# A Sea of Change in Delaware Corporate Dilution Claims

Earlier this year, the Supreme Court of Delaware decided Brookfield Asset Mgmt. v. Rosson,1No. 406, 2020, 2021 WL 4260639 (Del. June 30, 2021). overturning fifteen years of precedent and simplifying an area of law the Court itself referred to as “reflect[ing] fundamental unworkability.”2Id. at *49.

To understand the importance of this case, some background is necessary. According to the Delaware Court’s holding in Tooley v. Donaldson, Lufkin, & Jenrette, Inc.,3845 A.2d 1031 (Del. 2004). corporate lawsuits can be either direct or derivative.4Id. at 1033. The test for distinguishing these categories focuses on the identity of the party which suffered the alleged harm and which would receive recovery (either the corporation or its individual stockholders).5Id. A derivative suit occurs when a stockholder sues on behalf of the corporation for harm done to the corporation, while a direct suit allows a stockholder to “bring an individual action for injuries affecting his or her legal rights as a stockholder.”6Id. at 1036. In direct suits, the recovery goes directly to the stockholders, while corporations receive recovery in derivative suits.7Id. The distinction is important because a broad array of legal consequences flows from categorizing a lawsuit as either one or the other, many of which might have a large financial impact on the parties.8Id.

However, two years after Tooley was decided, the Delaware Supreme Court created an exception in Gentile v. Rossette.9906 A.2d 91 (Del. 2006), overruled by Brookfield Asset Mgmt. v. Rosson, No. 406, 2020, 2021 WL 4260639 (Del. June 30, 2021). That case recognized a specific kind of claim as being derivative and direct: when a majority or controlling stockholder causes the corporation to issue excessive shares for less valuable assets of the controlling stockholder, thus increasing the percentage owned by the controlling stockholder while decreasing the percentage of the remaining stockholders.10Id. at 99–100.

Brookfield Asset Management was the controlling stockholder of TerraForm Power, Inc., and appointed TerraForm’s CEO and four of its seven directors.11Brookfield, 2021 WL 4260639, at *2. In 2018, Brookfield approached TerraForm about an opportunity to acquire a Spanish corporation for $1.2 billion.12Id. at *3. TerraForm could have funded much of this acquisition itself, but Plaintiffs alleged that Brookfield pushed TerraForm to make an equity offering that would let Brookfield increase its ownership percentage at a discount.13Id. TerraForm eventually approved the sale of shares to Brookfield for$650 million, increasing Brookfield’s voting power from 51% to 65.3%.14Id. at *4. TerraForm then used this money, along with its own resources, to complete the acquisition.15Id. at *5. Plaintiffs, bringing claims they alleged were both direct and derivative, argued that Brookfield caused TerraForm to issue shares for inadequate value, diluting the financial and voting interest of minority stockholders and damaging TerraForm.16Id. at *5 & n.14

While litigation was ongoing, Brookfield’s affiliates executed a merger and acquired all shares of TerraForm not already held by Brookfield.17Id. at *6. As a result, the trial court granted an order dismissing the derivative claims, since Plaintiffs ceased having any interest in TerraForm and all TerraForm causes of action passed to Brookfield.18Id. Defendants, arguing that all the claims brought by the Plaintiffs were solely derivative, moved to dismiss the entire case.19Id. at *5. The Court of Chancery concluded that “under Tooley alone, Plaintiffs’ overpayment claims neatly fall into the derivative category.”20Id. at *6 (citing In re TerraForm Power, Inc. S’holders Litig., No. CV 2019–0757–SG, 2020 WL 6375859, at *1 (Del. Ch. Oct. 30, 2020), rev’d sub nom. Brookfield, 2021 WL 4260639). However, the facts of the case followed Gentile enough that the Court of Chancery found that Plaintiffs had stated direct claims and denied the motion.21Id.

On appeal, the Supreme Court of Delaware overruled Gentile for three reasons. First, Gentile is in tension with Tooley,22Id. at *12–19. which stated that a direct injury must be independent of any alleged injury to the corporation, since Gentile found that dilution claims could be both derivative and direct.23Id. at *12. Gentile also relied on the “special injury” test, an area of analysis that had been discarded by Tooley.24Id. at *17. Finally, Gentile used the presence of a controlling shareholder as an element of its test to find claims both direct and derivative, even though the Tooley test only looks at who suffered the harm and who received the benefit.25Id. Second, other theories already provided remedies for stockholders to address fiduciary duty violations in a change of control context.26Id. at *19–20. Moreover, under Gentile, both direct and derivative claimants could seek the same recovery, leading to a complicated analysis to divide up the funds.27Id. at *20. Third, Gentile had been decided long enough ago that the Supreme Court of Delaware could with a clear conscience acknowledge its inherent unworkability and difficulty of application.28Id. at *22.

As a result of this decision, stockholders will no longer be able to bring any derivative claims after a merger.29Marie C. Bafus, et al., Delaware Supreme Court Holds That Dilution Claims Against a Controller Are Solely Derivative, Overruling Prior Precedent, Fenwick (Sept. 23, 2021), https://perma.cc/GB8S-T6BX. The presence of a controlling stockholder also no longer radically changes the analysis of dilution claims, simplifying a confused area of law.30William Savitt & Ryan A. McLeod, Delaware Supreme Court Eliminates “Dual-Natured” Direct and Derivative Claim, Harv. L. Sch. F. on Corp. Governance (Sept. 23, 2021), https://perma.cc/UPD5-HDFF.

Joseph Downey

The University of Chicago Law School