Delaware Supreme Court Provides Additional Guidance on Pleading Direct Claims Against Controllers and Control Groups

Morris James LLP

Sheldon v. Pinto Technology Ventures, L.P., No. 81, 2019 (Del. Oct. 4, 2019).

The Delaware Supreme Court affirmed the Court of Chancery’s dismissal of an alleged direct claim for dilution of the voting and economic interests of plaintiff stockholders because they failed to adequately plead that several venture capital firms constituted a “control group.”  The Court began its analysis with a review of the standard for a controller or control group under Delaware law.  In Gentile v. Rossette, 906 A.2d 91 (Del. 2006), the Court ruled that multiple stockholders can constitute a control group if they are connected in some legally significant way, such as by contract or other agreement, or working together towards a shared goal.  The Court noted the guideposts that define a “control group” established by In re Hansen Medical, Inc. Stockholders Litigation, 2018 WL 3025525 (Del. Ch. June 18, 2018) and van der Fluit v. Yates, 2017 WL 5953514 (Del. Ch. Nov. 30, 2017).

Here, in contrast to a twenty-one year coordinated-investment history by the stockholder control group in Hansen, the Court held that the stockholders being parties to a voting agreement and periodically investing in the same companies in the past was insufficient to establish the existence of a control group.  The Court pointed out that, unlike the voting agreement in Hansen, the voting agreement here only required the parties to vote together to select certain directors, but did not require the parties to vote together on any transaction, including the allegedly dilutive transactions.  Turning to the alleged common investment history, the Court emphasized that the complaint identified only four companies in which two or more of the three stockholders shared investments, and the plaintiffs failed to identify a single company in which all three stockholders were alleged to be part of the control group that had invested.  Additionally, other investors that received the same rights as the defendant investors in the financing were not alleged to be part of the control group.  Without more, the Court explained that plaintiffs’ “allegations merely indicate that venture capital firms in the same sector crossed paths in a few investments.”  In sum, because the plaintiffs had not made a pre-suit demand upon the board or pled demand futility for a derivative claim, and failed to adequately plead the existence of a control group to support a direct claim, the Court affirmed the dismissal of the action with prejudice.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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