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A person enters the Delaware Supreme Court in Dover, Delaware, U.S., June 10, 2021. REUTERS/Andrew Kelly
(Reuters) - It is an audacious strategy to argue in a dismissal motion that binding precedent is wrong and should be overturned. Also audacious? Arguing that the precedent can be chucked in an interlocutory appeal, before there's even a decision on the merits of the case.
That’s nevertheless what Weil, Gotshal & Manges proposed last year in Delaware Chancery Court, where its client, Brookfield Asset Management Inc, was facing breach of duty claims by shareholders of TerraForm Power Inc.
The shareholders' lawsuit, as I’ll explain, rested entirely on the Delaware Supreme Court’s 2006 ruling in Gentile v. Rossette. Gentile allowed minority shareholders, in some narrow circumstances, to bring direct claims against controlling shareholders instead of suing on behalf of the company in a procedurally more complex derivative claim.
Weil’s motion to dismiss the Brookfield lawsuit contended that the Supreme Court’s Gentile precedent has led to confusion and inconsistency. The ruling should be “jettisoned,” the brief said, “including, if necessary, via an interlocutory appeal.”
That is exactly how the litigation played out. Last October, Vice Chancellor Sam Glasscock denied Brookfield’s dismissal motion, citing Gentile even as he recognized “ongoing uncertainty over whether (the ruling) remains good law.” Weil asked Glasscock to certify an interlocutory appeal to resolve that uncertainty. The vice chancellor sent the appeal to the Delaware justices.
And on Monday, in Brookfield Asset Management Inc v. Rosson, the Delaware Supreme Court unanimously overturned its own precedent in Gentile, holding that the 2006 decision carved out a contradictory and unnecessary exception to the test that establishes whether shareholders’ claims are direct or derivative.
The ruling means that shareholders can no longer sue controlling shareholders directly for diluting the value of their shares and their voting rights. Those claims, the court concluded, can only be brought derivatively under the Supreme Court’s 2004 test in Tooley v. Donaldson, Lufkin & Jenrette Inc because the harm to individual shareholders flows from harm to the corporation, and any recovery to shareholders would flow from the company’s recovery.
The 2006 Gentile court had opined that the exception it created – allowing minority shareholders to bring direct claims against controllers who act to expand their ownership – “fits comfortably within ... Tooley.” In Monday’s opinion overturning Gentile, the Delaware justices said the ensuing 15 years have shown that “the ‘fit’ is not so ‘comfortable.’”
“We intend no disrespect to any prior panel of this court,” wrote Justice Karen Valihura. “Rather, we recognize that the law must evolve as a result of trial and error, through the tests of time and practical application.”
Monday’s ruling ends the case against Weil Gotshal’s client. Shareholders had alleged that in 2018, Brookfield entities underpaid for the TerraForm shares they acquired in a $650 million private placement that increased Brookfield’s ownership stake in the green energy company from 51% to 63.5%. A Brookfield entity acquired the remaining public shares in 2020, depriving minority shareholders of standing to bring derivative claims stemming from the private placement. So plaintiffs’ only shot at recovery was a direct suit against Brookfield.
The Delaware Supreme Court decision not only barred shareholders' direct claims under Gentile but also rejected their alternative argument for direct standing based on interference with their voting rights. The justices said that the particular facts of the case did not support the voting-rights theory.
Shareholder lawyers Steven Purcell and Douglas Julie of Purcell Julie & Lefkowitz did not respond to my email query on the decision.
Weil Gotshal’s swing-for-the-fences dismissal brief in the Brookfield case relied heavily on a concurring opinion by then-Chief Justice Leo Strine in 2016’s El Paso Pipeline GP Co LLC v. Brinckerhoff. By then, Chancery Court judges had begun expanding the boundaries of the Supreme Court’s holding in Gentile, allowing shareholders to bring direct claims of dilution against board members as well as controlling shareholders, reasoning that it didn’t make sense to hold controlling shareholders to a higher standing than corporate directors.
El Paso involved exceedingly unusual facts. Shareholders asserting derivative claims won a trial ruling that found the board had approved a deal favoring the company’s controlling general partner. After the trial, however, the plaintiffs lost standing for their derivative claims when the limited partnership was acquired in a merger.
The trial judge held that the shareholders could continue to assert their theory as a direct claim under Gentile. The Delaware Supreme Court reversed the ruling, finding that Gentile could not be expanded beyond the particular circumstances of that case, in which minority shareholders allegedly lost both economic value and voting power because of the actions of the controlling shareholder.
In a concurrence, Strine said Gentile should be overruled altogether, though he agreed that the El Paso case did not squarely present the opportunity. Gentile, he wrote, is “a confusing decision, which muddies the clarity of our law in an important context,” he wrote. The precedent “cannot be reconciled with the strong weight of our precedent,” Strine said, and purports to address a gap in Delaware law that is already filled by case law allowing shareholders to sue board members directly over transactions that shift control of a company to a majority stakeholder.
“Gentile undercuts the clarity and coherence that Tooley brought to the determination of what claims are derivative,” Strine wrote.
Weil, which declined to provide a statement about Monday’s ruling, recognized that Brookfield’s case presented an opportunity that eluded the Delaware Supreme Court in the 2016 El Paso case. The facts in Brookfield aligned quite neatly with those in Gentile. This was the court’s chance, Brookfield told the Delaware justices, to overrule the precedent that had so troubled the former chief justice.
“Practitioners and jurists alike have advocated that Gentile should not remain good law, and this Court's decision to clarify and harmonize the law will have no surprising or destabilizing effect,” Weil argued in its final Supreme Court brief. “To the contrary, eliminating the Gentile standing doctrine will promote a more consistent, common-sense application of Delaware law.”
The justices agreed. Once in a while, when you swing for the fences, you manage to hit a grand slam.
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