A recent corporate opportunity decision, Dweck v. Nasser, offers a fascinating read. The opinion, by Vice Chancellor Laster of the Delaware Court of Chancery, tells a story of deceit, conspiracy, and breaches of the duties of loyalty and good faith not often illustrated in such graphic detail. The demise of Kids International Corporation ("Kids"), a one-time apparel giant that supplied products to Walmart, Target, and the like, sets the background for a messy split between its co-founders Gila Dweck and Albert Nasser.
Looking for an investor to acquire assets of a failing family apparel business, Dweck turned to Nasser to provide financing and start-up capital for a new venture. The transaction closed in September 1993, and the resulting entity, Kids, was profitable from day one. While Dweck did not receive any equity in Kids until Nasser's loan was repaid, she ran the business and spearheaded its expansion. Nasser acted as a passive investor. By 1998, Nasser had received the return of the full amount of his investment (about $9 million), plus interest. At that time, Nasser issued 45% of Kids' outstanding equity to Dweck and her brother.
Despite receiving equity and otherwise receiving distributions from the Kids business through licensing payments, Dweck felt that her contributions were not adequately compensated. In 2001, Dweck, together with Taxin, the company's Sales and Merchandising Vice President, formed Success Apparel, LLC ("Success"), a limited liability company to which they began to channel new business. Success had no start-up expenses because it utilized Kids' employees, headquarters, distributors, and administrative personnel.
Between 2001 and 2005, Success operated out of Kids' premises, drew on Kids' letter of credit, sold products under Kids' vendor agreements, and otherwise capitalized on Kids' customer relationships and distributions network. Under Dweck's direction, certain distributorship and licensing agreements were revised to replace Kids with Success. Kids' CFO, Fine, never questioned this practice, nor did he ever question Dweck's requests for reimbursement for personal luxury items.
By 2004, Kids stopped providing Nasser with quarterly financial reports. During this same period, it became apparent that Kids' projected profits would not be realized. All the while, Dweck and Taxin were scheming their escape. Following an abrupt confrontation with Nasser, they informed all employees that May 18, 2005 would be their final day with Kids. When Dweck and Taxin left Kids, they took with them substantial materials, including hard drives, samples and files. As it later turned out, in the weeks leading up to their departure from Kids, Dweck and Taxin had met with their respective contacts at Target and Walmart, and effectively shut down Kids' apparel business by diverting incoming orders to Success.
In ruling on the issues before the Court, the Vice Chancellor applied the well-established rubric that the duty of loyalty proscribes a fiduciary from any means of misappropriating assets entrusted to his management and supervision. The doctrine of corporate opportunity represents one species of the broad fiduciary duties assumed by a corporate director or officer. The doctrine holds that a corporate officer or director may not take a business opportunity for his own if: (1) the corporation is financially able to exploit it; (2) the opportunity is within the corporation's line of business; (3) the corporation has an interest or expectancy in the opportunity; and (4) by taking the opportunity for his own, the corporate fiduciary will thereby be placed in a position antithetical to his duties to the corporation. Applying these factors to Dweck's and Taxin's conduct, the Court had little difficulty finding them in breach. In terms of damages, while all sides offered damages experts, the Court ordered that Kids recoup its lost profits, calculated by the profits of Success, for the following two seasons, as such revenue would have properly belonged to Kids had the breaches not occurred. In limiting damages in this fashion, the Court observed that Dweck and Taxin were free to leave and otherwise compete and were not parties to any restrictive covenants. In essence, the plaintiff could only recoup that which was taken from Kids wrongfully.
Nasser did not escape the Court's scrutiny either. Dweck claimed Nasser received consulting fees from Kids while he performed no such services. Because Nasser remained a majority stockholder, his conduct was reviewed pursuant to the doctrine of entire fairness. Under this doctrine, Nasser was required to prove that (1) the payments he received from Kids, and (2) the process by which such payments were set, was entirely fair to Kids. The Court found that Nasser could not meet his burden of proof and ordered the return of consulting payments.
Another interesting wrinkle concerns a free-for-all provision often encountered in alternative entity formation documents. These provisions (often seen in alternative entities such as limited liability companies) permit members to compete with the company and participate in any business opportunities they may encounter.
Nasser and Dweck were parties to a limited liability agreement that contained such a provision. Kids was not mentioned, however. The Court found that the presence of such a provision in one venture does not automatically vitiate fiduciary duties with respect to another.
This opinion offers a treasure trove of "corporate opportunity" jurisprudence, including a creative damages analysis rooted within the equitable powers of the Court rather than traditional tort models of conversion or misappropriation of trade secrets.
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