In a post-trial decision, the Court of Chancery in Dweck
v. Nasser, C. A. No. 1353-VCL (Jan. 18, 2012), found that Dweck, the former
CEO, a director and 30% stockholder in Kids International Corporation ("Kids"),
and Kevin Taxin, Kids' President, breached their fiduciary duties of loyalty to
Kids by establishing competing companies that usurped Kids' corporate
opportunities and converted Kids' resources.
The Court also found that Dweck breached her fiduciary
duties by causing Kids to reimburse her for hundreds of thousands of dollars of
personal expenses and that Bruce Fine, Kids' CFO, breached his fiduciary duties
by abdicating his responsibility to review Dweck's expenses and signing off on
This summary was prepared by Kevin F. Brady.
The background to this case is long and complex as shown
by the trial logistics - five-day trial, 930 exhibits, almost 30 fact and three
expert witnesses. As a result, I will only provide a high-level summary
of the facts here. In 1993, Dweck and Nasser (Chairman and controlling
shareholder of Kids) and others purchased the assets of EJ Gitano. As part of
the transaction, Kids was formed and designated for tax purposes as a
Subchapter S Corporation so Kids' profits would be attributed pro rata to
Kids stockholders (originally only Nasser). In 1994, Taxin joined Kids as Vice
President of Sales and Merchandising, and Kids' sales subsequently increased by
a factor of five over a four-year period. Around 1998, Dweck was issued
45% of Kids' outstanding equity. However, Dweck believed she was not being
adequately compensated and so in October 2001, she formed Success Apparel LLC
("Success"), to operate as a wholesaler of children's clothing.
From 2001 until 2005, Success operated out of Kids' premises using Kids'
employees. Success drew on Kids' letters of credit, sold products under Kids'
vendor agreements, used Kids' vendor numbers, and capitalized on Kids'
relationships. Then in June 2004, Dweck founded Premium Apparel Brands
LLC ("Premium"), a clothing wholesaler, which also operated out of Kids' premises,
and used Kids' employees and resources. Dweck owned 100% of Premium and served
as its CEO. Between 2002 and 2005, Dweck charged almost $500K in expenses to
Kids and at least $172K were personal expenses, including vacations and
assorted luxury goods. In March 2005, Dweck admitted at a stockholder
meeting that she was selling "overlapping product" and competing with Kids from
Kids' premises. However, Dweck continued to work out of Kids' offices until
April 11, 2005, and Dweck and Taxin continued to divert Kids' business to
Success. Dweck and Taxin also arranged for a mass exodus of Kids'
employees to join Success.
Eventually there was a falling out with Nassar and Dweck
accusing each other of breaching their fiduciary duties (Nassar also asserted third-party
claims against Taxin and Fine). Nasser sought damages equal to
Kids' purported going-concern value at the time of the split, which his expert
values at between $70.8 million and $458.2 million.
The Court found that Dweck, as a director and officer of
Kids and Taxin as an officer of Kids, each owed a duty of loyalty to Kids and
that they breached their duty of loyalty by diverting what they decided were
"new opportunities" to Success and Premium. Dweck and Taxin used Kids'
personnel and resources to pursue each opportunity, demonstrating that Kids
just as easily could have pursued the opportunities in its own name. After
appropriating the opportunities, Dweck and Taxin operated Success and Premium
as if the companies were divisions of Kids, but kept the resulting profits for
themselves. By doing so, Dweck and Taxin placed themselves "in a position
inimicable to [their] duties to [Kids]."
The Court provided eminently quotable well-established
law on the fiduciary duty of loyalty and the corporate opportunity doctrine:
The essence of a duty of loyalty claim is the assertion
that a corporate officer or director has misused power over corporate property
or processes in order to benefit himself rather than advance corporate
purposes." Steiner v. Meyerson, 1995 Del. Ch. LEXIS 95, at *4 (Del. Ch. July 19, 1995) (Allen, C.) [an enhanced version of this opinion is available to lexis.com subscribers].
At the core of the fiduciary duty is the notion of loyalty-the equitable
requirement that, with respect to the property subject to the duty, a fiduciary
always must act in a good faith effort to advance the interests of his
beneficiary." US W., Inc. v. Time Warner Inc., 1996 Del. Ch. LEXIS 55, at *65 (Del. Ch. June 6, 1996) (Allen, C.)
[enhanced version]. Most basically, the duty of
loyalty proscribes a fiduciary from any means of misappropriation of assets entrusted
to his management and supervision. Id. The doctrine of corporate
opportunity represents . . . one species of the broad fiduciary duties assumed
by a corporate director or officer." Broz v. Cellular Info. Sys., 67
A.2d 148, 154 (Del. 1996).
