Pleading Standards Alive and Well in Court of Chancery
Reprinted with permission from the March 3, 2015 edition of the Delaware Business Court Insider. © 2015 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited. (ALMReprints.com, 877.257.3382)
Delaware Court of Chancery Chancellor Andre G. Bouchard recently eliminated any doubt that properly pleading all elements of a cause of action remains a fundamental aspect of stating a claim under Delaware law, reiterating that a party must plead all elements to survive a motion to dismiss even under Delaware's comparatively lenient reasonable-conceivability standard.
In Fortis Advisors v. Dialog Semiconductor, No. 9522-CB (Del. Ch. Jan. 30, 2015), the plaintiff equity-holder representative alleged that the defendant acquirer failed to maximize potential earnouts for the selling equity holders of iWatt, a provider of digital power management circuits. Pursuant to a merger agreement, Dialog agreed to use its commercially reasonable best efforts to achieve and pay one or more earnouts based on revenues generated by Dialog's power conversion business group, where iWatt's business resided following its acquisition. The merger agreement contemplated several scenarios under which an earnout may be payable, and Dialog claimed that none of the earnouts had been or would be achieved.
The plaintiff's complaint asserted five counts: (I) breach of contract; (II) specific performance; (III) in the alternative to count I, breach of the implied covenant of good faith and fair dealing; (IV) fraudulent inducement; and (V) in the alternative to count IV, negligent misrepresentation. The defendant moved to dismiss count III under Court of Chancery Rule 12(b)(6) for failure to state a claim, and counts IV and V under Court of Chancery Rule 9(b) for failure to plead with particularity. The court ruled in favor of the defendant and dismissed counts III, IV and V of the plaintiff's complaint.
A Properly Pleaded Breach of the Implied Covenant
In his opinion, Bouchard provided an instructive analysis of what constitutes a properly pleaded claim for breach of the implied covenant. The chancellor reviewed situations in which the implied covenant may be pleaded, specifically "where a contract lacks specific language governing an issue and the obligation the court is asked to imply advances, and does not contradict, the purposes reflected in the express language of the contract." He further framed the standard, noting that the court "must focus on what the parties likely would have done if they had considered the issues involved. It must be clear from what was expressly agreed upon that the parties who negotiated the express terms of the contract would have agreed to proscribe the act later complained of ... had they thought to negotiate with respect to that matter." Finally, he noted that to state a claim for breach of the implied covenant, "a litigant must allege a specific obligation implied in the contract, a breach of that obligation, and resulting damages."
In this case, the chancellor concluded, the plaintiff failed to identify a specific contractual gap or term in the merger agreement to be implied. In its breach of contract count, Fortis alleged that Dialog had breached the merger agreement by taking or failing to take six actions. Fortis' implied-covenant count merely restated those six alleged breaches, but "failed to identify any gap or ambiguity in [the merger agreement] as a basis for implying an additional obligation owed by Dialog with regard to any of these six alleged actions or failures," instead merely mimicking the language of the breach of contract claim. The merger agreement "sets a contractual standard by which to evaluate if Dialog's failure to achieve and pay the earnout payments in its operation of the power conversion business group was improper," and thus no gap existed to fill. The chancellor also noted that Fortis had undercut its own argument by acknowledging that it had not pleaded a gap, but arguing that count III should survive as a possible alternative basis for relief "in case 'the court may disagree' down the road."
The chancellor drew upon similarity with a 2012 case, Matthew v. Laudamiel, C.A. No. 5957-VCN (Del. Ch. Feb. 21, 2012), where Vice Chancellor John W. Noble rejected an implied-covenant argument on the ground that an LLC agreement addressed the manager's conduct in managing the affairs of the company. Because actions cannot constitute a breach of the implied covenant if they are addressed in the contract, the implied-covenant claim could not survive in either case.
Bouchard also rejected Fortis' argument that its implied-covenant claim should survive despite its failure to identify a gap because it was pleaded in the alternative. Concluding that Court of Chancery Rule 8(e)(2), which permits litigants to plead alternative claims, "does not obviate the need to provide factual support for each theory," the chancellor reinforced that Fortis had failed to plead the existence of any gap in the merger agreement that the implied covenant could fill, and that count III of the complaint failed to state a claim for relief.
