Chodniewicz v. ART.com CA1/2 ( 2021 )

Filed 9/29/21 Chodniewicz v. ART.com CA1/2
NOT TO BE PUBLISHED IN OFFICIAL REPORTS
California Rules of Court, rule 8.1115(a), prohibits courts and parties from citing or relying on opinions not certified for
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ordered published for purposes of rule 8.1115.
IN THE COURT OF APPEAL OF THE STATE OF CALIFORNIA
FIRST APPELLATE DISTRICT
DIVISION TWO
JOSHUA CHODNIEWICZ, et al.,
Plaintiffs and Appellants,
A159720
v.
ART.COM, INC., et al., (Alameda County
Super. Ct. No. RG19001604)
Defendants and Respondents.
Plaintiffs are shareholders of ART.com, Inc. (ART) who brought suit
against four of ART’s directors and the venture capital firms they control,
alleging that the board of directors breached their fiduciary duties to ART in
approving the sale of ART to Walmart, Inc. (Walmart), and that the venture
capital firms aided and abetted those breaches. The trial court sustained the
venture capital firms’ demurrer to the operative complaint’s second cause of
action for aiding and abetting breach of fiduciary duty, and dismissed the
venture capital firms from the case, concluding that plaintiffs failed to allege
“knowing participation” in the alleged breaches as required under Delaware
law. Our review leads to the opposite conclusion, and we reverse.
1
BACKGROUND1
The Parties
Plaintiffs and appellants Joshua Chodniewicz and Michael Marston are
the founders of defendant and respondent ART, a Delaware corporation with
its principal place of business in Emeryville, California, that was at one time
one of the world’s largest online sellers of artwork. Plaintiffs are also
shareholders of ART, and Chodniewicz serves on ART’s board, alongside six
other directors: Dan Marriott (the chairman), Robert Kagle, David
Quinlivan, Alan Spoon, Kira Wampler (the CEO), and Sharon McCollam.
Four of ART’s directors (the VC Directors) are also affiliated with
venture capital firms (the VC Stockholders) who hold common and/or
preferred stock in ART, specifically: Marriott is managing member of SG
Growth Partners I, L.P.; Kagle is a general partner of Benchmark Capital
Partners IV, L.P., and Benchmark Capital Partners V, L.P.; Quinlivan is
managing member of each of the limited liability companies that control
Saints Capital VI, L.P. and Saints Ventures II, L.P.; and Spoon is partner
emeritus of Polaris Venture Partners IV, L.P. and Polaris Venture Partners
Entrepreneurs’ Fund IV, L.P.
The Walmart Transaction
In the first quarter of 2018, ART’s CEO Wampler and CFO Chuck
Kurth began to advise ART’s board of directors to explore a sale of ART.
According to the May 29, 2018 board minutes, “the Board authorized the
Company’s officers to continue discussions with . . . third parties and to seek
to elicit written acquisition offers from such parties.” And as early as March
1The factual background is drawn from the allegations of the operative
Third Amended Complaint.
2
2018, ART began supplying Walmart with confidential information related to
a potential sale.
On October 29, Walmart sent ART a letter of intent proposing that
Walmart acquire ART’s selected U.S. assets for a purchase price of
$40,000,000, leaving ART with its international operations and all its
liabilities. The proceeds from the transaction were “to be used to pay
creditors in full, leaving between $8,000,000–$10,000,000 for Management
bonuses, Management severance payments, and distributions to VC
Stockholders, yet distributing nothing to holders of common stock.” The
letter of intent gave ART 24 hours to decide whether to accept its terms. It
also contained a “no-shop” restriction, preventing the board from entertaining
any other offers for the sale of ART, and a “no-talk” provision, preventing the
board from entertaining unsolicited offers to purchase ART.
The next day, over Chodniewicz’s objection, the board voted to accept
the terms of the letter of intent.
Chodniewicz proposed an alternative to the Walmart transaction that
“would remove inept management, cut unnecessary expenses, and restore
ART to health.” Through “causal conversations” with “only a few other
shareholders, [Chodniewicz] obtained millions of dollars in financial
commitments to fund” this alternative transaction, including $1,800,000 from
the board’s chairman, Marriott. Chodniewicz obtained a written letter of
intent from Clinton Phillips, a wealthy entrepreneur, who offered to infuse
$15,000,000 into ART. He also spoke with Jason Caplain, who offered an
additional $2,000,000 on the condition that Chodniewicz assume control of
the company.
By December 5, Walmart had presented ART an asset purchase
agreement, which was considered at a meeting of the board on December 5.
3
Again over Chodniewicz’s objection, the board approved the Walmart
transaction. The board allegedly did so because the directors “feared that
creditors could sue the Board if they accepted anything other than the
WALMART transaction,” and because they “believed they owed their
fiduciary duties to ART’s creditors, and these fictitious duties to creditors
would be violated, thus creating liability for themselves, if the WALMART
fire sale was not accepted.”
