prior to the entry of a final judgment. Therefore, they contended that he no longer had standing to pursue derivative claims on behalf of the company. The defendants further argued that application of the continuous ownership rule to limited liability companies was appropriate because 6 Del. C. § 18-1002, the statutory provision governing standing in derivative actions against limited liability companies, sets forth the same requirements as the corresponding provision of the Delaware General Corporation Law, 8 Del. C. § 327. Although TWF contended that the sale of Zimmerman’s units was covered by the fraud exception to the continuous ownership rule, the Court rejected this argument. Instead, the Court held that there was no reason why the continuous ownership rule should not also apply in the context of limited liability companies and, applying the rule to circumstances before the Court, granted the defendants’ motion to dismiss.

In its petition for attorneys’ fees, TWF relied on both the common fund and corporate benefit doctrines, arguing first that its efforts throughout the litigation created a “common fund of tangible and substantial monetary benefit to Adhezion in improvements to subsequent financing transactions” and, second, that the success of the breach of contract claim conferred a corporate benefit on Adhezion “by giving [its] Class A Common unitholders the power to negotiate or challenge subsequent financing transactions.”  The common fund doctrine provides that a litigant or lawyer is entitled to seek reasonable attorneys’ fees if his or her actions in the underlying litigation results in an ascertainable monetary benefit to the company or its unitholders. By contrast, the corporate benefit doctrine applies where a monetary benefit has not been conferred, but some other benefit is realized by the company or the unitholders.  In either case, fees are awarded only if (1) the claim was meritorious when filed; (2) the action resulted in a substantial benefit to an identifiable group; and (3) the benefit was causally related to the litigation. Nonetheless, in all circumstances, the decision of whether to award fees, and the amount of any such award, lies within the court’s sound discretion. 

Noting that an action is meritorious if it can withstand a motion to dismiss on the pleadings, the Court found that the plaintiff’s action, which proceeded through a trial on the merits, easily qualified as a meritorious claim. Turning to the second requirement, TWF contended that, as a direct result of the litigation, the defendants “improved” the terms of two additional financing transactions that took place during the pendency of the litigation (the “Unchallenged Transactions”). These “improved terms” allegedly saved the company money and mooted potential future claims. The Court, however, rejected TWF’s argument, finding that the alleged common fund was too speculative to produce a tangible monetary benefit to the company or its unitholders. Therefore, because TWF did not establish a quantifiable, monetary benefit, the Court held that the common fund doctrine provided no basis for a fee award.

TWF was successful in its petition for fees based on the corporate benefit doctrine. In support of its petition, TWF argued that its efforts throughout the litigation resulted in a substantial benefit to the company under the corporate benefit doctrine. Although the Court held in its post-trial opinion that the individual defendants had not breached their fiduciary duties, it did conclude that the defendants breached Adhezion’s operating agreement by not seeking approval from the Class A Common unitholders before authorizing new units in connection with the Challenged Transactions. Vice Chancellor Parsons noted that while this ruling was limited to the Challenged Transactions, it could have a broader effect on the ongoing relationship between Adhezion’s management and unitholders with respect to required voting processes under the operating agreement.  As such, this litigation pointed out a repeated failure of the company’s management to comply with the  operating agreement and validated the right of Class A Common unitholders to approve future equity issuances.  Thus, TWF’s efforts produced a substantial corporate benefit for Adhezion and its Class A Common unitholders and provided a sufficient basis for the requested fee award.

Finally, the Court addressed the amount of fees to be awarded to TWF. In its petition, TWF sought an award of $400,000, allocating $200,000 to the “improvements” in the terms of the Unchallenged Transactions and $200,000 to the increase in monitoring by the Class A Common unitholders over subsequent financing transactions. Because the Court found no basis for TWF’s claim that its actions resulted in improvements to the Unchallenged Transactions, it attributed no fees to that alleged benefit. However, using a quantum meruit analysis, the Court found it fair and equitable to award an aggregate amount of $300,000 to TWF for its attorneys’ fees, cost, and expenses throughout the litigation. Moreover, because the benefit secured by TWF was of general value to the company, the Court held that Adhezion was responsible for the payment of this award.

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