Case Analysis: Reserve Solutions v. Vernaglia: Oppression Claim Involving Delaware Corporation

Reserve Solutions, Inc. v. Vernaglia, 438 F. Supp.2d 280 (S.D.N.Y. 2006).

A Delaware closely-held Corporation brought suit against a minority shareholder and former officer and director. The minority shareholder counter claimed for shareholder oppression and other claims and brought third-party claims against the majority shareholders for oppression. The counterclaim-defendants moved to dismiss for failure to state a claim. Vernaglia formed Reserve Solutions, Inc. with three other shareholders who were members of the same family. Vernaglia received 45% of the stock in exchange for his agreement to devote his efforts to managing to Corporation and to developing software for the Corporation, applying for patents, and assigning his intellectual property to the Corporation. Vernaglia was requested to make a capital contribution in the amount of $132,000, which he did. The remaining shareholders also agreed to make a capital contribution in the amount of $3 million, but recorded it as a loan from the shareholders. The majority shareholders also transferred the administration of the Corporation's finances to a related Corporation that they controlled. After several years, Vernaglia began investigating financial improprieties, eventually concluding that $20 million of corporate money had been misappropriated by the majority shareholders. Shortly thereafter, Vernaglia was terminated on the grounds that he had misappropriated corporate funds to pay personal credit card bills. Vernaglia contended that each of the payments was authorized by the other shareholders, and each was either compensation owed to him by the Corporation or reimbursement for business expenses.

The Court held that Delaware law recognizes a cause of action for minority shareholder oppression, citing Litle v. Waters, 1992 WL 25758 (Del. Ch. 1992). The Court held that shareholder oppression under Delaware law is satisfied by proof of a violation of the reasonable expectations of the minority shareholder or "a visible departure from the standards of fair dealing and fair play." On the basis of the facts pleaded by Vernaglia, the court denied the motion to dismiss.

"Accepting the facts as alleged by Vernaglia as true for the purposes of this motion, Vernaglia had a reasonable expectation of continued participation in the management of Reserve and in the exploitation of the patents he developed. On the same basis, the Bents had no good faith grounds to believe that Vernaglia was converting corporate funds for his personal use. Instead, they persuaded Vernaglia to contribute the $132,000, duped him into believing that his shares had been diluted, and ousted him from the company in retaliation for his legitimate investigation into corporate waste and mismanagement and for the purpose of consolidating their control of the company, and against any interest of the corporation. Thus, if the evidence bears out Vernaglia's pleadings, the Bents' behavior departed significantly from the standards of fair dealing and fair play expected between co-fiduciaries. Vernaglia has properly stated a claim for oppression of a minority shareholder under Delaware law." 438 F. Supp.2d at 290.