Together with the board’s approval, the VC Directors each executed a
written consent to the Walmart transaction, “giving written consent with
respect to all shares of the Company’s capital stock by such Stockholder in
favor” of the transaction. On December 11, ART’s CEO Wampler sent a
notice to ART’s shareholders regarding the transaction, stating that ART
“expects that substantially all or all of the proceeds will be used to pay its
creditors. If any proceeds remain and the Company winds down its
operations, the Company may make a modest distribution to the holders of
Series B Preferred Stock, but it is expected that no proceeds will be available
to make any distributions to the holders of Series A Preferred Stock, Series
A-1 Preferred Stock or Common Stock.”
The Lawsuit
On January 7, 2019, plaintiffs Chodniewicz and Marston filed suit
against ART, the individual members of the board of directors, and Walmart,
alleging breach of fiduciary duty, breach of Delaware General Corporation
Law section 124, aiding and abetting breach of fiduciary duty against
Walmart, fraud and constructive fraud, and seeking declaratory relief.
Plaintiffs sought a temporary restraining order and an injunction blocking
the closing of the Walmart transaction. The trial court denied the request for
injunctive relief.
4
On February 14, plaintiffs filed a First Amended Complaint, now
including the VC Stockholders as defendants. The trial court sustained
Walmart’s demurrer to the First Amended Complaint with leave to amend,
concluding that the “no-shop” provision and sale price of the Walmart
transaction were not per se breaches of the board of directors’ fiduciary
duties.
On June 12, plaintiffs filed a Second Amended Complaint. The second
cause of action was for breach of fiduciary duty against the VC Stockholders,
alleging that they “control[led] ART not only because of their shareholdings,
which combined equals a ‘majority’ controlling interest, but also because of
their control over the Board, which they dominate[d] thus giving them such
formidable voting and managerial power that they control[led] the business
of ART,” and that the breaches of fiduciary duty by ART’s directors were
“accomplished at the behest and direction” of the VC Stockholders.
The VC Stockholders filed a demurrer to the second cause of action,
and the trial court sustained the demurrer with leave to amend, holding as
follows:
“As the Second Amended Complaint is currently pled (at paragraph
129), Plaintiffs appear to allege that the VC Stockholders are vicariously
liable for purported breaches of fiduciary duties by members of the VC
Stockholders who sit on the Art.com board. That is not a viable theory of
liability. (See, e.g., Khanna v. McMinn (Del. Ch. May 9, 2006) 2006 WL
1388744.) Plaintiffs are given leave to amend to make clear that they are
proceeding on their breach of fiduciary duty claims against the VC
Stockholders under an aiding and abetting theory, and to allege facts in
support of that theory.”
5
On October 7, 2019, plaintiffs filed the operative Third Amended
Complaint (TAC), alleging five causes of action: (1) breach of fiduciary duty
against the VC Directors as well as Wampler and Kurth; (2) breach of
fiduciary duty and aiding and abetting breach of fiduciary duty against the
VC Stockholders; (3) aiding and abetting breach of fiduciary duty against
Walmart; (4) constructive trust, disgorgement, and unjust enrichment
against Walmart; and (5) declaratory relief against all defendants.
With respect to the second cause of action against the VC Stockholders,
the TAC alleged that “[e]ach of the . . . VC Stockholders control the business
and affairs of ART in so far as the WMT Transaction is concerned,” that they
“control ART not only because of their shareholdings, which combined equals
a ‘majority’ controlling interest, but also because of their control over the
Board, which they dominate,” and thus they constituted a “control group”
analogous to a controlling shareholder, and therefore owed a fiduciary duty to
their fellow shareholders; and that they acted “in concert to accomplish the
joint purpose of controlling ART in general and in particular in approving the
WALMART transaction.” The TAC also alleged that the VC Directors “were
agents of and made decisions for their respective VC Stockholder,” such that
the knowledge of the VC Directors was imputed to the VC Stockholders and
they therefore aided and abetted the VC Directors’ alleged breaches of
fiduciary duty. And, the TAC alleged, that “acting as a single group the VC
Directors and VC Stockholders planned and caused ART to engage in the
WMT Transaction that had the purpose and effect of gaining their personal
release from creditor claims, and did so at the expense of the minority
shareholders of ART. Through a series of meetings and agreements they
worked together to establish the exact terms and timing of the WMT
Transaction.”
6
The Demurrers and The Trial Court’s Ruling
The VC Directors, Walmart, and the VC Stockholders filed separate
demurrers to the TAC. The trial court overruled the demurrers of the VC
Directors and Walmart to the first, third, fourth, and fifth causes of action,
concluding that the TAC sufficiently alleged a breach of fiduciary duty by
Walmart and by the VC Directors. However, the trial court sustained the VC
Stockholders’ demurrer to the second cause of action without leave to amend,
concluding that plaintiffs had failed to allege that the VC Stockholders
constituted a control group and thereby owed a fiduciary duty to minority
shareholders. With respect to the aiding and abetting allegations, the trial
court held as follows:
“Second, Plaintiffs alleged that the VC Stockholders are liable for
aiding and abetting the breach of fiduciary duties by ART’s directors. This
claim is based on the fact that certain of ART’s board of directors were also
members of the VC Stockholders, and that those directors were managing
members of the VC Stockholders who made the decisions for those entities.
