SDF Funding LLCv. Stanley B. Fry

Citation: Not availableDocket: C.A. No. 2017-0732-KSJM

Court: Court of Chancery of Delaware; October 4, 2021; Delaware; State Appellate Court

Original Court Document: View Document

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The Court of Chancery of Delaware, led by Chancellor Kathaleen St. Jude McCormick, has requested additional briefing regarding the standing issue raised in the defendants' motion for summary judgment in the case SDF Funding LLC, et al. v. Stanley B. Fry, et al. The defendants argue that SDF lacks standing to pursue claims in Counts I through IV of the amended complaint due to the contemporaneous ownership requirement outlined in 8 Del. C. § 327, asserting that SDF cannot challenge actions that occurred before it became a stockholder. The plaintiffs contend that Stuart D. Feldman, the original investor in Flashpoint Technology through Chelsey Capital, has equitable standing to pursue these claims, despite SDF’s lack of standing. The Chancellor acknowledges her personal reservations about the contemporaneous ownership doctrine but emphasizes her obligation to apply the law. Notably, both parties’ initial briefs did not sufficiently explore the equitable standing doctrine, prompting the Chancellor to conduct independent research. She has asked the parties to further develop their arguments on standing. The plaintiffs intend to argue for a "look through" approach to grant Feldman derivative standing based on his ownership of the LLCs. The Chancellor critiques the legal precedents cited by the plaintiffs as lacking strong support for their position, specifically referencing the cases In re Carlisle Etcetera LLC and Theodora Holding Corp. v. Henderson, indicating that while they are informative, they do not strongly bolster the plaintiffs' claims.

The court addressed and dismissed the defendants’ standing argument in a footnote, highlighting two main points. First, it emphasized that Section 327 is intended to prevent abuse in derivative lawsuits and should not preclude actions by stockholders with long-standing equitable interests. Second, the court noted that the procedural defect could have been rectified by adding Ms. Henderson, who held preferred stock, as a plaintiff. The plaintiffs contended that Feldman shares similarities with Ms. Henderson, possessing a long-standing equitable interest, thus satisfying Section 327. However, they overlooked the distinction that Feldman, unlike Ms. Henderson, never owned Flashpoint stock, thereby lacking the ability to cure standing defects through intervention. Consequently, Theodora Holding is not particularly relevant to their case.

In discussing Carlisle, the court outlined a scenario where an LLC was formed, and a member interest was transferred to a subsidiary, which was treated as a member but did not qualify under the Delaware LLC Act. When deadlock occurred, the parent sought dissolution, but the court initially found the parent lacked standing as a member. Nevertheless, it recognized the parent's equitable standing based on the genuine relationships among the parties, comparable to a joint venture. The court noted that the deadlock created a power vacuum, necessitating equitable standing for the LLC to function.

The plaintiffs argued for similar equitable standing in their case, but they failed to recognize crucial differences from Carlisle; Feldman was not treated as an equal partner by Flashpoint, and the absence of equitable standing would not impede Flashpoint’s operations. Therefore, the relationship dynamics in this case weaken the plaintiffs’ reliance on Carlisle. They also referenced other Delaware cases related to Section 327’s exception for stock transferred by operation of law but did not argue that Feldman acquired stock through such means, rendering those cases largely unhelpful to their argument.

Plaintiffs argue that property transfers between wholly owned subsidiaries do not change ownership or control, citing federal cases. However, these cases do not support this claim universally, as one case addresses stock transfer rights and the others focus on securities fraud, which are irrelevant to the standing issue at hand. Additionally, while the plaintiffs reference Delaware cases that broadly interpret stockholder status for derivative standing, they do not assert that Feldman holds derivative standing in a manner applicable to this case. The court emphasizes that adopting the plaintiffs' arguments would create a new application of the equitable standing doctrine, which Delaware law limits. The court questions whether a "complete failure of justice" standard should guide the expansion of this doctrine and requests parties to provide comprehensive analyses of equitable standing and its implications. The importance of the plaintiffs' "look through" argument in relation to LLC law is also noted. Furthermore, the court acknowledges a request from plaintiffs’ counsel to seek a substitute representative if standing challenges are successful. The court received a letter regarding a recent Delaware Supreme Court decision that alters the test for demand futility but does not require supplemental briefing on that issue. The court requests the parties to agree on a schedule for supplemental briefing on various topics and will pause deliberation on motions pending these submissions.