In the decision of Dengrong Zhou v. Long Deng and Mark Fang, C.A. No. 2021-0026-JRS (Del. Ch. Apr. 6, 2022) (Mem. Op.), the Delaware Court of Chancery found that a majority of stakeholders from iFresh, Inc. (the “Control Group”) had validly executed a written consent (the “Consent”) removing Defendants Deng and Fang from the iFresh Board of Directors and replacing them with two new members.
Plaintiff Dengrong Zhou sought a judicial declaration affirming the Consent’s validity pursuant to 8 Del. C. § 225, and Defendants filed counterclaims alleging the Control Group had fraudulently purchased their stock in iFresh, thus rendering the Consent invalid. As a preliminary matter, Vice Chancellor Slights made clear that a Section 225 action “is summary in nature, and narrow in purpose,” and his ruling would only determine the validity of the Consent. Mem. Op., at 8. The Court then addressed Defendants’ three allegations of fraud as follows.
First, Defendants claimed that iFresh’s CFO had breached her fiduciary duty by supporting Plaintiff’s purported scheme to acquire control of iFresh, and this breach had wrongfully enabled the Control Group to acquire the shares used to supplant Defendants. Vice Chancellor Slights denied this allegation on procedural grounds—Defendants did not raise this alleged breach of fiduciary duty until their post-trial brief and, therefore, had waived the argument.
Second, Defendants sought to invalidate votes cast by one of the Control Group stockholders, HK Xu Ding Co. Ltd. (“HK XD”), for breach of contract because it initially only paid $5 million of a $7 million stock purchase in iFresh (of note, HK XD paid the additional $2 million to Deng after he prevailed on a breach of contract claim in New York). While the Court acknowledged that a breach of contract could invalidate a corporate election, that breach of contract must relate to the election for it to also affect its validity. The Court specifically stated that its previous decision in Zohar II 2005-1, Ltd. V. FSAR Hldgs., Inc., 2017 WL 5956877 (Del. Ch. Nov. 30, 2017) “does not stand for the proposition that any showing of a breach of contract provides a basis to set aside a stockholder vote in a Section 225 action.” Mem. Op. at 19 (emphasis in original). Accordingly, the Court ruled that the breach of contract by HD XD had already been resolved and did not affect the validity of the Consent.
Third, Defendants alleged that the Control Group members had fraudulently obtained their shares in iFresh, and the Court separately analyzed each of the three stock purchase agreements at issue. In general, though, the Court noted that each allegation relied on a common law duty for a shareholder to disclose intent to take control of a company when purchasing stock in that company. Vice Chancellor Slights found that no such common law duty existed and for this reason, among others, Defendants’ allegations of fraud failed. Having denied each of Defendants’ claims of breach of fiduciary duty, breach of contract, and fraud, the Court of Chancery found the Consent was valid in removing Defendants from iFresh’s Board of Directors and replacing them with alternative members.
Key Takeaway: Any general allegation of fraud will not invalidate a corporate election under Section 225. Instead, a party seeking such invalidation will need to show how a breach of duty relates to the corporate election at issue. And, specifically, Delaware does not enforce a common law duty for a stockholder to disclose an intent to take control of a company when purchasing that company’s stock.
Carl D. Neff is a partner with the law firm of FisherBroyles, LLP, and practices in Delaware. You can reach Carl at (302) 482-4244 or at Carl.Neff@FisherBroyles.com.