(See Third Amended Complaint, paragraphs 127–128 and 138–140.) A
shareholder is not vicariously liable for an alleged breach of fiduciary duty by
one of its members. (See, e.g., Khanna v. McMinn[, supra,] 2006 WL
1388744.) Plaintiffs argue, however, that a shareholder may be liable for a
breach of fiduciary duty by an affiliated corporate director who controls the
shareholder and/or occupies a sufficiently high position in the shareholder
such that the director’s knowledge is imputed to the shareholder. (See, e.g.,
In re PLX Technologies Inc. Stockholders Litig. (Del. Ch. Oct. 16, 2018) 2018
WL 5018535, at p. *107 (PLX).)
“But Plaintiffs’ focus on whether the knowledge of an affiliated
corporate director can be imputed to the shareholder misses the key point,
7
i.e., that a claim for breach of fiduciary duty requires not just knowledge, but
‘knowing participation’ by the shareholder. Plaintiffs must allege facts
demonstrating that the VC Stockholders knowingly participated in the
purported breach of fiduciary duties by ART’s board of directors by providing
‘substantial assistance’ to the breach. (See e.g., Buttonwood Tree Value
Partners L.P. v. R.L. Polk & Co. (Del. Ch. July 24, 2017) 2017 WL 3172722, at
p. *9, and Malpiede v. Townson (Del. 2001) 780 A.2d 1075, 1096.) Here,
Plaintiffs fail to allege facts demonstrating that any of the VC Stockholders
took any action that substantially assisted in the purported breach of
fiduciary duties by ART’s board. [Citation.] Rather, as discussed above,
Plaintiffs simply allege that each of the VC Stockholders voted in favor of the
asset sale to Walmart, pursuant to their rights under ART’s Certificate of
Incorporation.
“To the extent Plaintiffs contend the VC Stockholders are themselves
liable for alleged breaches of fiduciary duties by their affiliated directors,
Plaintiffs are seeking to hold the VC Stockholders vicariously liable for the
actions of their affiliated directors. That is not a viable theory of liability.”
The trial court also sustained the VC Stockholders’ demurrer to the
fifth cause of action for declaratory relief, finding that they did not owe an
independent fiduciary duty to the plaintiffs. The trial court then dismissed
the VC Stockholders from the action with prejudice.
Plaintiffs filed a notice of appeal.
DISCUSSION
Plaintiffs argue that the trial court erred in sustaining the VC
Stockholders’ demurrer to the second cause of action because they sufficiently
pled the elements of aiding and abetting a breach of fiduciary duty or, in the
alternative, that they sufficiently alleged that the VC Stockholders acted as a
8
“control group” in approving the transaction and therefore owed fiduciary
duties to the minority shareholders, and that they should have been granted
leave to amend to cure any deficiencies in the TAC. We agree with plaintiffs’
first argument, and need not reach the second.
Applicable Law: Demurrer
On appeal from a dismissal after an order sustaining a demurrer, we
review the order de novo, exercising our independent judgment whether the
complaint states a cause of action as a matter of law. (Moore v. Regents of
University of California (1990) 51 Cal.3d 120, 125; Chen v. PayPal, Inc.
(2021) 61 Cal.App.5th 559, 568.) We give the complaint a reasonable
interpretation, reading it as a whole and viewing its parts in context.
(Blank v. Kirwan (1985) 39 Cal.3d 311, 318; see Aubry v. Tri-City Hospital
Dist. (1992) 2 Cal.4th 962, 966–967.) We deem to be true all material facts
properly pled (Serrano v. Priest (1971) 5 Cal.3d 584, 591), and also accept as
true those facts that may be implied or inferred from those expressly alleged.
(Richelle L. v. Roman Catholic Archbishop (2003) 106 Cal.App.4th 257, 264.)
And we “adopt[] a liberal construction of the pleading and draw[] all
reasonable inferences in favor of the asserted claims.” (Candelore v. Tinder,
Inc. (2018) 19 Cal.App.5th 1138, 1143.)
Applicable Law: Aiding and Abetting Breach of Fiduciary Duty
In PLX, supra, 2018 WL 5018535, the Delaware Court of Chancery
gave the following exposition of Delaware law on aiding and abetting a
breach of fiduciary duty:
A claim “for aiding and abetting breaches of fiduciary duty . . . has four
elements: (i) the existence of a fiduciary relationship, (ii) a breach of the
fiduciary’s duty, (iii) knowing participation in the breach by a non-fiduciary
9
defendant, and (iv) damages proximately caused by the breach.” (Id. at
p. *27.)
We briefly interrupt the PLX description to note that, as the VC
Stockholders acknowledge, the only element in dispute here is the third,
knowing participation. And as to this, PLX continues: “The third element of
a claim for aiding and abetting is the third party’s knowing participation in
the breach. ‘The adjective “knowing” modifies the concept of “participation,”
not breach.’ The underlying wrong does not have to be knowing or
intentional; it can be a breach of the duty of care.
“Under 876(b) of the Restatement (Second) of Torts, knowing
participation exists when a third party:
“(a) does a tortious act in concert with the other or pursuant to a
common design with him, or
“(b) knows that the other’s conduct constitutes a breach of duty and
gives substantial assistance or encouragement to the other so to conduct
himself, or
“(c) gives substantial assistance to the other in accomplishing a tortious
result and his own conduct, separately considered, constitutes a breach of
duty to the third person.
