Since Delaware’s storied Chancery Court is widely regarded as the alpha and omega of corporate law venues, this opinion from Halloween eve of this year captured my attention.
The issues addressed in Doberstein v. G-P Industries, Inc. (http://courts.delaware.gov/opinions/download.aspx?ID=231700) concern the scope of the Chancery Court’s jurisdiction and the quantum of pleading specificity needed to state a piercing the corporate veil claim.
Plaintiff, who lived most of the year in Switzerland, sued the defendants for failing to timely construct renovations to her Delaware home. All told, the plaintiff paid over $500K to the defendant for only about $300K worth of work (according to the plaintiff’s construction expert). The plaintiff brought legal (fraud, breach of contract) and equitable claims (unjust enrichment, piercing the corporate veil, negligent misrepresentation (i.e. “equitable fraud”) against the corporate and individual defendants.
The Delaware court struck the equitable claims for failure to state a claim and dismissed the ancillary law claims for lack of subject matter jurisdiction.
The piercing claim failed because the plaintiff conflated (a) fraudulent conduct by the corporate defendant with (b) abuse of the corporate form by the corporation’s controlling shareholder. The former is actionable under a fraud theory while the latter scenario gives rise to a piercing the corporate veil of limited liability claim.
A piercing plaintiff must do more than formulaically allege that a corporation is the alter ego of another or of its main shareholder, though. He must instead plead facts that show a corporate shareholder abused the corporate form in order to defraud an innocent third party.
Here, since plaintiff’s piercing claims only alleged fraud by the defendants in connection with charging for construction work they didn’t do, there were no allegations that the corporate form was abused or that the individual defendant siphoned corporate funds.
The court also dismissed the plaintiff’s negligent misrepresentation count. Also called “equitable fraud”, a negligent misrepresentation claim under Delaware law generally requires the existence of a fiduciary relationship and the abuse of that relationship by one of the parties.
A contractual relationship between two sophisticated parties does not equate to a fiduciary one. As a result, the court found that the plaintiff’s remedy lies in a breach of contract action at law (as opposed to an action in equity).
Finally, the court dismissed the plaintiff’s unjust enrichment count since there was an express contract between the parties. An unjust enrichment claim cannot co-exist with a breach of express contract one.
The court then found that it lacked jurisdiction over the remaining law counts for breach of contract, fraud and fraudulent concealment.
The Delaware Chancery Court is a court of limited jurisdiction. It has jurisdiction only in three settings: (1) where a party seeks to invoke an equitable right; (2) where the plaintiff lacks an adequate remedy at law; and (3) where there is a statutory delegation of subject matter jurisdiction. The prototypical equitable claims are those involving fiduciary duties that arise in the context of trusts, estates and corporations.
Where a claim contains both legal and equitable features, the Chancery court does have discretion to resolve the legal portions of the controversy. However, where the equitable claims are dismissed and there is no basis for the court to assert jurisdiction over the remaining legal claims, the court lacks subject matter jurisdiction over the legal claims and they will be dismissed.
Here, once the plaintiff’s equitable claims (unjust enrichment, negligent misrepresentation) were disposed of, there was no “hook” for the court to retain jurisdiction over the legal claims.
The case solidifies proposition that a plaintiff who seeks to pierce the corporate veil must show fraud in connection with an abuse of the corporate form. If the fraud relates to conduct by the corporation and not to a misuse of the corporate form (i.e. as an alter-ego or instrumentality of the key shareholder), the plaintiff’s remedy is an action at law against the corporation; not the individual corporate agent.
The case also provides a useful summary of what types of claims the Delaware Chancery Court will entertain and when it will handle legal claims that are filed in conjunction with equitable ones.