This is Part 2 in a 2-part series discussing developments around contractual waivers of the corporate opportunity doctrine in the private equity realm.
In Part 1, we discussed a recent Texas Court of Appeals case which held that members of a Delaware LLC can contract around (i.e., waive) the general principle protecting against usurpation of corporate opportunities. See Patterson v. Five Point Midstream Funds I and II, L.P., Case No. 01-19-00-643-CV (Tex. App. Dec. 8, 2020). We discussed that the Patterson decision followed a trend in Delaware that permits parties to contract around the traditional rules prohibiting usurpation of corporate opportunities. See Alarm.com Holdings, Inc. v. ABS Capital Partners Inc., No. CV 2017-0583-JTL, 2018 WL 3006118 (Del. Ch. June 15, 2018), aff’d, 204 A.3d 113 (Del. 2019). In December 2019, the Delaware Supreme Court in Alarm.com, affirmed a decision penned by Vice Chancellor Laster out of the Court of Chancery dismissing a claim under the Delaware Uniform Trade Secret Act (DUTSA).
In this Part 2, we will take a deeper dive into Alarm.com, the open questions it left, and potential new developments to keep an eye out for concerning waiver of usurpation of corporate opportunities in the private equity realm. This decision — and the open questions that have not yet been addressed by subsequent cases — is of particular importance to private equity owners that hold investment in companies governed by Delaware law.
Background — Alarm.Com
Defendant, ABS Capital Partners, Inc. (“ABS”) is a private equity firm that invested in Plaintiff, Alarm.com. One of ABS’s partners, Ralph Terkowitz, served on Alarm.com’s board of directors. In 2017, ABS acquired a significant ownership stake in a venture that competed directly with Alarm.com — Resolution. A different partner, Phil Clough, joined Resolution’s board of directors. The complaint alleged that Terkowitz (the ABS representative on Alarm.com’s board) obtained confidential information during multiple Alarm.com board meetings. Alarm.com alleged that “Terkowitz passed this information along to his partners at ABS in oral or written reports.” Based on ABS’s investment in Resolution and Clough’s service as a Resolution director, Alarm asserted that “ABS must already have misappropriated or inevitably will misappropriate its trade secrets in violation of DUTSA, or in the absence of any trade secrets, has engaged or inevitably will engage in common law misappropriation of Alarm’s confidential information.”
The Chancery Court rejected this claim, noting that “[m]ultiple agreements between the private equity firm and the corporation memorialized that the private equity firm could and would invest in competing businesses.” In particular, the Chancery Court noted the following:
- 2008 Non-disclosure Agreement
In late 2008, the parties entered into a non-disclosure agreement that “established ABS’s confidentiality undertaking and recognized that ABS might invest in a competing business.” The agreement specifically stated that ABS “shall use the Confidential Information solely for the purpose of evaluating the Proposed Transaction [and] that the Confidential Information will be kept confidential . . . Subject to your observance of all the terms of this letter agreement, including the confidentiality obligations, nothing in this letter agreement will prevent you from evaluating a possible investment in . . . a company whose business is similar or competitive.” The NDA expired in 2011.
- The 2009 and 2012 Stockholders Agreements
The 2009 Stockholders Agreement stated that holders of more than 5% of Alarm.com’s equity could have an observer attend board meetings, but that right terminated if the equity holder invested in a competitor entity. That same limitation, however, did not apply to ABS or its representatives.
The 2012 Stockholders Agreement contained a provision in which the “parties agreed to protect information that the Company had identified in writing as being confidential or proprietary.” Moreover, the 2012 Stockholders Agreement permitted ABS to “‘invest in … any other company (whether or not competitive with the Company,)’ as long as they did not ‘disclose or otherwise make use of any proprietary or confidential information of the Company in connection with such activities.’”
- Amended Charter
The Chancery Court found that “the Amended Charter included a provision authorized by Section 122(17) of the Delaware General Corporations Law (“DGCL”) which exempts stockholders such as ABS from any duty not to pursue corporate opportunities that otherwise might arguably belong to Alarm.” The 2012 Stockholders Agreement expired in 2015 when the company went public in an IPO.
- Code of Business Conduct
After its IPO, Alarm.com adopted a Code of Business Conduct that stated that if any member of the Board who is also a partner or an employee of an entity that is a holder of Alarm.com common stock or an entity that managed such an entity (“Fund”) and acquired knowledge of a potential corporate opportunity that may be of interest for both Alarm and the Fund, it would not be deemed a “conflict of interest” under the policy provided that such director has acted reasonably and in good faith with respect to the best interests of the corporation.
The Chancery Court held the complaint failed to state a claim for misappropriation of trade secrets because the parties contemplated the firm would invest in opportunities. Vice Chancellor Laster stated that “[i]n my view, in light of the clear understanding that ABS could invest in competitive businesses, it is not reasonably conceivable that the fact of ABS’s investment in Resolution and the placement of a different ABS representative on the Resolution Board could support an inference of misappropriation. The only reasonably conceivable inference is that the parties contemplated that ABS could do precisely what it did. The complaint fails to state a claim under DUTSA.”
The Chancery Court held that “Alarm and ABS’s shared understanding about ABS’s ability to invest in a competitor dates back to the 2008 NDA . . . The same is true about the 2009 Stockholders Agreement and the 2012 Stockholders Agreement.” The Chancery Court went on to reason that “[c]ementing this understanding is the Amended Charter, which along with the Code of Conduct, remains binding and operative.” The Chancery Court reasoned that under the DUTSA “misappropriation” is defined as “Acquisition of a trade secret of another by a person who knows or has reason to know that the trade secret was acquired by improper means” and that “improper means” includes “theft, bribery, misrepresentation, breach or inducement of a breach of a duty to maintain secrecy, or espionage through electronic or other means.” The Chancery Court concluded that “[t]he only reasonably conceivable inference is that the parties contemplated that ABS could do precisely what it did” and dismissed the DUTSA claim. The Court also dismissed the common law misappropriation claim holding that it was preempted by DUTSA.
On February 7, 2019, the Supreme Court of Delaware affirmed the Chancery Court decision in a one-line Order. The Supreme Court, however, clarified in a footnote its order was limited to the Chancery Court’s decision that the complaint did not plead sufficient facts to state a claim that trade secrets were misused or misappropriated. Alarm.com Holdings, Inc. v. ABS Cap. Partners Inc., 204 A.3d 113 (Del. 2019).
Takeaways & Open Questions
- Future Challenge to Scope of Waiver
Alarm.com left open a challenge in future litigation to a broad, open-ended waiver, as opposed to a knowing waiver based on a specific fact pattern. The Chancery Court specifically noted that “[n]o one has challenged the scope of the waiver, and this decision provides no opportunity to opine on the validity of a broad and general renunciation of corporate opportunities, as contrasted with a more tailored provision addressing a specified business opportunity or a well-defined class or category of business opportunities.”
The Chancery Court’s decision was clear that the dismissal resulted from the fact that the complaint did not plead specific facts concerning misuse of trade secret information; it only pleaded usurpation of a corporate opportunity. In affirming the decision on appeal, the Delaware Supreme Court made clear to limit its holding to such facts. Thus, there is an open question about whether the use of confidential information to engage in a subsequent transaction would create a claim under the Delaware Uniform Trade Secrets Act.
This post is as of the posting date stated above. Sidley Austin LLP assumes no duty to update this post or post about any subsequent developments having a bearing on this post.