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Chancery Court Requires All Sellers To Be Joined To A Rescission Claim Relating To Merger Agreement; Allows Unjust Enrichment Claim To Proceed

 In Shareholder Representative Services LLC v. RSI Holdco, LLC, C.A. No. 2018-0517-KSJM (Del. Ch. May 22, 2019), the Court of Chancery held that the buyer could not seek remedy outside of the scope of a merger agreement from the sellers’ representative without bringing in all sellers as parties to the action because the representative’s authority was limited to matters relating to or arising under the four corners of that agreement.  The Court also denied the representative’s motion to dismiss the buyer’s unjust enrichment claim because the buyer properly alleged that the contract arose from sellers’ wrongdoing.

RSI Holdco, LLC (“Holdco”) acquired Radixx Solutions International, Inc. (“Radixx”) in a merger transaction in which Shareholder Representative Services LLC (“SRS”) served as the representative of Radixx’s selling stockholders.  SRS commenced the present litigation to recover a $9 million holdback amount that Holdco refused to pay citing breaches of representations and warranties by the selling stockholders.  In response, Holdco counterclaimed against SRS and five selling stockholders stating that Radixx’s founder fraudulently induced the merger and sought rescission of the Merger Agreement.  Holdco also brought a third-party claim for unjust enrichment against the selling stockholders.  SRS and the selling stockholders moved for dismissal of the request for rescission and unjust enrichment claim.

The Court first looked to Court of Chancery Rule 19, which establishes a multi-step test for determining when absent parties must be joined to an action: first, whether an absent person “should be party to the litigation” and second, whether “joinder is feasible.”  Applying this test, the Court found first that Radixx’s unnamed stockholders should be parties as they were indispensable to the action and that “[d]isposition without the Company Holders may impair or impede their ability to protect their interests.”  The Court next found that the unnamed stockholders were able to be joined because they were named as defendants in a prior purchase price adjustment litigation filed by Holdco in the Court. Thus, both prongs of the Rule 19 test were met and the selling stockholders must be named as defendants in the rescission action.  The Court rejected Holdco’s argument that joinder of the stockholders was unnecessary because SRS will fully represent the stockholders’ interests.  The Court pointed to the fact that SRS’s authority was defined by contract in the Merger Agreement, which limited the scope of SRS’s authority to “any matter relating to or under this [Merger] Agreement.” Thus, the Court dismissed Holdco’s request for rescission without prejudice to permit it to join the selling stockholders.

The Court finally addressed the claim of unjust enrichment that the Company Holders were unjustly enriched by the monies they received from the merger “in excess of a true and fair valuation of Radixx” at the time the Merger closed. The Court explained that under Delaware law, if a contract comprehensively governs the parties’ relationship, then it alone must provide the measure of the plaintiff’s rights and any claim of unjust enrichment will be denied.  However, if the claim is premised on an allegation that the contract arose from wrongdoing and the defendant has been unjustly enriched thereby, the claim will be permitted.  The Court held that “[b]ecause Holdco [had] challenged the validity of the Merger Agreement, the Merger Agreement does not preclude an unjust enrichment claim from proceeding.” Accordingly, the Court denied SRS’s motion to dismiss the unjust enrichment claim.

Shareholders Representative Services LLC v. RSI Holdco, LLC, C.A. No. 2018-0517-KSJM (Del. Ch. May 22, 2019)

Copyright 2019 K & L Gates

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David L. Forney, KL Gates, strategic joint venture lawyer, Corporate Transactions,
Partner

David Forney is a “company side” corporate lawyer specializing in corporate, strategic joint venture and M&A transactions. For nearly 30 years, David has represented industry parties in complex joint venture, M&A, and other strategic transactions. This experience allows David to have a greater perspective and understanding of company side concerns and processes, whether the other side in the transaction is a competitor, another strategic party or a private equity fund.  His experience includes developing close working relationships with in-house counsel, in-house...

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Mark L. Hammes, KL Gates, general corporate lawyer, securities law attorney
Associate

Mark Hammes is a corporate associate in the firm’s Los Angeles office. His practice focuses on general corporate and securities law, including mergers and acquisitions, public and private securities offerings, corporate governance, equity and debt financing, project finance, real estate, and other regulatory compliance matters. Mr. Hammes also advises cleantech and renewable energy companies in corporate, project development, and financing matters.

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