Kitchen-Sink Pleading Will Not Fly In Delaware

Vice Chancellor Glasscock recently affirmed in BV Advisory Partners, LLC v. Quantum Computing Inc., C.A. No. 2022-0719-SG, that more is not always better when it comes to pleading claims.  In ruling on motions to dismiss filed by all defendants, the Court dismissed six Defendants for failure to plead personal jurisdiction under Rule 12(b)(2), and also dismissed eight of ten causes of action pled against the remaining Defendants for failure to state a claim under Rule 12(b)(6).  In each of the Court’s holdings dismissing both Defendants and causes of action (summarized below), the Court identified the various ways in which Plaintiff relied to its detriment on conclusory allegations and impermissible bootstrapping.  This ruling serves as a reminder to litigants that the Court of Chancery is well-equipped to strip down complaints bloated by tangential claims and theories of liability that are not sufficiently supported by alleged facts.

Background.  In 2020, defendant Yuping Huang formed QPhoton to develop quantum computing.  Early in the company’s life, Plaintiff, BV Advisory, LLC, became involved in QPhoton in a variety of ways.  Specifically Plaintiff:  (a) brokered a lease of the QPhoton IP; (b) purchased 10% of QPhoton’s equity pursuant to a stock purchase agreement (the “SPA”); (c) entered a voting agreement with QPhoton and Huang (the “Voting Agreement”), which required Huang to create a three-person board of directors and appoint Plaintiff’s designee, Michael Kotlarz, to the board; and (d) entered a Note Purchase Agreement with QPhoton (the “NPA”), under which Plaintiff purchased US$500,000 worth of notes convertible to equity in QPhoton.  In addition, “two entities allied with Plaintiff’s principals signed a letter of intent (the “October LOI”) with QPhoton, which contemplated investment in QPhoton in exchange for convertible preferred stock.”  Order at 1.

The case before the Court arose out of the May 2022 acquisition of QPhoton by Quantum Computing Inc. (“Quantum”).  At the outset of merger negotiations, Plaintiff negotiated and signed a term sheet on behalf of QPhoton that contemplated a stock-for-stock merger which would leave QPhoton equityholders in the minority and also anticipated a post-merger role and salary for Huang.  When the Plaintiff-led negotiations broke down, Huang took over and also negotiated a post-merger salaried role for himself.  Although the final merger agreement was reached at the same exchange ratio as contemplated in the term sheet, Quantum’s stock was volatile, and the exchange ratio implied a lower value for Quantum than that implied at the time of the term sheet.  Plaintiff contends that Quantum and Huang entered into an “unfair merger transaction that undervalued QPhoton to the detriment of Plaintiff, and that QPhoton breached Plaintiff’s contractual right to accelerate the October LOI ‘Investor Financing’ to acquire 45% of QPhoton’s equity, as promised under the Note Purchase Agreement.”  Order at 19.  Plaintiff threatened litigation and a Special Committee was formed that excluded Plaintiff’s director designee, Kotlarz, which Plaintiff further alleges violated the Voting Agreement.  When the merger closed, the successor entity attempted to redeem Plaintiff’s convertible notes, at face value, plus interest.

Rule 12(b)(2) Holding.  Plaintiff named six executives and/or consultants of Quantum — the acquiror — as defendants (the “Individual Defendants”).  None of the Individual Defendants is a resident of Delaware and each moved to dismiss on the basis that the Court could not exercise personal jurisdiction over them.  The Court agreed, rejecting Plaintiff’s theory of “conspiracy jurisdiction.”  Order at 21-26.  The Court held that the complaint “does not allege any action taken by any Individual Defendant or any of their alleged co-conspirators taken in furtherance of this alleged conspiracy to freeze Plaintiff out of the merger negotiations, in Delaware” (emphasis in original).  Id. at 25.  In a further recognition that Plaintiff’s theory of jurisdiction had stretched beyond the bounds of the law, the Court stated, “[s]ubjecting any of the Individual Defendants to personal jurisdiction based on their unspecified actions as buyer’s agents in the merger would also offend due process.”  Id. at 26.