“For purposes of a board decision, the requirement of participation can
be established if the third party ‘participated in the board’s decisions,
conspired with [the] board, or otherwise caused the board to make the
decisions at issue.’ In particular, a third party can be liable for aiding and
abetting a breach of the duty of care if the third party ‘purposely induced the
breach of the duty of care . . . .’ The method of facilitating the breach can
include ‘creating the informational vacuum’ in which the board breaches its
duty of care.
10
“When the aiding and abetting claim targets an unrelated third party,
a court’s analysis of whether a secondary actor ‘knowingly participated’ is
necessarily fact intensive. Illustrative factors include the following:
“• The nature of the tortious act that the secondary actor participated
in or encouraged, including its severity, the clarity of the violation, the extent
of the consequences, and the secondary actor’s knowledge of these aspects;
“• The amount, kind, and duration of assistance given, including how
directly involved the secondary actor was in the primary actor’s conduct;
“• The nature of the relationship between the secondary and primary
actors; and
“• The secondary actor’s state of mind.
“When the fiduciary and primary wrongdoer is also a representative of
the secondary actor who either controls the actor or who occupies a
sufficiently high position that his knowledge is imputed to the secondary
actor, then the test is easier to satisfy. For example, this court has
recognized that the acquisition vehicles that a controlling stockholder uses to
effectuate an unfair freeze-out merger are liable as aiders and abettors to the
same degree as the controller, because the controller’s knowledge is imputed
to those entities. [See In re Dole Food Co., Inc. Stockholder Litigation (Del.
Ch. Aug. 27, 2015) 2015 WL 5052214, at p. *39; In re Emerging
Communications, Inc. Shareholders Litigation (Del. Ch. May 3, 2004) 2004
WL 1305745, at p. *38.] This court also has employed the same reasoning to
recognize that an investment fund can be liable for aiding and abetting when
‘the same individuals who have made the Fund’s investment decisions’ are
also the fiduciaries who engaged in misconduct. [Forsythe v. ESC Fund
Mgmt. Co., (Del. Ch. Oct. 9, 2007) 2007 WL 2982247, at p. *13 [‘These
investment decisions form the basis of the plaintiffs’ breach of fiduciary duty
11
claims. Therefore, the court may infer CIBC’s knowledge of the Special
Limited Partner’s and Investment Advisor’s breaches of fiduciary duty’].]”
(PLX, supra, 2018 WL 5018535, at p. *47, fns. omitted.)
The Parties’ Arguments
Plaintiffs argue that where there is a “close identity between a director
who is breaching his fiduciary duties and the shareholder entity he controls
or manages,” Delaware law imputes the “knowing participation” element of
aiding and abetting to the shareholder entity and does not require a separate
allegation of “substantial assistance.” In support, they cite numerous cases
that have found knowing participation in similar circumstances, cases we
discuss below. In the alternative, Plaintiffs argue that the TAC pleaded
“substantial assistance” by alleging that the VC Stockholders signed the
written consent and thereby approved the Walmart transaction.
The VC Stockholders argue that the “element of ‘knowing participation’
requires that the secondary actor have provided ‘substantial assistance’ to
the primary violator,” even in cases where the director also controls the
shareholder, and that that element was not sufficiently alleged here. And in
claimed support they cite: “(See In re Oracle Corporation Derivative
Litigation (Del. Ch. June 22, 2020) 2020 WL 3410745, at p. *11 [plaintiff
‘must plead facts making it reasonably conceivable that the defendant
knowingly supported a breach of duty and that his resulting assistance to the
primary actor constituted substantial assistance in causing the breach’].)”
The VC Stockholders argue that in considering whether knowing
participation has been alleged, Delaware courts look to whether the
defendants acted with “improper motives of their own.” (Goodwin v. Live
Entertainment, Inc. (Del. Ch. Jan. 25, 1999) 1999 WL 64265, at p. *28; see
In re Comverge, Inc. (Del. Ch. Nov. 25, 2014) 2014 WL 6686570, at p. *18.)
12
Finally, they argue that finding the knowing participation element alleged
here would contravene Delaware law’s rejection of the proposition that
“whenever a director is affiliated with a significant stockholder, that
stockholder automatically would acquire the fiduciary obligations of the
director by reason of that affiliation alone.” (Emerson Radio Corp. v.
International Jensen Inc. (Del. Ch. Aug. 20, 1996) 1996 WL 483086, at p. *20,
fn. 18.)
We agree with plaintiffs. But before explaining why, we begin with
discussion of several Delaware cases that have held for plaintiffs on the issue
of knowing participation—indeed, two cases that found knowing participation
after trial.2
PLX
In PLX, supra, 2018 WL 5018535, Potomac Capital Partners, a
shareholder of PLX, launched an “activist campaign” to pressure PLX into
selling itself, a campaign led by Potomac’s co-managing member, Singer.
(PLX, supra, 2018 WL 5018535, at p. *1.) Potomac nominated five
candidates, including Singer, to replace a majority of PLX’s board. (Ibid.)
