Delaware Supreme Court Upholds Discovery Spoliation Sanctions, Rejects “Implied Ratification” Defense, Discusses Jurisdiction in Section 225 Actions. In Genger v. TR Investors, LLC (No. 592, 2010, Del. Supr. July 18, 2011), the Delaware Supreme Court upheld spoliation sanctions imposed by the Chancery Court in connection with a Section 225 action to determine the stockholder group entitled to elect the board of directors of Trans-Resources, Inc. The action stemmed from defendant Arie Genger’s disposition in 2004 of his 52.85% ownership in Trans-Resources, which allegedly violated the plaintiffs’ rights of first refusal and other purchase rights. Believing that they were now entitled to take a majority position in Trans-Resources, the plaintiff’s brought suit in the Chancery Court. In finding for the plaintiffs, the Chancery Court also sanctioned Genger for deleting files stored on his work computer at Trans-Resources and directing an employee to use special software to permanently delete the files, in violation of a Status-Quo Order. The Chancery Court awarded the plaintiffs $750,000 in attorney’s fees incurred to investigate and litigate the spoliation issue, ordered payment of an additional $3.2 million fee, which had been previously agreed to by the parties, and required that Genger prove his claims by the heightened standard of clear and convincing evidence. Sitting en banc, the Delaware Supreme Court upheld the spoliation finding and award. The Court noted that the Chancery Court had made its finding of spoliation on “narrow factual grounds -- that Genger, despite knowing he had a duty to preserve documents, intentionally took affirmative actions to destroy several relevant documents.” The Court further supported the Chancery Court’s inference that in addition to the documents that the plaintiffs knew were missing, other relevant documents were likely also permanently deleted. In so finding, the Court took care to state that the result might have been different if the software, which wipes out unallocated free space where deleted files are temporarily stored but still recoverable, had been run on a scheduled cycle pursuant to an existing data retention policy. The Court suggested that future litigants and trial courts address unallocated free space issues before document retention and preservation orders are implemented.
Addressing the merits of the Section 225 action, the Court upheld the Chancery Court’s finding that the plaintiffs had not impliedly ratified the 2004 transfers by later negotiating with Genger (who held an irrevocable proxy for the disposed shares) regarding a funding agreement. The Court then addressed the Chancery Court’s Side Letter Opinion which decided the ownership of shares allegedly transferred to entities not party to the original Section 225 action. After initially declining to decide the ownership of those shares, the Chancery Court determined that it was appropriate to reach the issue since arguably election of two of the six Trans-World directors would depend on the outcome. The Supreme Court held that while the Chancery Court had jurisdiction to determine record ownership of the contested shares, it did not have jurisdiction to determine beneficial ownership of shares putatively owned by a non-party to the action. The Court noted that a Section 225 action is a summary proceeding of an in rem nature, with the limited purpose of determining issues that pertain to the election or removal of an officer of the res, the disputed corporate office. Since adjudication of record ownership of stock was necessary to determine the rights to elect the directors, the Chancery Court was within its jurisdiction to determine that issue. However, the Court held that the since the parties allegedly holding a beneficial interest in the shares had not consented to jurisdiction, the Chancery Court had overstepped by “enlarg[ing] the Section 225 proceeding into a concurrent plenary action that would empower the court to determine the ultimate beneficial ownership” of the shares.
