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Court of Chancery Dismisses Action Where Plaintiff Failed to Plead Key Facts Challenging Breach of Fiduciary Duty and Entire Fairness Standard Applied

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In dismissing a complaint for failure to state a claim under Rule 12(b)(6), the Court of Chancery in Monroe County Employees’ Retirement Sys. v. Carlson, C.A. No. 4587-CC (Del. Ch. June 7, 2010), read letter decision here, held that to survive a motion to dismiss a claim for breach of fiduciary duty where entire fairness is the standard of review, the plaintiff must make factual allegations as to both prongs of the entire fairness test: fair dealing and fair price.

Telephone and Data Systems, Inc. (“TDS”) entered into a contract (the “Intercompany Agreement”) with United States Cellular Corporation (“USCC”). TDS was the controlling shareholder of USCC. Under the agreement, TDS provided various services (related to human resources, operations, marketing, etc.) and equipment to USCC, which in the most recent three years amounted to nearly $350 million in payments to TDS.

Plaintiff, a USCC shareholder, brought a derivative action alleging that (1) USCC’s directors breached the duty of loyalty; (2) TDS breached its fiduciary duties as USCC’s controlling shareholder by carrying out the Intercompany Agreement on terms that were unfair; and (3) TDS was unjustly enriched under the Intercompany Agreement. All three claims relate to the alleged unfairness of the Intercompany Agreement.

Because the Intercompany Agreement was a transaction between a corporation and its controlling shareholder, the transaction was reviewed by the Court under the entire fairness standard. The parties were in agreement that at the proof stage, the controlling shareholder would have the burden of proving the dual prongs of entire fairness: fair dealing and fair price. The parties, however, disagreed as to what the plaintiff’s burden would be at the pleadings stage. Plaintiff contended that to survive a motion to dismiss, it only needed to allege facts pertaining to a transaction between a controlling shareholder and the corporation to survive a motion to dismiss. The defendants argued that plaintiff had to make factual allegations in its complaint that would establish that the challenged transactions were not entirely fair.

The Court disagreed with the plaintiffs noting that, “[t]ransactions between a controlling shareholder and the company are not per se invalid under Delaware law. Such transactions are perfectly acceptable if they are entirely fair . . . .” As a result, to survive a motion to dismiss, a party must allege facts that, if proven, would establish that the transaction was not entirely fair as to both unfair dealing and unfair price. Because plaintiff alleged facts only as to unfair dealing, the Court dismissed the two breach of fiduciary duty counts. Moreover, because the claim for unjust enrichment was contingent upon the success of the breach of fiduciary duty claims against TDS, the Court dismissed that claim as well.

This summary was prepared by Kevin F. Brady and Ryan P. Newell.

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