Delaware Supreme Court clarifies that a party that contracted for the benefit of a subsidiary can bring a direct claim to seek contract damages and does not need to bring a derivative suit
On June 24, 2015, the Delaware Supreme Court decided upon a certified question of law submitted by the Court of Appeals for the Second Circuit and clarified that “a suit by a party to a commercial contract to enforce its own contractual rights is not a derivative action under Delaware law”.
NAF Holdings, LLC, a Delaware company (“NAF”), formed two wholly owned subsidiaries to acquire Hampshire Group, Ltd (“Hampshire”). To obtain the necessary financing NAF contracted with Li & Fung (Trading) Ltd. (“L&F”) to serve as a sourcing agent for Hampshire. NAF’s subsidiaries then entered into a merger agreement with Hampshire. NAF was not a party to the merger agreement. Allegedly L&F refused to act as sourcing agent, breaching its contract, and causing NAF to lose its funding commitments. NAF filed suit against L&F seeking approximately $30 million in damages.
L&F moved for summary judgment arguing that NAF could only bring its claim as a derivative action on behalf of the two subsidiaries, both of which had already released their claims in a separate settlement with Hampshire. The District Court granted Li&F‘s motion, concluding that NAF was only indirectly injured (i.e., in its capacity as 100% owner of the Subsidiaries) therefore the claim could not be maintained as a direct suit and could only be derivatively. The District Court relied on the Delaware Supreme Court’s 2004 decision in Tooley v. Donaldson, Lufkin & Jenrette, 845 A.2d 1031 (Del. 2004). See here.
NAF then appealed to the U.S. Court of Appeals for the Second Circuit, arguing that Tooley did not apply because Ithe latter involved a claim brought on behalf of the a corporation against the directors for breach of fiduciary duties.
Being skeptical that Tooley would bar NAF‘s commercial contract claim, the Second Circuit sought guidance from Delaware Supreme Court, certifying the following question
Where the plaintiff has secured a contractual commitment of its contracting counterparty, the defendant, to render a benefit to a third party, and the counterparty breaches that commitment, may the promisee-plaintiff bring a direct suit against the promisor for damages suffered by the plaintiff resulting from the promisor‘s breach, notwithstanding that (i) the third-party beneficiary of the contract is a corporation in which the plaintiff-promisee owns stock; and (ii) the plaintiff-promisee‘s loss derives indirectly from the loss suffered by the third-party beneficiary corporation; or must the court grant the motion of the promisor-defendant to dismiss the suit on the theory that the plaintiff may enforce the contract only through a derivative action brought in the name of the third-party beneficiary corporation?”
The Delaware Supreme Court, held that “a party to a commercial contract may sue to enforce its contractual rights directly, without proceeding by way of a derivative action”. In other words “a suit by a party to a commercial contract to enforce its own contractual rights is not a derivative action under Delaware law”.
The Court explained: “a promisee-plaintiff [may] bring a direct suit against the promisor for damages suffered by the plaintiff resulting from the promisor‘s breach, notwithstanding that (i) the third-party beneficiary of the contract is a corporation in which the promisee-plaintiff owns stock; and (ii) the promisee-plaintiff‘s loss derives indirectly from the loss suffered by the third-party beneficiary corporation… nothing in Delaware law requires the promisee-plaintiff‘s contract claim to be prosecuted as a derivative action.”
According to Delaware Supreme Court, Tooley is not applicable because it deals with the distinct question of whether a cause of action for breach of fiduciary duty or to enforce rights belonging to the corporation itself must be asserted derivatively. “It has no bearing on whether a party with its own rights as a signatory to a commercial contract may sue directly to enforce those rights”.
From a policy perspective, the Court noted that freedom of contracts and efficient corporate law would be frustrated if a party to a contract would be forced to go through a derivative action to obtain contract damages.
NAF Holdings, LLC v. Li & Fung Trading Ltd., C.A. No. 641, 2014, 2015 WL 3896792 (Del. June 24, 2015) is available at http://courts.delaware.gov/opinions/download.aspx?ID=225870
For more info, Francesca Giannoni-Crystal