The Court of Chancery Prunes Back the Limits of Its Jurisdiction
The Delaware Court of Chancery is one of limited jurisdiction, accessible only when complete relief at law is unavailable. On March 4, 2024, in Graciano v Adobe Healthcare, Inc., Vice Chancellor Glasscock continued a trend from other recent cases toward guarding the limits of the Court of Chancery’s equitable jurisdiction, when he concluded that a claim for release of funds in escrow established through an M&A transaction was not equitable in nature—even though framed as a request for specific performance—because a declaratory judgment was the only judicial action required to afford the Plaintiff relief.
Post-closing disputes are common fodder for Delaware litigation, and Graciano is one such case that arose out of an escrow fund for pandemic-era federal funding. In April 2020, Grane Hospital Care, Inc. received approximately $1.9 million in federal funds under the Coronavirus Aid, Relief, and Economic Security Act—otherwise known as the CARES Act. As a condition to receiving those funds, Grane was obligated under the CARES Act to repay any funds that were not used for COVID-related expenses.
Later that year, Plaintiff and three other individuals sold Grane to Abode Healthcare, Inc. (Abode was subsequently acquired by BrightSpring Health Services, Inc., and both entities were named as Defendants.) As part of the sale, the Sellers agreed to bear the risk that the federal government would seek reimbursement for any CARES funds that had been distributed to Grane. Accordingly, the parties executed an escrow agreement at closing, under which the Sellers placed $1.9 million into an escrow account. These funds were to be distributed in three stages: First, the funds would be used to satisfy any repayment required under the CARES Act; second, any remaining funds would be distributed to the Sellers for amounts spent on pre-closing CARES-eligible expenses; and third, any leftover funds would be distributed to Grane. The government did not seek any repayment but, when it came to the second step, Defendants refused to instruct the escrow agent to distribute any portion of the escrow funds to the Sellers. The Sellers asserted claims in the Court of Chancery for specific performance and breach of the escrow agreement.
Vice Chancellor Glasscock recognized that Plaintiff had framed the complaint as seeking relief, specific performance, that was equitable in nature. He observed, however, “in the hands of an artful pleader,” the equitable relief standard “is plastic; malleable to the extent that, without vigilance on the part of the Court, the legal shrubbery would soon overgrow the limited garden of equity.” He applied what he termed “vigorous jurisdictional topiary” to cut through Plaintiff’s framing of the relief.
As Vice Chancellor Glasscock discussed, the Court of Chancery’s precedent on this issue is conflicting. One line of cases finds that a request for specific performance is facially sufficient. Another line, however, looks past the face of the pleading to determine what relief the plaintiff is actually seeking. In Graciano, the Court of Chancery stood firmly in the second camp, reasoning that—consistent with its “duty to disallow jurisdiction through artful pleading alone”—it must look for “the true nature of the relief required, under the facts asserted in the complaint.”
Using that lens, Vice Chancellor Glasscock concluded that the true nature of the relief requested was the Sellers’ legal right to the escrowed funds. Because the Plaintiff could vindicate this right by a judgment at law, such as a declaration establishing the Sellers’ rights, the Court of Chancery lacked equitable jurisdiction over the claim.
The Delaware Court of Chancery is a desirable forum for many entities seeking to resolve a range of commercial disputes, including post-closing disputes arising from M&A transactions. But, as Graciano made clear, merely requesting some form of equitable remedy may not be enough to access this court, especially when complete relief is available through legal remedies and would render an order of specific performance unnecessary. In framing claims and defenses, potential litigants should take note that the Court of Chancery has shown itself willing to enforce its limited jurisdiction by digging beneath the surface of the pleadings to consider the true nature of the claims and relief being sought.
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.
