Kahn v. Kohlberg Kravis Roberts & Co., L.P.: Delaware Supreme Court Holds that Derivative Claims for Insider Trading Need Not Plead Actual Harm to Corporation
August 1, 2011
In Kahn v. Kohlberg Kravis Roberts & Co., L.P., No. 436, 2010 (Del. June 20, 2011), the Delaware Supreme Court held that a plaintiff may state a derivative claim for insider trading without a showing of actual harm to the corporation.
During a time when Primedia, Inc. (“Primedia”) had authorized the redemption of $200 million of its preferred stock, Kohlberg, Kravis Roberts & Co., L.P. (“KKR”) – Primedia’s indirect controlling stockholder – purchased, based on nonpublic information KKR received from its designees on Primedia’s board, over $75 million of preferred stock. Primedia stockholders brought a derivative action against directors and officers of Primedia and against KKR, claiming that KKR and the individual defendants breached their fiduciary duties in connection with several recent transactions involving Primedia, including an issuance of convertible preferred stock, the redemption of various series of preferred stock and the sale of various assets. After a motion to dismiss was denied, Primedia formed a special litigation committee (“SLC”) to investigate the claims. After the SLC had concluded its investigation, plaintiffs presented the SLC with a claim that KKR breached its fiduciary duty to Primedia by purchasing preferred stock at a time when KKR possessed material, nonpublic information (a “Brophy“1 claim). After determining that pursuit of the various claims was not in the best interests of the company, the SLC moved to dismiss. The Court of Chancery granted the dismissal.
In its granting of the motion to dismiss, the Court of Chancery held that disgorgement of profits was not an available remedy for the plaintiff’s Brophy claims due to a prior Court of Chancery decision in Pfeiffer v. Toll.2 The Pfeiffer Court, interpreting Brophy by determining that “the purpose of Brophy is to ‘remedy harm to the corporation,'” had limited the disgorgement remedy to instances involving the usurpation of a corporate opportunity or where an insider uses confidential corporate information to compete directly with the corporation.
The Delaware Supreme Court disagreed, finding that a corporation need not suffer actual harm for a viable Brophy claim to exist. The Supreme Court based its decision on Brophy‘s policy of “preventing unjust enrichment based on the misuse of confidential corporate information.” In light of the fact that the Court could not determine whether the Court of Chancery had “improperly rel[ied] on Pfeiffer,” the Court remanded the matter to the Court of Chancery for proceedings consistent with the holding. Accordingly, by declining to adopt Pfeiffer‘s interpretation of Brophy and strongly reaffirming the public policy of Brophy, the Supreme Court indicated that Delaware courts will not dismiss outright a well-pled allegation of insider trading under state law simply because there is no allegation that the corporation has suffered any actual harm.