Court of Chancery Considers Whether a Corporation’s Knowledge in a Laches Inquiry Bars a Derivative Suit

In its opinion last week in Microsoft Corporation v. Amphus, Inc., the Court of Chancery considered whether corporation’s knowledge in a laches inquiry can bar a plaintiff’s derivative suit under the theory that if laches bars the corporation from bringing a claim, then derivative plaintiffs should also be barred as well because they should not be in a better position than the corporation in prosecuting the corporation’s claim.  The Court in Amphus answered the question in the negative, but cracked the door open for reconsideration.

In this case, between 1999 and 2000, the defendant director restructured his corporation, so that the corporation’s assets spun off into four new subsidiaries.  These four subs were sprinkled with directors also on the board of the parent corporation.  The plaintiff alleges that the restructuring was a scheme by which the defendant director obtained a larger financial stake in valuable intellectual property, although the fledgling corporation was in need of capital.

Although the events giving rise to the litigation occurred over a decade ago, the plaintiff argued the three-year limitation on the breach of fiduciary duty claim should be tolled “under the doctrines of fraudulent concealment and equitable tolling.”

A plaintiff asserting fraudulent concealment must allege an “act of artifice by the defendant that either prevented the plaintiff from gaining material facts or lead the plaintiff away from the truth.”  Under the doctrine of equitable tolling, “the statute of limitations is tolled for claims of wrongful self-dealing, even in the absence of actual fraudulent concealment, where a plaintiff reasonably relies on the competence and good faith of a fiduciary.”  Even if the limitation period is tolled under either of these doctrines, the period is tolled only until the plaintiff has inquiry notice of their cause of action.

The defendant, on the other hand, argued that the corporation was on inquiry notice in 2000 and failed to bring an action, thus the derivative plaintiff’s claim is time-barred.  The Court then considered the relevance of the corporation’s knowledge.  The defendant asserted that the derivative plaintiff’s complaint is addressing harms suffered by the corporation, and, if the corporation had actual or inquiry notice of the harm, then it had a responsibility to take action to protect its rights.  A derivative plaintiff’s right to bring an action on behalf of the corporation, as the defendant argued, “should be no greater than the corporation’s right to pursue the claim directly.”

In response to this argument, the Court stated:

Although [the defendant’s] argument is intuitively appealing, [the defendant] has not cited any cases that supported its position that in a derivative suit, the nominal defendant company’s knowledge is relevant in determining whether there was inquiry notice.  For purposes of this case, in determining whether [the plaintiff’s] claims are time-barred, I have focused on whether [the plaintiff], and not [the corporation], had actual or inquiry notice of [the director’s] wrongdoing.

But the Court, in a footnote, signaled that the defendant’s knowledge could be “relevant in a laches inquiry in a derivative suit.”  It noted that the defendants had several “interlocking directors,” so it is possible that knowledge was imputed between the defendant and its subsidiaries.  However, the Court found that the defendants in this case did not point to any facts that indicated the directors had any knowledge about the challenged transactions.  Therefore the Court found that at the motion to dismiss phase it would be inappropriate to presume the defendant’s knowledge, but it did leave open the possibility of different result once a “factual record is created through discovery.”

The Court’s opinion nudges the defendants to raise their laches defense again after the record is more fully developed through discovery.  However, in this case should the Court accept defendants’ argument?  Is it possible that the corporate defendant’s knowledge bars a derivative action?  Perhaps the key question is whether the corporation with such knowledge was meaningfully able to pursue the claim, or whether the corporation was under the control of the alleged wrongdoers and thus effectively unable to bring the claim.  If the former circumstance were found to be the case, there is at least a reasonable argument that application of the equitable tolling doctrine would be inappropriate, and the corporation’s claim – and the ability to pursue it derivatively – should be time-barred.

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