Misappropriation of Corporate Opportunity: MobileActive Media, LLC under Delaware Law
Posted February 28, 2013 by Bierce & Kenerson, P.C. · 
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New ventures in Big Data, cloud-based computing, outsourced business process management (BPM), Internet-based SaaS services, IT-enabled marketing and mobile telephony face keen competition in the marketplace. However, when competition comes from a co-owner of the new venture, the results can be ugly, litigious and expensive for all parties. The MobileActive Media, LLC joint venture for mobile media advertising was formed in 2007 in Delaware and lasted only till 2010 before litigation about breach of contract, breach of fiduciary duty and dissolution. The MobileActive Media case offers insights into the importance of scope of business operations, joint control, relationship governance, vetoes, and personalities in achieving value and overcoming typical risks of joint ventures.
A January 25, 2013 decision of the Delaware Chancery Court decided that a 50% owner of a Delaware LLC was responsible for misappropriation (or “usurpation”) of corporate opportunities of the LLC by entering into business operations that competed with the LLC’s core purpose of business. The court awarded $3.08 million in damages from usurpation.
For new venture startups, friends and family investors, angel investors, venture capital investors as well as mid-sized businesses seeking growth, it is critical from the start to ensure that the new venture is designed well and implemented by all parties. The lessons apply to pre-nuptial agreements for strategic business relationships ranging from co-investment to supply chain and value chain relationships.
The New Venture. In 2006, a U.S. former senior executive of a national cable telecom company (the “Entrepreneur”) and a U.K. technology company (the “Platform Company”) formed a 50-50 Delaware LLC to exploit “interactive video and advertising” activities in North America. The Entrepreneur agreed to, and did, provide access to his broad industry contacts. The Platform Company, a United Kingdom business that owned proprietary mobile marketing technologies, would provide technical resources, and its 50% ownership would be held by a subsidiary.
Exclusivity of LLC’s Business Purpose. The Delaware LLC’s operating agreement contained an exclusive-dealing clause that stated that interactive video and advertising activities in North America by either joint venturer or their affiliates would take place exclusively through the joint venture. It excluded the UK company’s (and its subsidiaries‘) “North American non-video based mobile and on-line marketing businesses.” It expressly permitted the members and their subsidiaries to “engage in any business activities except those whose primary purpose involve the enabling and enhancing of interactive video programming and advertising content across multiple digital platforms.” In re: MobileActive Media, LLC, a Delaware LLC, Del. Chancery No. 5725-VCP (Jan.25, 2013), slip op. [Citations omitted]
Prospects for Success. The joint venture had bright prospects due to introductions provided by the Entrepreneur to executives in the telecommunications and advertising industries. These led to two business deals, but further growth was stunted due to a conflict of interest and lack of support from the UK Platform Company.
Struggles between the Members. Shortly after the operating agreement was signed, the UK Platform Company offered to buy out the Entrepreneur’s 50% interest. They realized it was a bad deal early, but did not resolve their differences. They ignored the disagreement without terminating the joint venture and made several acquisitions in related technologies. Over a period that started a few months after the signing of the LLC operating agreement for MobileActive, the UK Platform Company (and its subsidiaries) closed on acquisitions of companies that owned:
(1) an off-the-shelf SMS gateway and reporting package;
(2) a micropayments business that allowed users to send and receive a text message to authorize the purchase of virtual goods;
(3) a Toronto based advertising and marketing boutique that provided traditional types of marketing services;
(4) a Canadian analytics business that provided database solutions and predictive analytics; and
(5) a Canadian analytic search technologies company with technologies that allowed non-technical users ―to query very, very large databases and create customized reports in a very rapid fashion; and
(6) a Delaware corporation that had a sizeable SMS network of 17 million consumers and the technology to deliver advertising to the network.
The UK company never offered any opportunity to the Delaware LLC or the Entrepreneur to invest in such target companies.
Eventually, the subsidiary of the UK Platform Company that was the 50% member went through a restructuring and transferred all of its assets to a newly formed Canadian company for less than fair value. The Entrepreneur successfully disputed the value of the consideration the company paid in this transaction, claiming it violated the Delaware Uniform Fraudulent Transfer Act. The new Canadian company was then sold in 2011 for approximately $100 million. The Entrepreneur did not receive a cent from these transactions and chose to sue, claiming breach of fiduciary duty. The Court awarded him 3.08 million dollars and impressed a trust on the assets.
Elements of a Claim for Breach of Fiduciary Duty by Misappropriation of Corporate Opportunity. As a general reminder to all considering a new business venture, under Delaware corporate law (as recounted by Vice Chancellor Parsons):
“A claim for breach of fiduciary duty requires proof of two elements: (1) that a fiduciary duty existed and (2) that the defendant breached that duty. ―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. ―It forbids one joint adventurer from acquiring solely for himself any profit or secret advantage in connection with the common enterprise. ―The doctrine of corporate opportunity represents but one species of the broad fiduciary duties. The elements of misappropriation of corporate opportunity are: (1) the opportunity is within the corporation‘s line of business; (2) the corporation has an interest or expectancy in the opportunity; (3) the corporation is financially able to exploit the opportunity; and (4) by taking the opportunity for his own, the corporate fiduciary is placed in a position inimical to his duties to the corporation.” Id.
Lessons for New Ventures (especially Tech Ventures and IT-Enabled Business Process Management Ventures). This case highlights classic truths of business law.
- Clear Definition of Corporate Purpose. Every equity owner of a company should agree on the shared scope of business. The definition should serve as a clear guide for future conduct to avoid possible breaches of the fiduciary duty of loyalty.</li>
- Get All Parties to Approve. The senior management of all equity owners should exercise their business judgment and commit to the new venture’s scope. What the Delaware court failed to mention was that the board of directors and officers of the UK Platform Company are liable to the shareholders under UK fiduciary duty principles because they knew, or should have known, of the conflicts with the US Entrepreneur and sought to circumvent his rights anyway.
- Relationship Management. The US Entrepreneur was partially at fault for not getting all of the UK Platform Company’s management “on board” and fully committed. He also failed to manage the relationship through a specific management procedure under the Operating Agreement to ensure full disclosure and early resolution of conflicts.
- Valuation. The litigation occurred because the parties disagreed on the value of what was created and what was eventually to be divided among the owners. The $3.08 million damage award shows that disloyal conduct can be expensive. Both parties should consider use of appraisals or other methods for valuation when a dispute becomes irreconcilable.
- Dispute Resolution Process and Exit Plan. A well-drafted Operating Agreement will identify the method for resolving disputes. Under Delaware LLC law, liquidation and dissolution is the only solution permitted, unless the parties have agreed otherwise. Investors and other passive owners should be particularly concerned about the risk of dissolution, so they may wish to provide for some form of “work out” involving ongoing operations to be managed by an interim manager while a buyer is sought to buy the entire business.
- Legal Fees. Legal fees for enforcement of contract rights under an LLC’s Operating Agreement are not recoverable as damages, unless the contract requires it or unless statutes allow such recovery. The weaker party should consider the impact of such a clause.
- Fiduciary Duty. Some LLC’s may be managed by members (or managers) who have no fiduciary duty to the members. Depending on the applicable law, such exculpatory provisions could have a serious impact on the future of the enterprise and enable one member to take unfair advantage of the others. The equity owners who are not managers should consider the impact of such an exculpatory clause.