Delaware Court of Chancery Decides in Connection with Failure to Disclose Material Information in a Share Purchase that “Special Facts Doctrine” Applies to a Breach of Fiduciary Duty Claim and Fraud Claim Requires Specific Duty to Speak


Corporate & Finance Alert

June 5, 2013


The Delaware Court of Chancery recently addressed the disclosure obligations in a sale of shares by one shareholder to another (insider) shareholder who had undisclosed knowledge of material facts. The Court of Chancery decided: (i) to apply the “special facts doctrine” in the context of a breach fiduciary duty claim; and (ii) that the failure to disclose the information constituted fraud only when the buyer had assumed a duty to speak.

Plaintiff Brett Stewart (“Stewart”) was a stockholder (and former officer and director) of Wayport, Inc. (“Wayport”). Defendants Trellis Fund (“Trellis”) and New Enterprise Associates VIII L.P. and New Enterprise Associates 8A L.P. (“NEA”), each of which had the right to appoint a board reprsentative, owned Wayport preferred stock.

Stewart sold Wayport shares to NEA on June 13, 2007 and to Trellis on June 20, 2007. During the negotiations for the sale to Trellis, Stewart had expressed concerns about Trellis having information unavailable to him, to which Trellis responded it was not “aware of any bluebirds of happiness in the Wayport world.” No such communications were made by NEA.

Earlier in February 2007, Wayport had begun an auction process to sell certain of its patents. On June 29, 2007, Wayport sold the patents to Cisco Systems, Inc. (“Cisco”) for $9.5 million. The board was informed on July 2, 2007. Stewart was not made aware of the Cisco sale.

Subsequently, in September 2007, Stewart sold an additional 100,000 Wayport shares to Trellis and NEA for $2.50 per share. In October 2007, Stewart received Wayport’s audited financial statements that included general information about the patent sale. Stewart requested more detailed information about the patent sale, which Wayport refused to provide. Stewart had to make a formal demand under Section 220 of the Delaware General Corporation Act and file a books and records action to obtain more information.

In November 2008, Wayport announced that it would be acquired by AT&T Inc. (“AT&T”) for $7.20 per share and Stewart sued NEA and Trellis for damages based on breach of fiduciary duty and fraud. The Court of Chancery first rejected the plaintiffs’ claim that Trellis and NEA had breached their fiduciary duties by failing to disclose material information. The Court of Chancery applied the “special facts doctrine” under which Trellis and NEA (both of which knew from their board representatives about the patent sales since July 2007) had no duty to disclose information about Wayport when they purchased the shares from Stewart in September, unless the information was of sufficient magnitude to constitute a “special fact.” A “special fact” was only a substantial transaction, such as an offer for the whole company, which would substantially affect the value of a company’s stock. Stewart had failed to prove that the patent sale had a substantial effect on the value of the stock. As a result, that sale was not a special fact and there was no duty of disclosure based on fiduciary duties.

Second, the Court of Chancery addressed common law fraud based on the failure to disclose the patent sales. The Court of Chancery found that a duty to speak only exists when a speaker learns of information that makes a previous statement materially misleading. The court found that NEA had never made any representation that became untrue. Accordingly, there could be no liability for NEA based on a failure to disclose the patent sales. However, Trellis’ statement that it was not aware of any “bluebirds of happiness in the Wayport world,” although correct when made before the sales in June 2007, became materially misleading on July 2, 2007, when the board learned of the patent sale to Cisco. At that point, Trellis had a duty to disclose the patent sale to Cisco. If so informed, Stewart would have reconsidered the September 2007 stock sales and requested detailed information about the patent sale. In light of Wayport’s reluctance to provide the detailed information (as evidenced by Wayport’s refusal to provide details on the patent sales in October 2007), Stewart would still have been holding his shares when the sale to AT&T occurred. Therefore, the Court of Chancery awarded Stewart $475,000 in damages (plus interest) for common law fraud. The damages were based on the 100,000 shares sold in September 2007, and the difference between the sale price in that transaction ($2.50 per share) and the price per share in the AT&T transaction ($7.25 per share).

This Alert was written by Peter Flägel, a director in the Firm’s Corporate Group. For more information on this topic, please also contact Frank Cannone or Steven Sholk.