The Who, When, What and Why Still Required to Plead Fraud
Bouchard also dismissed the plaintiff's fraudulent inducement and negligent misrepresentation claims, concluding that Fortis had failed to allege its claims with the particularity required by Court of Chancery Rule 9(b). The rule provides that averments of fraud must allege: (1) the time, place and contents of the false representation; (2) the identity of the person making the representation; and (3) what the person intended to gain by making the representations, all in sufficient detail to apprise the defendant of the basis for the claim.
Count IV of Fortis' complaint alleged that Dialog had made four materially false statements during the parties' negotiations to induce iWatt to enter into the merger agreement, all of which were alleged promises of future performance. The chancellor noted, however, that insufficient detail was provided about these four alleged statements, particularly when each statement was allegedly made, and which Dialog employee allegedly made each statement. The chancellor determined that the complaint's broad assertion that each of the alleged misrepresentations was made during the three-and-a-half-month period when the parties were negotiating was insufficient to put Dialog on notice of when the statements were allegedly made. When alleged misrepresentations occurred is especially important where alleged promises are of future performance, because in such instances, "a plaintiff must demonstrate that the defendant had no intention of keeping its promises at the time they were made. To defend against such assertions, a defendant logically must be apprised when the alleged statements were made in order to counter the assertion that it did not intend to keep its promise at that time." Because he concluded that Fortis failed to provide such information, the chancellor found that Rule 9(b) had not been satisfied.
Additionally, the chancellor determined that the complaint failed to identify who made each particular alleged misrepresentation. He noted that the complaint asserted that one of two Dialog officers made each of the representations, but did not aver which officer made each such statement. Rejecting Fortis' argument that its pleading was consistent with Anvil Holding v. Iron Acquisition, C.A. No. 7975-VCP (Del. Ch. May 17, 2013), where the plaintiff had alleged that all of the defendants committed fraud by affirmatively concealing material information from the plaintiff at two specific meetings, the chancellor differentiated Anvil on the ground that allegations that all defendants were present when misrepresentations occurred sufficiently averred that each defendant participated in the withholding. In contrast, Fortis failed to identify which Dialog officer was responsible for each alleged statement, which failed to adequately inform Dialog of the accusations against it.
The chancellor noted the complaint failed to assert to whom the statements were made, stating only that each alleged misrepresentation was made to iWatt's former CEO and other unnamed iWatt directors and officers, and such allegations were insufficient because "we do not know who was the recipient of, or even a witness to, any particular statement."
The chancellor noted the complaint did not disclose where or by what means the misrepresentations were allegedly made. The complaint "referred generally to 'discussions' or 'conversations,' but it does not describe where (e.g., at iWatt's offices, Dialog's offices, a mutual meeting place) or how (e.g., in person, over the phone, by email) any of these communications occurred." Bouchard concluded that considering "the lack of these details ... together with the failure of the complaint to identify when any of the alleged misrepresentations were made and who made any of them, the complaint fails in my view to apprise Dialog of sufficient information concerning the circumstances of the alleged fraud and thus does not satisfy the particularity requirement of Rule 9(b)."
Finally, Bouchard dismissed the plaintiff's negligent misrepresentation count because the plaintiff (in addition to not alleging the elements of fraud) had failed to allege a special relationship between the parties or otherwise justify an equitable remedy. The chancellor noted the complaint alleged that the parties were arm's-length negotiators to the merger agreement, such that no special relationship existed between them, and that count V sought damages but not any equitable relief.
Conclusions
The court's holding in Fortis highlights the importance of a lawyer's diligence in formulating and advancing a client's claims, and adhering to pleading standards prescribed by the Chancery Court rules and precedents. Though Fortis presents an extreme example, imprecise pleading (even in the alternative) can materially impair a party's ability to recover for wrongs against them. Counsel must take care to draft pleadings to ensure they comply with established standards to preserve their clients' claims and meet their obligations to their clients and the court.
The material in this publication was created as of the date set forth above and is based on laws, court decisions, administrative rulings and congressional materials that existed at that time, and should not be construed as legal advice or legal opinions on specific facts. The information in this publication is not intended to create, and the transmission and receipt of it does not constitute, a lawyer-client relationship.
Content contributed by attorneys of Troutman Sanders LLP and Pepper Hamilton LLP prior to April 1, 2020, is included here, together with content contributed by attorneys of Troutman Pepper (the combined entity) after the merger date.