Delaware’s Evolving Equity Dilution Standing Rules


In a recent decision from the Delaware Court of Chancery, Vice Chancellor J. Travis Laster provided what seems to be an important step towards reconciling two strands of Delaware law, addressing the distinction between direct and derivative claims, that have been in subtle conflict for years. That decision, Carsanaro v. Bloodhound Technologies, Inc., has already been recognized as an important development in the law governing the relationship between company founders and venture capitalists. The Vice Chancellor held that cashed-out stockholders had standing to bring direct, as opposed to derivative, claims alleging that a group of venture capital funds with majority representation on the Board inequitably diluted plaintiffs’ equity stake before ultimately selling the company. In addition to expanding the breadth of stockholder rights to bring direct actions, Carsanaro is notable as an apparent step toward reconciling the accepted test under Delaware law for distinguishing between direct and derivative claims with one line of cases that has stubbornly stood outside of its ambit. It bears emphasis, however, that Carsanaro is only one step towards such reconciliation, and it remains to be seen whether Delaware law will continue down its path.

Tooley and Development of the Delaware Standard -

The standards for distinguishing derivative from direct claims under Delaware law were substantially clarified in the Delaware Supreme Court’s 2004 decision in Tooley v. Donaldson, Lufkin & Jenrette, Inc. Prior to Tooley, there existed ‘‘no standard test . . . applied in all cases to determine whether a given claim is derivative or direct.’’ Frequently, however, Delaware courts in the pre-Tooley era applied the so-called ‘‘special injury’’ test, according to which a plaintiff could only bring direct claims if it suffered a ‘‘special injury,’’ defined as ‘‘a wrong suffered by plaintiff that was not suffered by all stockholders generally or . . . [a] wrong [that] involves a contractual right of the stockholders, such as the right to vote.’’ In Tooley, the Delaware Supreme Court disapproved of the special injury test, together with the related ‘‘concept that a claim is necessarily derivative if it affects all stockholders equally.’’ Rather than looking to whether a plaintiff could plead a special injury, the Delaware Supreme Court in Tooley ruled that the classification of claims as direct or derivative ‘‘must turn solely on the following questions: (1) who suffered the alleged harm. . .; and (2) who would receive the benefit of any recovery or other remedy. . . .’’

Originally published in Securities Regulation & Law Report, 45 SRLR 1093, 06/10/2013.

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