This article originally appeared on Law360, here. 

A Delaware vice chancellor said Thursday she “wasn’t very persuaded” by some arguments from an investor seeking derivative damages from the top figures of online legal services venture UpCounsel Inc., who the investor says licensed away the heart of the company without adequate disclosures before folding the business.

During a teleconference case dismissal hearing, Vice Chancellor Kathaleen S. McCormick pressed Ann M. Kashishian of Kashishian Law LLC, counsel for the investor, to explain arguments that UpCounsel’s board acknowledged “and actually acceded to” some pre-suit demands from the stockholder despite allegations in the suit that demands would have been futile and were not made.

“Our court has consistently adopted a ‘No gaming the system’ rule where we don’t allow stockholders to pursue both avenues of demand futility and wrongful refusal by attempting to carefully word the pre-suit communications,” the vice chancellor told Kashishian, noting later that the court “wasn’t very persuaded” by the plaintiff’s argument on the demand futility point.

Derivative suits, which seek damages on behalf of a business rather than stockholders, oblige those who sue to either first ask a board to act on allegations involved or to show that demands would have been futile. Attempting to argue both, Vice Chancellor McCormick said, would create a “giant loophole.”

“It’s a ‘Walk like a duck’ kind of analysis,” the vice chancellor added. “We look at the substance of the communications and ask what is happening — is the stockholder asking the board to take an action that the stockholder would ask the court to handle.”

In the suit, Raj Abhyanker, a Palo Alto, California-based attorney who is trustee of a family trust that holds UpCounsel stock, accused founders Mason Blake and Matthew Faustman of hiding details about the company’s financial troubles while lining up the sale of key licenses to LinkedIn Corp., and then joining the buyer’s business, with UpCounsel closed up and positioned for eventual dissolution.

Alan D. Albert of O’Hagan Meyer PLLC, counsel to Blake, Faustman and former UpCounsel CEO Greg Rudin, told the vice chancellor that, in addition to potentially nullifying the derivative claim, the suit failed to accurately reflect the status of the company and the stockholder ratification that authorized the sale.

The suit, Albert said, “in essence was premature when filed and in a way premature now, because the consideration that the corporation and thus the stockholders are getting is going to be paid over the course of four years.”

Albert said separately that “it seems beyond reasonable dispute that demand has been made in this case. If that is the case, the complaint really starts on the wrong foot.”

Judge McCormick observed that the stockholders argued that the founders’ response to claims about dissolving the company relied on a “tremendous” amount of information that went beyond the complaint and initial pleadings.

But Albert said the suit lacked hard evidence of the claims, and said the complaint’s flaws and gaps justified tossing claims of corporate waste and disclosure failures prior to ratification of the licensing agreement.

Kashishian told the vice chancellor that it was possible that shareholders were not fully informed prior to the ratification, and, as a result, the case should move forward into discovery. In addition, Kashishian said, the court should consider as a “scrivener’s error” a failure to include an explicit claim for corporate waste, or a count that would seek damages directly for stockholders, in addition to derivative claims.

“You understand that there are very few circumstances in which derivative claims can also be pursued directly,” Vice Chancellor McCormick said, noting the 2006 Delaware Supreme Court decision in Gentile v. Rossette. That case, the vice chancellor said, viewed circumstances for dual direct-derivative claims “quite narrowly, and for good reason.”

Kashishian said the defense had introduced a multitude of evidence prior to the commencement of discovery and was seeking to have “the entire case dismissed only on their side of the evidence, rather than allowing us to investigate.”

Abhyanker, an investor and an attorney, alleged that after filing a California federal lawsuit in 2018, his firm uncovered “significant evidence of UpCounsel’s wrongdoing, including its false advertising, fabricated ratings and reviews, and evidence of rampant fee sharing among attorneys and nonattorneys, and deception of not only its customers, but its investors and its partners.”

In the Chancery complaint, Abhyanker said he made “numerous offers” to help turn around UpCounsel’s financial prospects or purchase its assets. Instead, Abhyanker contended, company officers froze him out of talks about UpCounsel’s future until late 2019, when he was told the company was seeking to migrate “certain assets, clients, lawyers and demand over to LinkedIn” and wind down and dissolve business operations.

The vice chancellor said she would take the arguments under advisement.

Mason Blake, Matthew Faustman and Greg Rudin are represented by Alan D. Albert of O’Hagan Meyer PLLC.

The Raj and Sonal Abhyanker Family Trust and proposed class are represented by Ann M. Kashishian of Kashishian Law LLC and Raj Abhyanker, Nicholas Craft and Wensheng Ma of LegalForce RAPC Worldwide.

The case is The Raj and Sonal Abhyanker Family Trust v. Blake et al., case number 2020-0521, in the Court of Chancery of the State of Delaware.

By: Jeff Montgomery

–Additional reporting by Emma Cueto and Rose Krebs. Editing by Aaron Pelc.