Default In Our Stars

The Delaware Court of Chancery explored the consequences of a default by the defendant in a civil action

This case serves as a reminder that although “[y]ou miss 100% of the shots you don’t take[,]”sometimes you miss even when shooting at an open net.

The defendants defaulted after ceasing to participate in this litigation and failing to obey orders of this Court. The operative complaint asked only for “compensatory damages in appropriate amounts to be determined at trial[.]” So, after the default, I held a Rule 55(b) hearing to determine the amount of damages. The plaintiffs submitted a sixty-four-page pre-hearing brief, a set of demonstratives, and nearly 200 evidentiary exhibits. They even hired an expert who submitted a report and testified at the hearing.

What could go wrong? A lot.

The plaintiffs make two critical errors. First, they seek $1.3 million in “rescissory damages” as their primary damages award. In other words, the plaintiffs changed the remedy they sought in the operative complaint from only seeking “compensatory damages” to seeking both compensatory and rescissory damages. Although a court can award relief after trial that is just, equitable, and potentially different from the remedies specified in the complaint, the same is not true after a default. In that context, Court of Chancery Rule 54(c) prohibits an award that is “different in kind” from what the operative pleading requested. Why? Because a defendant might rationally choose to default and accept the remedy sought. That option reduces the burdens of litigation and the need to adjudicate cases. But if the remedy could change, then a defendant who chose to default could be ambushed. I therefore cannot award rescissory damages because the plaintiffs did not seek that relief in the complaint.

Second, the plaintiffs seek as damages the pro rata value of eight corporate opportunities. But the plaintiffs only value the corporate opportunities based on their gross revenue, not their profits.

This would be a novel and unprecedented method of calculating the damages associated with a corporate opportunity, and I reject it. I would have been prepared to award lost profits, but, with one exception, the plaintiffs did not submit any evidence to support that calculation, thereby failing to meet their burden of proof. The one opportunity for which the plaintiffs provided that evidence shows it generated a net loss.

Notwithstanding these blunders, the plaintiffs prove damages arising from the misappropriation of funds and a breach of contract. They also show they are entitled to reasonable attorneys’ fees under a contractual fee-shifting provision.

The parties

Defendant Treats!, LLC (“Treats”) is a Delaware limited liability company that owns and operates Treats! (“Treats! Magazine”). Plaintiffs describe it as a “fine art print and digital magazine”; it seems to specialize in nude or semi-nude photography. Defendant Stephen Shaw was Treats’ sole member and the publisher and editor-in-chief of Treats! Magazine. In March 2012, Shaw transferred his entire member interest to defendant The Westerman Trust U/T/D February 25, 2011 (the “Trust,” together with Treats and Shaw, “Defendants”). Shaw was the Trust’s settlor, trustee, and sole beneficiary.

In August 2012, plaintiffs Tyler and Cameron Winklevoss (together, the “Winklevoss Brothers”) invested in Treats through their investment fund, plaintiff Winklevoss Capital Fund, LLC (“Winklevoss Capital,” together with the Winklevoss Brothers, “Plaintiffs”). Winklevoss Capital purchased 1,310,000 Series A Convertible Preferred Units (approximately 38.24% of Treats’ equity) for $1,310,000 (the “Investment”). The transaction was governed by the Treats!, LLC Series A Preferred Unit Purchase Agreement (the “Purchase Agreement”) between Winklevoss Capital, the Trust, and Treats. Shaw signed for both entities, and he retained the remaining majority member interest through the Trust.

(Mike Frisch)