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In re Nine Systems Corp. Shareholders Litigation

Court of Chancery of Delaware

May 7, 2015

In re Nine Systems Corporation Shareholders Litigation

Submitted: January 13, 2015

Anne C. Foster, Esquire Richards, Layton & Finger, P.A.

Andrew D. Cordo, Esquire Ashby & Geddes

Dear Counsel:

In its post-trial opinion, the Court found that Defendants[1] breached the duty of loyalty (or aided and abetted such a breach) by conducting a self-interested recapitalization.[2] Unfortunately for Plaintiffs, monetary damages were not available because the pricing was fair and Plaintiffs suffered no quantifiable damage. The Court granted the Plaintiffs-shareholders in their individual capacities-leave to "petition the Court for an award of attorneys' fees and costs, " noting "its inherent equitable power to shift attorneys' fees and its statutory authority to shift costs."[3] After briefing and oral argument on the topic, the Court finds that an award of $2 million for attorneys' fees and expenses (other than court costs) is equitable.[4]

The post-trial opinion recounted the factual background of this dispute in detail, and the Court will not do the same here. Relevant to the pending motion, Plaintiffs' counsel accrued $11, 427, 195.23 in fees and costs, representing Plaintiffs through two complaints, motion to dismiss proceedings, summary judgment proceedings, an eleven-day trial, and related efforts.[5] Plaintiffs' lead counsel, Jones Day, performed a majority of the work and paid fees and expenses for Delaware counsel.[6] Jones Day had a contingency-fee agreement contemplating a return of its "out-of-pocket expenses" and 40% of any excess recovery as attorneys' fees.[7]

Plaintiffs claimed that Streaming Media Corporation, later known as Nine Systems (the "Company"), was worth $30.89 million at the time of a recapitalization in 2002 that materially diminished their equity percentages.[8] An individual affiliated with a major shareholder had valued the Company at $4 million for that recapitalization. Plaintiffs sought damages of over $130 million, plus interest, after the Company was acquired for approximately $175 million in 2006.[9]

This Court has "equitable power to award fees in a proper case."[10]However, equitable fee shifting is "unusual relief" because of the American Rule, under which each party generally must pay its own attorneys' fees.[11] The American Rule is subject to a number of well-established exceptions, such as "cases where the underlying (pre-litigation) conduct of the losing party was so egregious as to justify an award of attorneys' fees as an element of damages."[12]There is substantial authority indicating that the bad faith exception is limited to cases of "intentional misconduct, "[13] but the Court's equitable powers can be viewed more broadly as permitting fee shifting "where the situation or the equities dictate that such a burden should not fall on the prevailing party."[14] In awarding fees, whether as a proxy for unquantifiable damages or as a traditional fee award, Delaware courts have considered a need "to discourage outright acts of disloyalty" and to avoid penalizing plaintiffs "for bringing a successful claim against the [defendants] for breach of their fiduciary duty of loyalty."[15]

After trial, the Court determined that Defendants breached their duty of loyalty to Plaintiffs. Among the Court's findings were that they (1) "utter[ly] fail[ed] to understand th[eir] fiduciary relationship" with Plaintiffs, [16](2) "knowingly excluded" from the decision-making process a director who represented a group of minority shareholders, [17] (3) effected the recapitalization through a "grossly inadequate process, "[18] and (4) "sought to avoid full and fair communications with the Company's stockholders."[19] Plaintiffs could not recover monetary damages, however, because "the equity value of the Company in January 2002 before the Recapitalization was $0."[20] The failure of the fiduciaries to follow a credible valuation process perhaps can be explained through consideration of the Company's limited financial means at the time. No similar benefit of the doubt cloaks the failure to disclose the recapitalization and its consequences to the shareholders or the lack of information about the Company's activities and relocation over several years. A finding of "bad faith" depends on context, and the Court is satisfied that Defendants' pre-litigation conduct qualifies.[21]

Moreover, the broader, unusual circumstances of this case support an equitable shifting of fees. Namely, Plaintiffs held reasonable concerns about the recapitalization, Defendants' concealment of information hindered pre-merger legal action, and Plaintiffs succeeded in showing that Defendants breached their duty of loyalty. The Plaintiffs did not incur any out-of-pocket obligation to pay attorneys' fees because of the contingent nature of their fee agreement with counsel, but that does not necessarily equate Jones Day's efforts to the functional equivalent of a charitable undertaking. In other words, Defendants who rightfully ought to owe Plaintiffs' attorneys' fees should not be able to avoid their obligations because of the way in which the Plaintiffs structured their relationship with their counsel.[22]

This is a troubling case that tests the range of equity's powers. Defendants' conduct warrants a shifting of fees, but the shifting of fees cannot be in an amount grossly disproportionate to the benefit the litigation can achieve. Litigation of this nature is expensive. Jones Day's efforts were not unreasonable if Defendants' potential liability was in excess of $30 million. The Court, obviously with the benefit of trial, concluded that such an amount was not supported, but it could have been reasonable to anticipate before trial a recovery of $3-4 million (before interest).[23] The fees sought by Jones Day are disproportionate and plainly excessive in relation to the Court's perception of a plausible pre-trial damages assessment.[24]

If Plaintiffs' lodestar is unreasonable, what does the Court do?[25] Some fee is warranted, and that any fee would be speculative and uncertain does not necessarily lead to the conclusion that no fee can be set. Just because determining an award of fees is difficult is not an excuse for not awarding any fees. One approach, and there is much room for doubt and second-guessing, is to project a reasonable pre-litigation recovery range, but to discount it based upon the ultimate failure to recover any damages. If Saliba is correct about the right of a party to recover attorneys' fees even though that party recovers nothing, then there should be some substitute process to allow for a fee award even though the actual billings are disproportionate.

A projection of a litigation recovery range would enable the Court to undertake a quasi-Sugarland[26] analysis in light of the considerations set forth above. The Sugarland analysis considers "1) the results achieved; 2) the time and effort of counsel; 3) the relative complexities of the litigation; 4) any contingency factor; and 5) the standing and ability of counsel involved, " with the results achieved carrying the most importance.[27] Strictly speaking, the quantifiable benefit obtained in this litigation was $0.[28] Nonetheless, Plaintiffs were harmed by faithless fiduciaries, and the litigation vindicated certain important rights related to a company that was arguably worth more than $4 million at the relevant time. Over 19, 000 hours were dedicated to this litigation; the Court has no reason to question the integrity of that effort.[29] Counsel tackled complex legal issues, "including standing doctrines . . .; the doctrinal limitations of Gentile; the existence of self-dealing, conflicts of interest and a control group; and the valuation of a start-up company."[30] Jones Day worked on a completely contingent fee arrangement, paying Delaware counsel. Finally, Jones Day and Plaintiffs' Delaware counsel are able representatives and respected practitioners in this Court.

In conclusion, based on a more realistic benchmark of a $7-10 million benefit, [31] Plaintiffs are entitled to an award of $2 million in attorneys' fees and expenses (other than court costs). Such an award promotes meritorious litigation to address harm from disloyal acts and comports with equitable principles. Indeed, it is a ...

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