Rule 12(b)(6) Holding.  Plaintiff asserted ten claims against Quantum, QPhoton, Huang and Xiao Pan (the third QPhoton director).  Although the “central” issue in the litigation is the effect of the merger on the convertible notes purchased under the NPA, no party moved to dismiss the core contract cause of action for breach of the NPA (Count II).  Defendants moved against the other nine causes of action, and the Court dismissed eight out of the nine as follows:

• Breach of the Voting Agreement (Count I): Dismissed.  “Plaintiff cannot succeed on their breach of contract claim for QPhoton’s alleged failure to inform Plaintiff or Kotlarz of the existence of the Special Committee because Plaintiff and Kotlarz were informed prior to the creation of the Special Committee, an act that Kotlarz himself voted against.”  Order at. 29-30.  The Court further held it “is unreasonable to infer that the Special Committee, created after the Merger Agreement was executed, was intended to freeze Plaintiff and Kotlarz out of the merger negotiations” (emphasis in original).  Id at 30.  And, the Court rejected Plaintiff’s argument that the Voting Agreement conveyed to Plaintiff Kotlaz’s right as a director to information or to participate in the merger negotiations.
• Breach of the October LOI (Count III): Dismissed.  Plaintiff was not a party to the October LOI and “there are no non-conclusory allegations in the Complaint that BV Advisory had the authority to exercise rights belonging to the Investors,” nor did Plaintiff adequately allege any assignment of rights (emphasis in original). at 35-36.  In any event, Plaintiff failed to allege any breach of the October LOI because no investor had sought to exercise its rights under the agreement.  Id. at 39.
• Tortious Interference with Contract (Counts IV-VI): Dismissed.  The Court addressed Count V which was alleged against Quantum and director Pan for purportedly interfering with QPhoton’s obligations under the NPA.  The Court found Plaintiff’s theory — that Quantum and Pan collaborated to freeze Plaintiff out of the merger negotiations to strike a deal that would circumvent Plaintiff’s rights under the NPA — entirely conclusory, stating “[a] plain statement that puts the defendant on notice of the claim is sufficient.  But this pleading fails that most basic of thresholds.”  at 42.  The Court further found Plaintiff failed to plead any other theory by which Quantum was a significant factor in causing QPhoton to breach the NPA.  Counts IV and VI were dismissed in light of the failure to plead any other breach of contract.
• Breach of Fiduciary Duty (Count VII): Dismissal Denied.  Plaintiff alleged Huang and Pan breached their fiduciary duties by, among other things, failing to retain professionals to assist QPhoton in the merger negotiations, failing to obtain an independent valuation of QPhoton, failing to obtain a fairness opinion for the merger, and approving the merger.  Plaintiff further contended that the merger was a conflicted transaction that should be reviewed under the entire fairness standard, thereby precluding dismissal.

The Court rejected Plaintiff’s allegation of an interested transaction and chastised Plaintiff for “impermissible bootstrapping” of a breach of fiduciary duty claims to breach of contract claims.  In so holding, the Court found unpersuasive Plaintiff’s allegation that Huang was conflicted by his anticipated post-merger position and salary, stating “[t]o accept Plaintiff’s assertion would require the Court to infer that Huang acted against his own economic interests by leaving tens millions of dollars in merger consideration at the bargaining table in favor of an employment agreement, the value of which is not material in comparison.  Such an inference is unreasonable.”  Id. at 47-48.  Nevertheless, the Court concluded that it “cannot say at the pleadings stage that Huang and Pan were not grossly negligent [in negotiating and approving the merger].  That will require a record.”  Id. at 49.

• Aiding and Abetting Breach of Fiduciary Duty (Count VIII): Dismissed.  “The actual pleading is entirely conclusory — Plaintiff repeats its allegation that the Quantum and its fiduciaries conspired with QPhoton to cause Huang and Pan to breach as fiduciaries, and is once again silent as to the details of the conspiracy.”  at 50.
• Fraudulent Transfer (Count IX): Dismissed.  The Court again found Plaintiff’s claims regarding QPhoton’s insolvency conclusory and that the fact pled did not support a claim under Delaware Uniform Fraudulent Transfer Act.  at 52.
• Unjust Enrichment (Count X): Dismissed. “Plaintiff has either failed to plead an unjust enrichment claim, or is simply recasting a tort or contract claim, against each Defendant.” at 54.

As a result of the Court’s methodical review of each cause of action as to each Defendant, Plaintiff’s case will proceed, but in a substantially narrower and more focused posture than pled.

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.