The Court also rejected various defenses raised by Dweck
and Taxin. Dweck and Taxin tried to distinguish the new line of business
they were entering into from Kids' line of business. However, the Court
rejected that argument noting that "[w]hen determining whether a corporation
has an interest in a line of business, the nature of the corporation's business
should be broadly interpreted. '[L]atitude should be allowed for development
and expansion. To deny this would be to deny the history of industrial development.'"
Dweck also argued that Nasser gave Dweck permission to compete with Kids
but the Court failed to find Dweck's version of what occurred to be
Dweck also argued that an operating agreement which
contained a so-called "free-for-all" provision authorized her to compete with
Kids. The Court rejected Dweck's reading of the operating agreement and
as to any ambiguity in the agreement, regarding the parties' course of
performance, the Court noted:
It is a familiar rule that when a contract is ambiguous,
a construction given to it by the acts and conduct of the parties with
knowledge of its terms, before any controversy has arisen as to its meaning, is
entitled to great weight, and will, when reasonable, be adopted and enforced by
the courts. Radio Corp. of Ain. v. Phila. Storage Battery Co., 6
A.2d 329, 340 (Del. 1939). The evidentiary record reflects that before
this litigation, the parties did not believe that the essential free-for-all
provision granted Dweck the right to compete with Kids. Dweck repeatedly sought
to have Nasser sign the Kids stockholders' agreement, each draft of which
contained a functionally identical free-for-all provision. Nasser refused to
sign the draft agreements, specifically objecting to the free-for-all
provision. Before founding Success and taking the Bugle Boy opportunity, Dweck
sought Nasser's consent (albeit in a vague and ambiguous manner). She received
approval only after assuring Shiboleth that her new business would not compete
with Kids. If the Essential agreement operated as Dweck now contends, then she
had no reason to seek Nasser's consent.
The Court determined that with respect to the damages for
usurping Kids' corporate opportunities, Dweck, Taxin, Success, and Premium were
jointly and severally liable to Kids for the lost profits Kids would have
generated from business diverted to Success and Premium between January 1, 2005
and May 18, 2005, which were over $9M. In addition, among other things,
the Court found that Dweck, Taxin, Success, and Premium were also jointly and
severally liable for profits generated by Success and Premium after May 18,
2005. This analysis may also be relevant in covenant not to compete cases. See,
e.g., Slip op. at 36.
With respect to the mass departure of Kids' employees and
the taking of Kids' property and files, the Court found that Dweck actively
conspired with Taxin and Fine, thereby aiding and abetting Taxin and Fine's
breaches of fiduciary duty. As a result, the Court found that Kids'
remedy for the departure-related breaches of fiduciary duty should be limited
to the damages Kids suffered over and above where Kids would have been had
Dweck and Taxin resigned in an appropriate manner. The Court then awarded Kids
the profits generated by Success in its non-branded business for the Holiday
2005 and Spring 2006 seasons.
Liability of Officers for Breach of Fiduciary
Duty (Approving Personal Expenses of Superior to be Paid by Company Funds)
Finally, with respect to the personal expenses, the Court
found Dweck liable to Kids for a total of $342,366 in expenses, comprising both
the $171,966 of admittedly personal expenses and the $170,400 of indeterminate
expenses. The Court also found that Fine was jointly and severally liable
for those amounts because Fine co-signed for the reimbursement of Dweck's
personal expenses, and he admitted at trial that he did not perform any review
of Dweck's expenses before co-signing her reimbursement checks. See
generally, Slip op. at 37-40.
As proven by this case and at least one
other prior Chancery opinion cited in this opinion, an officer who
approves personal expenses of a superior, which are to be paid with company
funds, faces an unenviable binary choice: risk losing one's job by refusing to
process the reimbursement of personal expenses as requested by the
superior, or risk personal liability in a court proceeding for approving those
expenses in violation of the officer's fiduciary duty to the company.
Commentary on Credibility
There is an important theme that the Court mentions a
number of times in the opinion that has to do with witness credibility
especially in fiduciary cases. While every litigator know that a witness
(and their lawyer's) credibility is very important, it is worth a reminder now
and again. It is also important to remember that credibility does not
just come into play at trial. It starts at the very beginning of the case
with the filing of the complaint and motion practice especially in
discovery disputes before the Court of Chancery. A good example of this
comes from Vice Chancellor Laster's comments in Eagle Rock when he was
dealing with a discovery dispute as to whether an individual should be
trusted to identify, preserve, review, and produce relevant electronically
stored information. His larger concern went to the trustworthiness and
credibility of an individual who was involved in the litigation and whether
he/she should be trusted to do the right thing (in the Eagle Rock case
he said that they shouldn't be trusted to do that without a lawyer being
Postscript: Professor Gordon
Smith blogged about the case here,
with scholarly insights on the "free for all" clause that can attempt to
eliminate a corporate opportunity claim. See DGCL Section 122(17).
Read more Delaware business
litigation case summaries and commentary on Delaware
Corporate and Commercial Litigation Blog, a blog hosted by Francis G.X.
Pileggi, of Eckert Seamans.
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