Singer then received a tip from Krause, a representative of Avago, a potential
purchaser, informing him what Avago wanted to pay for PLX and when it
was likely to bid, but he did not share this information with the rest of PLX’s
board. (Id. at p. *1.) After Avago ultimately purchased PLX, plaintiffs sued
the board of directors for breaching their fiduciary duties in approving the
merger, and sued Potomac for aiding and abetting those breaches. (Id. at
p. *2.) In a post-trial decision, the Delaware Court of Chancery found that
plaintiffs had proved Potomac’s “knowing participation”:
2 Although these decisions are unpublished, they have precedential
effect in Delaware. (See Aprahamian v. HBO & Co. (Del. Ch. 1987) 531 A.2d
1204, 1207.)
13
“In this case, Singer was a co-managing member of Potomac and its
agent, and his knowledge is imputed to Potomac in those capacities. Singer
led Potomac’s activist campaign at PLX. Potomac owned PLX stock, filed
Schedule 13Ds, served books and records demands, nominated the dissident
director slate, filed the proxy materials, and stood to collect the short-term
gains from a quick sale. Singer directed Potomac’s activities and once elected
to the Board, Singer continued to act on Potomac’s behalf. By failing to share
Krause’s tip with the Board, Singer created a critical informational gap that
contributed to the Board’s breach of duty.
“Because of Singer’s relationship with Potomac and his role in directing
and implementing Potomac’s strategy, Singer’s knowledge and actions can be
attributed to Potomac. This holding does not stand for the proposition that
the actions of the director-representative of a stockholder can always be
attributed to a stockholder. For example, Delaware law does not recognize
any basis to attribute the actions of an independent director to the control of
the stockholder that nominated or appointed him, simply by virtue of the fact
of the nomination or appointment. In this case, the combination of Singer’s
position with, ties to, and actions on behalf of Potomac supports a different
result and warrants a finding that Potomac knowingly participated in the
steps Singer took to breach his fiduciary duties and induce a breach by the
Company’s other directors. The plaintiffs thus satisfied the third element of
their claim for aiding and abetting a breach of fiduciary duty.” (PLX, supra,
2018 WL 5018535, at pp. *49–*50, fns. omitted.)
Emerging
In In re Emerging Communications, Inc. Shareholders Litigation (Del.
Ch. May 3, 2004) 2004 WL 1305745 (Emerging), Prosser was ECM’s
Chairman and CEO, and also the owner of ICC, which owned 100 percent of
14
Innovative and 52 percent of ECM. (Id. at p. *1.) Plaintiffs, including an
investment fund named Greenlight, challenged a privatization transaction in
which Innovative acquired the publicly owned shares of ECM, alleging that
Prosser had breached his fiduciary duties to ECM. (Ibid.) After trial, the
court concluded that Innovative and ICC were liable for aiding and abetting
Prosser’s breaches:
“Prosser, as majority stockholder, breached his duty of loyalty to
Greenlight and the plaintiff shareholder class, by eliminating ECM’s
minority stockholders for an unfair price in an unfair transaction that
afforded the minority no procedural protections. For that breach of duty
Prosser is liable to Greenlight and the shareholder class. So also are the two
Prosser-controlled entity defendants, Innovative and ICC, which were the
mechanisms through which Prosser accomplished the Privatization. Those
entities are liable for having aided and abetted Prosser’s breach of fiduciary
duty. [Citations.] One of the requirements for ‘aiding and abetting’ liability
is the third party’s ‘knowing participation’ in the directors’ breach of fiduciary
duty. In that case, Prosser’s knowledge must be attributed to the entities
that he controlled and used to effectuate his breaches of duty.” (Emerging,
supra, 2004 WL 1305745, at p. *38, fn. 176.)
Forsythe
In Forsythe v. ESC Fund Mgmt. Co. (U.S.), Inc. (Del. Ch. Oct. 9, 2007)
2007 WL 2982247 (Forsythe), a bank (CIBC) gave certain of its employees
partnership interests in a fund intended to co-invest with the bank in its
proprietary investments. (Id. at p. *1.) Plaintiffs sued the fund, its
individual directors, an investment advisor, and a special limited partner for
breach of fiduciary duty, in a pleading described by the court this way:
15
“According to the complaint, these CIBC senior executives, sitting as
the CIBC Investment Committee, make and continue to make investment
decisions for CIBC. When investments lose significant value, these same
executives change hats and, sitting as the Special Limited Partner or the
Investment Advisor, allegedly approve the Fund’s purchase of the same
investments from CIBC. The plaintiffs allege the Fund is forced to buy these
investments from CIBC at prices equal to CIBC’s original cost of investment
and pay CIBC a 7 [percent] finder’s fee. The complaint alleges that CIBC,
the Special Limited Partner, and the Investment Advisor have violated and
continue to violate their fiduciary duties to the Fund through this activity.
“At the same time, the plaintiffs allege that the General Partner and
the Individual Defendants have violated their fiduciary duties to the Fund by
abdicating their oversight responsibilities, ‘[n]ever once question[ing] either
the Special Limited Partner, the Investment Advisor, or any other person or
entity regarding the investments being made or transferred to the Fund.’
