Venture Capital Board Politics: Fiduciary Duty of “Stockholder Control Groups.”

Lots of recent blogging about this Q4 case out of the Court of Chancery (Dubroff v. Wren Holdings, LLC (Del. Ch. Oct. 28, 2011 (“Dubroff II” in the lexicon of court cases, to distinguish it from an earlier case in the same matter), which has some terrific language and useful reminders.

Among the latter:

First, the Court of Chancery reaffirmed that (1) individual stockholders without individual control positions can combine to form a “control group” working together to control corporate affairs, and (2) that such a “control group” owes a fiduciary duty to minority stockholders. Venture investors and angels in operating in concert can easily fall into the control group rubric.

Second, minority stockholders can sue a control group directly (as opposed to derivatively) for a breach of such duties if their interests have been diluted in favor of the group. As the Court of Chancery put it …

… minority stockholders may have a direct equity dilution claim when their holdings are diluted, and those of the [control group] are not. In other words, as long as the [control group’s] holdings are not decreased, and the holdings of the minority shareholders are, the latter may have a direct equity dilution claim … .

In holding that the minority held a direct claim against the Dubroff II control group, the Court of Chancery noted – eloquently IMO - that the transaction in question was an “extraction” of “economic value and voting power” from the minority and a “redistribution” thereof to the control group.

Finally, the contours of DGCL §228(e) (regarding “prompt” disclosure of actions taken by majority stockholder written consent) remain elusive. Certainly it would appear that in the dilutive transaction at issue in Dubroff II, mere disclosure of the fact of the recapitalization - without mention of the redistribution of economic and voting power effected - was insufficient.

Net: Some good learning here. The pleading and disclosure items are useful technical points. More nuanced, however, is the control group point. Dubroff II is an interesting read/reminder that there are an array of shifting fiduciary duties afoot as board and stockholder politics unfold in any rapidly growing company.

© david jargiello 2012 all rights reserved

First Posted January 31, 2012, Re-Posted March 6, 2012