In re Wayport, Inc. Litigation: Court of Chancery Applies “Special Facts” Standard to Fiduciary Duty Claims Arising out of Stock Purchase Transaction Between Minority Common Stockholder and Preferred Stockholder
June 18, 2013
In a post-trial opinion, In re Wayport, Inc. Litigation, 2013 WL 1811873 (Del. Ch. May 1, 2013), Vice Chancellor Laster of the Court of Chancery held that corporate fiduciaries do not have a duty to disclose information about the corporation in connection with direct stock purchases from stockholders absent knowledge of “special facts.” The Court, however, held one trading fiduciary liable for common law fraud due to its failure to correct a statement to the selling stockholder that was truthful when made, but became inaccurate due to subsequent events.
Plaintiff Brett Stewart was the original chief executive officer and a named inventor on most of the patents of Wayport, Inc. (“Wayport” or the “Company”), an Austin, Texas based technology company. In 1998 and 1999, Wayport sold preferred stock to Trellis Partners Opportunity Fund, L.P. (“Trellis”) and funds associated with New Enterprise Associates (“NEA”). In connection with the stock purchases, Trellis obtained the right to appoint a member of Wayport’s board of directors, and NEA obtained the right to designate a board observer. Plaintiff resigned his positions as director and CEO by late 2001, and at the time of the challenged transactions in 2007 received no information from the Company other than quarterly and annual financial reports.
Plaintiff’s claims centered on sales of his common stock to Trellis and funds affiliated with NEA, which closed in June 2007 and late September 2007, and a patent sale agreement between Wayport and Cisco Systems, which was signed at the end of June 2007, approximately a week after plaintiff’s earlier sales. Plaintiff was not aware of the transaction with Cisco until after the last of his stock sales was completed. In December 2008, AT&T acquired Wayport for $7.20 per share.
Following announcement of the AT&T transaction, plaintiff filed suit against Wayport’s board of directors, Trellis and NEA, among others, asserting that the Company’s board breached its fiduciary duties by failing to disclose material information to him in connection with his stock sales and a claim for common law fraud. Plaintiff sought damages equal to the difference between $2.50 per share, the price at which he sold his shares in 2007, and $7.20 per share price, the price at which AT&T acquired the Company.
In addressing the plaintiff’s breach of fiduciary duty claim, the Court noted that there are four common scenarios in which the duty of disclosure is implicated. The first is common law ratification, in which directors seek approval for a transaction that does not otherwise require a stockholder vote under the Delaware General Corporation Law. The second scenario occurs when directors submit to the stockholders a transaction that requires stockholder approval or a stockholder investment decision. The third scenario arises when a corporate fiduciary speaks outside the context of soliciting or recommending stockholder action. In the first and second scenarios, the directors owe a duty to disclose all material facts, but in the third, they are obliged only to refrain from knowingly making false statements. Finally, the fourth scenario arises when a corporate fiduciary buys shares directly from or sells shares directly to an existing outside stockholder. The Court of Chancery held that in this scenario, the fiduciary’s duty of disclosure is governed by the “special facts” doctrine described in the Delaware Supreme Court’s decision in Lank v. Steiner, 224 A.2d 242 (Del. 1966). The special facts doctrine requires a director to disclose information in the context of a sale of the stock of a privately held corporation “only when a director is possessed of special knowledge of future plans or secret resources and deliberately misleads a stockholder who is ignorant of them.” To satisfy the special facts requirement, a plaintiff must point to knowledge of a substantial transaction, such as an offer to acquire the whole company. The Court held that the purchasers’ failure to volunteer information about the patent sale transaction to the plaintiff was not actionable under the special facts doctrine. The Court reasoned that although the completion of the patent transaction might have been material to plaintiff, the transaction was not so substantial as to trigger the special facts doctrine. The Court accordingly entered judgment in the defendants’ favor on the fiduciary duty claims.
However, the Court reached a different conclusion with regard to plaintiff’s common-law fraud claims, as to one defendant. During the course of negotiations over the content of the representations and warranties to be included in the stock purchase agreement for the June 2007 transaction, a representative of Trellis had written in an email to plaintiff that Trellis was “not aware of any bluebirds of happiness in the Wayport world right now and have graciously offered to rep that.” The trial witnesses offered varying interpretations of the email, and the Court agreed with plaintiff’s assertion that the email referred to any unspecified good news. The Court concluded that the statement, although truthful when made, became false when the patent sale transaction occurred and remained false at the time of plaintiff’s September 2007 sale. The Court held that Trellis, by speaking, had undertaken “a duty to update its statement to the extent that subsequent events rendered its representation materially misleading.” The Court found that the other elements of the common-law fraud test, including scienter, reasonable reliance and causation, had been met, and awarded plaintiff damages of $4.70 per share as to his September 2007 sale to Trellis.