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Dweck v. Nasser: In Classic Usurpation of Corporate Opportunity Case, the Court of Chancery also Imposes Joint and Several Liability on an Officer for Failure to Act in the Face of a Known Duty to Act

March 2, 2012

In its post-trial opinion, Dweck v. Nasser, C.A. No. 1353-VCL (Del. Ch. Jan. 18, 2012), the Court of Chancery found that officers and directors of children’s apparel manufacturer Kids International Corporation (“Kids”) breached their fiduciary duties of loyalty to Kids by establishing competing clothing companies that usurped opportunities and converted resources from Kids. In addition, the Court found that an officer who approved expense reimbursements of another officer and director without considering their validity or asking any questions failed to act in the face of a known duty to act, and imposed liability for the improper expenses on a joint and several basis.

In 1993, Gila Dweck and her brother formed Kids with financial assistance from Albert Nasser. By 2001, Dweck owned 30% of Kids’ stock and was CEO and a director. Nasser held a 50% stake in the company and was chairman of the board. As the company proved to be quite profitable, Dweck sought to increase her equity share, but she was rebuffed by Nasser and her brother.

Convinced that her compensation was inadequate, Dweck formed two competing clothing companies, Success Apparel LLC (“Success”), which she formed with Kids’ president Kevin Taxin in October 2001, and Premium Apparel Brands LLC (“Premium”), which she formed in June 2004. Dweck and Taxin channeled business opportunities from Kids to Success and Premium. In addition, they operated Success and Premium out of Kids’ facilities and utilized Kids’ employees, letters of credit, and vendors. According to the Court, Dweck and Taxin “operated Success and Premium as if the companies were divisions of Kids, but kept the resulting profits for themselves.”

Around January 2005, Nasser became concerned about Dweck’s management of Kids and attempted to gain more control over the company. Dweck and Taxin subsequently decided to leave Kids in May 2005. Before doing so, Dweck and Taxin diverted orders placed by Wal-Mart and Target from Kids to Success, took boxes of company files, and, with the assistance of Kids CFO David Fine, convinced a number of Kids employees to join Success. Litigation ensued, with Dweck and Nasser each alleging that the other had breached fiduciary duties.

In analyzing the conduct of Dweck and Taxin, the Court applied the corporate opportunity doctrine, which holds that a corporate officer or director may not take a corporate opportunity for his own if: (i) the corporation is financially able to exploit the opportunity; (ii) the opportunity falls within the corporation’s line of business; (iii) the corporation has an interest or expectancy in the opportunity; and (iv) the officer or director will be placed in a position inimical to his or her duties to the corporation by exploiting the opportunity. Under this standard, the Court determined that Dweck and Taxin had violated their duty of loyalty to Kids by diverting opportunities to Success and Premium. The fact that Success and Premium utilized Kids’ resources and personnel convinced the Court that Kids could have pursued the opportunities in its own name. As a remedy, the Court awarded damages for Kids’ lost profits from the founding of Success and Premium through May 2005, as well as profits lost after May 2005 from license agreements signed by Success and Premium while Dweck and Taxin were Kids employees.

In their defense, Dweck and Taxin argued that because Kids had focused on the manufacture of non-branded clothing, they were free to exploit opportunities related to branded clothing. The Court rejected this contention, noting that a corporation’s interest in a line of business should be “broadly interpreted.” The Court also rejected Dweck’s contention that Nasser had consented to her establishing the competing companies. Dweck referenced purported oral communications and pointed to drafts of an agreement among Kids’ stockholders that contained a “free-for-all” provision permitting the parties to exploit corporate opportunities that belonged to Kids. Acknowledging that such a provision would raise “complex legal issues,” the Court ultimately concluded that it had never become effective because Nasser had never signed or approved the stockholders’ agreement or any of its drafts. Finally, Dweck argued that her conduct was justified by a similar “free-for-all” provision in the operating agreement of Essential Childrenswear, a different company formed by Nasser, Dweck, and Dweck’s brother. The Court responded that even if the provision applied with regard to Essential Childrenswear, it could not eliminate the duty of loyalty for other entities formed by the same parties.

The Court also concluded that Dweck, Taxin, and Fine had breached their duties of loyalty in May 2005 by diverting orders from Kids to Success, taking boxes of company files, and orchestrating a mass departure of Kids’ employees. As Kids failed following these events, Nasser argued that Kids was entitled to damages equal to the company’s going concern value in May 2005. Since Dweck and Taxin were not bound by restrictive covenants and, in the Court’s opinion, could have captured Kids’ core business had they left the company legitimately, the Court awarded damages only for those orders that Dweck and Taxin had diverted from Kids to Success.

In addition, the Court found Dweck liable to Kids for over $300,000 in personal expenses she had billed to the company, including vacations and luxury goods. Finding that Fine had abdicated his responsibilities as CFO by failing to review such expenses before reimbursing Dweck, the Court found Fine jointly and severally liable for the expenses.

Finally, the Court also considered Dweck’s claim that Nasser had received improper consulting fees from Kids. Due to Nasser’s position as Kids’ controlling stockholder, the Court applied the entire fairness standard. Because Nasser had not performed any actual consulting work for Kids, the Court determined that the consulting payments were not fair to Kids and ordered Nasser to return them.