May 31, 2017

Controlling Shareholders & the “Known Looter” Doctrine

Under Delaware law, controlling shareholders are generally free to dispose of their shares as they see fit. This Morris James blog notes that the Chancery Court recently addressed an exception to that general rule in Ford v. VMware (Del. Ch.; 5/17):

Generally speaking, controllers can sell their stock to whoever they want. After all, why be a controller unless you have the right to exercise control free from liability for doing so. But, as this decision points out, there are limits, such as selling to a known looter who in fact ends up looting the company. Along the same lines, directors may be liable for failing to protect the company against a controller’s sale to a known looter.

This excerpt from Vice Chancellor Laster’s opinion lays out the elements of a “known looter” claim :

To state a claim under the “known looter” doctrine, a complaint must allege facts supporting a reasonable inference that the seller (i) knew the buyer was a looter or (ii) was aware of circumstances that would “alert a reasonably prudent person to a risk that his buyer [was] dishonest or in some material respect not truthful.” Harris, 582 A.2d at 235; accord Abraham, 901 A.2d at 758. The complaint also must allege that the buyer subsequently looted the corporation, thereby inflicting injury. Abraham, 901 A.2d at 758. If the feared or threatened looting never occurred, then there is no harm to remedy and no ripe claim to address.

In this case, the Vice Chancellor determined that the derivative plaintiff’s allegations did not state a claim. However, the opinion provides a detailed overview of the “known looter” doctrine and the circumstances under which it may apply to controlling shareholders & directors.

John Jenkins