Michael Lastowski

Fee shifting is always the exception, rather than the rule, and a party may reasonably expect that each party will bear its own costs. In receivership actions, the receivership will usually bear its own costs. In Longoria v. Somers and LC Therapeutics, C.A. No. 2018-0190-JTL, memo. op. (Del. Ch. May 28, 2019), the Delaware Court of Chancery held that, where the receivership cannot bear the costs of the receivership, such costs may be taxed against a petitioner.

LC Therapeutics, Inc. (LCT) was formed to develop and commercially exploit patents (the “Patents”). LCT has two 50% shareholders, James Longoria (Longoria) and Charles Somers (Somers). Longoria owned the Patents and contributed them to LCT. Somers made “significant capital contributions” to LCT.

The shareholders reached a deadlock on several issues. Longoria filed a petition for dissolution and eventually filed a dissolution plan under which Somers would be a trustee. Somers opposed the plan. Instead, he sought the appointment of a receiver. Eventually, the parties agreed to the appointment of a receiver. The receiver retained a patent prosecution firm to maintain the patents and sought the sale of the patents. The appointment order provided that the receiver could seek to tax his fees and expenses as costs in the event that the sale of the Patents yielded insufficient sale proceeds.

Although the parties had agreed to pay the fees and expenses of receiver and his counsel, Longoria took the position that the Patents were worthless and objected to the receiver’s incurring any expenses to sell or maintain the patents. Somers, on the other hand, agreed to pay 50% of these expenses so long as Longoria agreed to pay the remaining 50%. The receiver petitioned the court for a ruling as to whether he could tax the expenses of the receivership to the parties.

Generally, “a receiver’s compensation and expenses are payable from the funds in his hands, and no part is taxable against the party at whose instance the receiver was appointed,”see  Brill v. Southerland, 14 A.2d 408, 413 (Del. 1940). When there is no fund from which expenses may be paid, the party who sought the appointment of the receiver, should be required to pay.

Longoria sought to avoid the application of the general rule on several grounds. His primary argument was that, as a shareholder, he could not be compelled to pay the expenses of the receivership, since shareholders are not generally liable for the debts of a corporation. Nothing in LCT’s governing documents authorized fee shifting. Moreover, the General Assembly has enacted legislation prohibiting corporations from adopting fee-shifting provisions in their governing documents.

The flaw in Longoria’s position was that he was not only a stockholder, he was also a litigant. Longoria too had earlier petitioned for the appointment of the receiver. A petitioner can be required to pay the receivership’s expenses when no other funds are available.

Longoria made four other arguments. First, he protested that Somers was supposed to fund LCT’s operations and that Somers’ breach of the obligation led to the appointment of a receiver. This breach should excuse Longoria from payment. Second, his proposed plan of dissolution did not require the services of a third party. Third, Somers had sued him in another forum and he needed to preserve his own assets for that litigation. Fourth, as a director of LCT, Longoria was entitled to indemnification. He therefore should not be required to fund LCT.

The court was not persuaded. First, any breach of contract claim against Somers should be litigated in another forum. Second, given the parties’ deadlock, Longoria should have known that his plan of dissolution was unlikely to be accepted. Third, Somers’ lawsuit was “not a reason to give Longoria a free pass on the cost of the receivership.” Fourth, any indemnification claim should be submitted and litigated as part of the receivership process.

Although the court’s ruling was predictable, it was undoubtedly a bitter pill for Longoria to swallow. Having contributed the patents to LCT, with the expectation that Somers would thereafter fund the corporation’s operations, Longoria may have had the further expectation that Somers would be required to fund the receivership. Unfortunately, Longoria was a petitioner. Had he been the only petitioner for a receiver, the court could have ordered him to pay all of the expenses. Somers’ own petition and his agreement to pay one-half of the expenses spared Longoria from being solely responsible.

Michael R. Lastowski is the managing partner of Duane Morris’ Wilmington office. He practices in the areas of bankruptcy law and commercial litigation.

Reprinted with permission from Delaware Business Court Insider, © ALM Media Properties LLC. All rights reserved.