The plaintiffs further allege that the Investment Advisor, Special Limited
Partner, and CIBC have aided and abetted the General Partner’s and the
Individual Defendants’ violations of their fiduciary duties.” (Forsythe, supra,
2007 WL 2982247, at pp. *3–*4, fn. omitted.)
The court concluded that plaintiffs had adequately alleged that CIBC
aided and abetted the breaches of the investment advisor and the special
limited partner: “CIBC created the Fund and populated the Fund’s decision-
making entities with CIBC’s own employees. Thus, the same individuals who
have made the Fund’s investment decisions are also high-level CIBC
executives. These investment decisions form the basis of the plaintiffs’
breach of fiduciary duty claims. Therefore, the court may infer CIBC’s
16
knowledge of the Special Limited Partner’s and Investment Advisor’s
breaches of fiduciary duty.” (Forsythe, supra, 2007 WL 2982247, at p. *13.)
Khanna
In Khanna v. McMinn (Del. Ch. 2006) 2006 WL 1388744 (Khanna),
Shapero was managing and general partner of Crosspoint Venture Partners,
L.P., a large shareholder of Covad Communications Group, Inc., and served
as Crosspoint’s designee to Covad’s board of directors. (Id. at pp. *1, *3.)
Plaintiffs alleged that Crosspoint aided and abetted Shapero’s breaches of
fiduciary duty with respect to certain transactions entered into by Covad,
including Covad’s acquisition of BlueStar. (Id. at pp. *2, *10.) The court
concluded that plaintiffs had adequately alleged knowing participation:
“As to the requirement that there be ‘knowing participation’ in the
breach by the non-fiduciary defendant (i.e., Crosspoint), ‘[a] claim of knowing
participation need not be pled with particularity. However, there must be
factual allegations in the complaint from which knowing participation can be
reasonably inferred.’ Shapero’s status as a Covad director and General and
Managing Partner of Crosspoint is sufficient to impute knowledge of
Shapero’s conduct with respect to the BlueStar acquisition to Crosspoint, for
purposes of this motion to dismiss. The allegations of the Amended
Complaint support the reasonable inference that Shapero, and therefore
Crosspoint, knew of BlueStar’s gloomy business prospects at the same time
he was touting the potential acquisition.” (Khanna, supra, 2006 WL
1388744, at p. *27, fns. omitted.)
Carr
In Carr v. New Enterprise Associates, Inc. (Del. Ch. 2018) 2018 WL
1472336 (Carr), plaintiffs challenged an issuance of preferred stock by the
company ACT, over 90 percent of which was acquired by defendant NEA,
17
allowing it to become ACT’s controlling shareholder. (Id. at p. *3.) Plaintiffs
alleged that the transaction undervalued ACT, and that ACT’s board of
directors breached their fiduciary duties. (Id. at p. *6.) The court concluded
that plaintiffs had adequately alleged that NEA aided and abetted the board
of directors’ breaches, because defendant Klein was both a director of ACT
and a partner on NEA’s healthcare team:
“Viewing the facts alleged in the light most favorable to Carr, as I must
at this stage of the proceedings, I find that Carr has adequately pled that
NEA knowingly participated in the Board’s breach. Klein served as both an
ACT director and an NEA partner, so his alleged knowing participation in
the Board’s breach of its fiduciary duty with respect to the Series A–2
Financing may be imputed to NEA. The Complaint alleges that both NEA
and Klein had a financial incentive to dilute cheaply ACT stockholders to
gain control of the Company at an unfairly low price, and that NEA exploited
conflicts of interest on the Board by deploying Klein to facilitate a transaction
purportedly unfair to the existing ACT stockholders. These interactions
between ACT and NEA, which acquired 90 [percent] of the Series A–2
Preferred Stock, ‘amount to more than simple arm’s-length negotiations,’
since Klein’s venture capital firm, where he is a partner, wanted NEA to
acquire the preferred stock at the lowest possible valuation. Accordingly, I
find it reasonably conceivable that NEA aided and abetted the Board’s breach
of fiduciary duty.” (Id. at p. *16, fns. omitted.)
BrandRep
In BrandRep, LLC v. Ruskey (Del. Ch. 2019) 2019 WL 117768(BrandRep), defendant director Ruskey allegedly stole BrandRep’s trade
secrets and transferred them to two entities he controlled (the Entity
Defendants), and those defendants then “allegedly concealed their use of
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BrandRep’s software.” (Id. at pp. *2, *6.) The court concluded that the
complaint adequately alleged an aiding and abetting claim against the Entity
Defendants:
“I conclude it is reasonably conceivable that Ruskey owned or
controlled the Entity Defendants, such that his knowledge of his alleged
breaches of fiduciary duties owed to BrandRep is imputed to both Entity
Defendants. Because Ruskey was ‘the fiduciary and primary wrongdoer’ and
also allegedly ‘control[led] [the Entity Defendants] or [ ] occupie[d] a
sufficiently high position that his knowledge is imputed to’ those entities, the
knowing participation test is ‘easier to satisfy.’ Based on Ruskey’s imputed
knowledge and the Entity Defendants’ alleged concealment, it is reasonably
conceivable that the Entity Defendants knowingly participated in Ruskey’s
alleged breaches of fiduciary duty.” (BrandRep, supra, 2019 WL 117768, at
p. *6.)
