Friday, September 5, 2008

Encite LLC v. Soni; Tortious Interference with Prospective Business Relationship - the Third Party Contract Element

Can a founder, director, and 30% stockholder of a Delaware corporation tortiously interfere with a prospective business relationship between his corporation and a third party?

Chancellor Chandler answered yes in his opinion entered August 1, 2008 in Encite LLC v. Soni, 2008 WL 2973015.

The case is about a venture investment gone bad. Echelon Ventures, L.P. and affiliates (“Echelon”) invested in Integrated Fuel Cell Technologies, Inc., a Delaware corporation (“IFCT”). Founder, former CEO, director, and 30% stockholder Stephen Marsh is the focus of this decision. IFCT failed and went into bankruptcy, and Marsh and friends formed Encite to purchase its assets. Among its other post-acquisition activities, Encite sued certain IFCT directors for breach of fiduciary duty and Echelon for aiding and abetting their breaches. Echelon filed a third-party complaint against Marsh and two former directors and stockholders of IFCT.

Echelon tried mightily to salvage its investment in IFCT, which included a proposal to acquire its assets. The board of IFCT approved Echelon’s proposal, but the approval was abandoned after a lawsuit was filed by one of Marsh’s co-defendants to scuttle it (instigated by Marsh, so Echelon alleges). The bankruptcy followed, and Marsh beat out Echelon in purchasing IFCT’s assets. Echelon, by its third-party complaint, alleges that Marsh torpedoed the Echelon proposal to purchase IFCT’s assets, intending to drive IFCT into bankruptcy and thereby acquiring its assets on the cheap.

Chancellor Chandler first had to resolve which law applied, Massachusetts’ or Delaware’s. He applied Massachusetts law but, in so doing, observed that both Massachusetts and Delaware required the same elements to be pleaded to state a claim for tortious interference with prospective business relationship. Opinion, note 11 These elements are:

· That plaintiff, here Echelon, had a business relationship for economic benefit with a third party (that is to say, not with Marsh, the cross-defendant);

· That Marsh knew of the relationship;

· That Marsh interfered with that relationship through improper motive or means; and

· That Echelon’s loss of the economic advantage was directly caused by Marsh’s conduct.

Marsh argued that he could not tortiously interfere with Echelon’s business relationship with IFCT because, as a director and a 30% stockholder of IFCT, he was, for this purpose, IFCT.

In ruling on this motion to dismiss, the Chancellor concluded that Echelon had alleged sufficient facts to establish that Marsh and IFCT were distinguishable. While Marsh’s status as the founder, a director, a significant stockholder, and former CEO of IFCT argued for a finding of indistinguishability, Chancellor Chandler found the following facts sufficient to establish, at the pleading stage, that Marsh and IFCT were distinguishable:

· Because he was considered an interested director with respect to his group’s bid to purchase the assets of IFCT, Marsh was not permitted to participate in any board evaluation of the bids submitted by interested parties, including by Echelon; and

· Marsh alone did not decide to withdraw the request for shareholder approval of Echelon’s bid — the board of directors of IFCT did.

To establish identity, the Chancellor, citing a Massachusetts employment decision, Harrison v. NetCentric Corp., 744 N.E.2d 622 (Mass. 2001), noted that the evidence would have to establish that Marsh controlled the operation of IFCT to a degree that he should be viewed as its alter ego.

It would be the rare case that would meet this standard. Accordingly, assuming the other elements for establishing tortious interference are met (and meeting the third element – interference of a relationship through improper motive or means is the challenge), executive officers or directors of a Delaware corporation are subject to claims for tortuous interference with prospective business relationships between their corporation and third parties.

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