Cumming
In Cumming v. Edens (Del. Ch. 2018) 2018 WL 992877 (Cumming),
plaintiff alleged that the board of directors of New Senior breached their
fiduciary duties in connection with a transaction whereby New Senior
acquired assets at an unfair price from Holiday, an entity controlled by
Fortress, itself a stockholder of New Senior that appointed all six members,
including two of its officers (Edens and Givens) to New Senior’s board. (Id. at
pp. *1–*3.) Edens was also Fortress’s founder, largest stockholder, and the
co-chairman of its board of directors. (Id. at p. *3.) The court concluded that
plaintiff had adequately alleged that Fortress and various of its subsidiaries
aided and abetted the alleged breaches of fiduciary duty by New Senior’s
board:
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“Based on the well-pled facts in the complaint, it is reasonably
conceivable that all five of the alleged aiders and abettors knowingly
participated in the directors’ alleged breaches. Under Delaware law, ‘the
knowledge of an agent acquired while acting within the scope of his or her
authority [and the acts of agents in that scope] [are] imputed to the
principal.’ In In re Emerging Communications[, supra, 2004 WL 1305745],
applying this fundamental agency principle, the court held that two entities
were ‘liable for having aided and abetted’ an individual defendant where the
entities were under the control of that defendant and ‘were the mechanisms
through which’ that defendant ‘accomplished’ the challenged transaction.
This same type of scheme is alleged here—Givens and Edens are alleged to
have facilitated the Challenged Transactions through the various Fortress
subsidiaries named as aiders and abettors. Under basic principles of agency,
all of their knowledge is imputed to the Fortress entities they served as
agents. [¶] . . . [¶] The allegations are similarly compelling against Fortress.
Plaintiff alleges that Fortress pushed the Acquisition in furtherance of a
broader plan to shift its assets under management to publicly-traded
companies that were externally managed by Fortress, such as New Senior, so
it (through FIG) could charge higher management fees over longer periods of
time. He further alleges that FHIF, Fortress’ private equity fund that is the
majority owner of Holiday, pushed the Holiday sale to facilitate the ‘return of
capital to its investors’ in advance of its ‘maturity date of January 2017.’
Those allegations, when coupled with the allegations that Givens ran the
negotiations for New Senior and made bids for the Holiday Portfolio without
any authorization from a Board comprised of members that were either
interested in the Challenged Transactions or beholden to others who were,
create a reasonably conceivable narrative that Fortress knowingly
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participated in the Board’s and Givens’ breaches.” (Cumming, supra, 2018
WL 992877, at pp. *26–*27.)
Plaintiffs Have Sufficiently Alleged Aiding and Abetting Breach
of Fiduciary Duty
Applying the foregoing authorities, we conclude that plaintiffs have
adequately alleged “knowing participation” on the part of the VC
Stockholders here. The TAC alleges that the VC Directors were general
partner, managing members, or “partner emeritus” of their respective VC
Stockholders, and “were agents of and made decisions for their respective VC
Stockholder,” in particular that each VC Director “makes decisions for [their
respective VC Stockholder] in relation to its ART holdings, and gives
instructions to [the VC Stockholder] personnel and dictates the actions of [the
VC Stockholder], in relation to ART.” The VC Directors were thus
“representative[s] of the secondary actor who either controls the actor or who
occupies a sufficiently high position that his knowledge is imputed to the
secondary actor” so that the “test [for knowing participation] is easier to
satisfy.” (PLX, supra, 2018 WL 5018535, at p. *49.)
The TAC further alleges that through their control of their respective
VC Stockholders, the VC Directors appointed themselves to ART’s board.
The TAC then alleges that the VC Directors—improperly concerned about
their own individual liability to ART’s creditors instead of maximizing value
for ART’s stockholders—approved the Walmart transaction, despite it
undervaluing the company and providing no value whatsoever to the holders
of ART’s common stock. Then, after the board approved the transaction, the
VC Directors “change[d] hats” (Forsythe, supra, 2007 WL 2982247, at p. *3),
and now acting as the managing members or controllers of their respective
VC Stockholders, voted the VC Stockholders’ shares in favor of the
transaction by executing the written consent. As in Forsythe, “the same
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individuals who . . . made [the decision to approve the transaction] are also
high-level [VC Stockholder] executives,” and it is that decision that “form[s]
the basis of the plaintiffs’ breach of fiduciary duty claims.” (Forsythe, supra,
2007 WL 2982247, at p. *13.) And as in Emerging and Cumming, because
the VC Directors executed the written consent on behalf of their respective
VC Stockholders, the VC Stockholders were the “mechanisms through which
[the VC Directors] accomplished the [transaction].” (Emerging, supra, 2004
WL 1305745, at p. *38; Cumming, supra, 2018 WL 992877, at p. *26.)
The VC Stockholders argue that a finding of knowing participation
requires that the entity defendants offer “substantial assistance” to the
primary wrongdoer or have “improper motives of their own,” and attempt to
distinguish the cases discussed above on the grounds that the entity
defendants in them took independent action or stood to gain from the
breaches at issue. In particular, the VC Stockholders argue that in PLX the
entity Potomac itself “owned PLX stock, filed Schedule 13Ds, served books
and records demands, nominated the dissident director slate, filed the proxy
materials, and stood to collect the short-term gains from a quick sale.” (PLX,
supra, 2018 WL 5018535, at p. *49.) They attempt to distinguish Khanna on
the grounds that Crosspoint itself “needed a bailout” from its investment in
BlueStar, and itself instigated the challenged transaction. (Khanna, supra,
2006 WL 1388744, at p. *5.) They rely on a single word in Carr—the
statement that “both” NEA and Klein had a financial incentive to complete
the challenged transaction. (Carr, supra, 2018 WL 1472336, at p. *16.) They
argue that BrandRep’s result turned on the fact that the entity defendants
themselves “concealed their use of BrandRep’s software.” (BrandRep, supra,
2019 WL 117768, at p. *6.) And in Cumming, they rely on a statement in the
introduction that Fortress was “advancing its own interests,” (Cumming,
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supra, 2018 WL 992877, at p. *1), and the statement that Fortress itself
“pushed the Acquisition in furtherance of a broader plan to shift its assets
under management to publicly-traded companies.” (Id. at p. *27.)
Such nitpicking is not availing.
To begin with, the opinions in these cases did not analyze or rely on the
motives or actions of the entity defendants in finding that knowing
participation had been alleged—or, in two cases, proven. Put slightly
differently, in each case, the VC Stockholders identify language that played
no part in the court’s analysis. In fact, Forsythe, Khanna, Carr, and
Cumming do not even mention “substantial assistance,” and PLX does so only
in its quotation of the Restatement of Torts. Cumming expressly noted that
allegations that aiders and abettors materially benefitted from the
challenged transaction are not required to support an aiding and abetting
claim. (See Cumming, supra, 2018 WL 992877, at p. *26.) Moreover, the VC
Stockholders’ argument ignores Emerging and Forsythe, where knowing
participation was found even though the entity defendants were not alleged
to have provided substantial assistance or to have had improper motives.
(See Emerging, supra, 2004 WL 1305745, at p. *38; Forsythe, supra, 2007 WL
2982247, at p. *13.)
The VC Stockholders’ reliance on In re Oracle Corporation Derivative
Litigation, supra, 2020 WL 3410745, for their argument that “substantial
assistance” is required, is also misplaced. There, Oracle acquired Netsuite,
before which acquisition officers of Oracle had certain discussions with
officers of Netsuite regarding a “price collar” for the acquisition and
NetSuite’s status as an independent entity post-acquisition. Although these
discussions were disclosed to NetSuite’s stockholders, plaintiffs—
shareholders of Oracle—alleged that the disclosures were inadequate.
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Plaintiffs further alleged that the Netsuite officers aided and abetted the
Oracle officers’ breach of duty to Oracle’s own shareholders by failing to make
adequate disclosures to NetSuite’s shareholders. (Id. at pp. *2, *3, *12.) The
court held that knowing participation had not been alleged for lack of
substantial assistance, because it was not reasonably conceivable that
adequate disclosures would have prevented the transaction, and in so doing,
the court stated—without citation to authority—that “[t]o withstand a motion
to dismiss, a plaintiff must plead facts making it reasonably conceivable that
the defendant knowingly supported a breach of duty and that his resulting
assistance to the primary actor constituted substantial assistance in causing
the breach.” (Id. at pp. *11, *15.)
But in any event, Oracle is factually distinguishable because the
alleged aider and abettors there—officers of NetSuite—were third parties
unrelated to Oracle. Here, by contrast, where “the fiduciary and primary
wrongdoer is also a representative of the secondary actor,” the test for
knowing participation “is easier to satisfy.” (PLX, supra, 2018 WL 5018535,
at p. *49.) To the extent that Oracle can be read to suggest “substantial
assistance” is required for a finding of “knowing participation” even in these
circumstances, it is inconsistent with the other authorities discussed above.3
In sum, we conclude that the TAC adequately alleges that the VC
Stockholders aided and abetted the alleged breaches of fiduciary duty by the
3 The VC Stockholders also cite In re Comverge, Inc. (Del. Ch. Nov. 25,
2014) 2014 WL 6686570, but that case merely explained that aiding and
abetting liability may exist in situations where the aider-and-abettor, for self-
interested reasons of its own, misleads the board into breaching its duty of
care. (Id. at p. *18.) It certainly did not hold that an aider-and-abettor must
have independent improper motives in order to support a finding of knowing
participation.
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VC Directors. In light of this conclusion, we need not reach the issue of
whether plaintiffs adequately alleged the existence of a “control group.”
DISPOSITION
The order sustaining the VC Stockholders’ demurrer to the second
cause of action for aiding and abetting breach of fiduciary is reversed and the
matter is remanded to the trial court for further proceedings consistent with
this opinion. Plaintiffs shall recover their costs on appeal.
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_________________________
Richman, Acting P.J.
We concur:
_________________________
Stewart, J.
_________________________
Miller, J.
Chodniewicz v. Art.com (A159720)
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