In Parseghian v. Frequency Therapeutics, Inc., the Delaware Court of Chancery dismissed a complaint for failure to state a claim as to Count II, which alleged that defendant Lucchino (the CEO of Frequency Therapeutics) breached his fiduciary duty of loyalty, and for lack of subject matter jurisdiction on the remaining counts. The court found that the plaintiffs’ sole equitable claim for breach of fiduciary duty was predicated on complete conjecture and did not provide a sufficient jurisdictional hook to adjudicate the plaintiffs’ other non-equitable claims under the cleanup doctrine.

The plaintiffs in this action are two trusts, The Gregory J. Parseghian Revocable Trust and The Christine M. Parseghian Revocable Trust (collectively the “Trusts” or “Plaintiffs”). The Trusts claimed to be stockholders of Frequency Therapeutics, Inc. (“Frequency”). Frequency is a biotechnology company focused on developing treatments that activate targeted regenerative cells in the human body.

In 2020, Frequency released positive results from its clinical study aimed at combating age-related hearing loss and announced its plan to press forward with clinical development. Following this announcement, Frequency’s stock price began to steadily climb, prompting the Trusts to decide to sell their shares. However, Frequency’s stock transfer agent (“Computershare”) was hesitant to initiate a necessary share transfer due to inconsistencies that existed between the Trusts’ account details in Computershare’s records and the Trusts’ brokerage account records. These discrepancies caused a six-week delay in the share transfer and, correspondingly, a six-week delay in the Plaintiffs’ ability to sell their stock.

The day before Computershare finally completed the share transfer, Frequency issued a press release announcing that its groundbreaking clinical study actually produced sub-par results. This news caused Frequency’s share price to plummet from $36.29 per share to $7.99 per share in a single day. As a result, the Trusts’ shares decreased roughly $3 million in value. Nonetheless, Computershare completed the stockholders’ requested transfers the very next morning.

Soon after, the Trusts sued Frequency, Frequency’s CEO, and Computershare in the Delaware Court of Chancery. Their sole equitable claim alleged that Frequency’s CEO breached his fiduciary duty of loyalty by taking actions to obstruct the Trusts from selling their shares at a time when “he was personally selling shares,” which served to benefit himself.

On July 19, 2021, Frequency and Lucchino jointly filed a motion to dismiss for failure to state a claim and failure to plead demand futility. On October 6, 2021, Computershare filed a motion to dismiss the counts against it for failure to state a claim. The court explained that Count II, the fiduciary duty claim, “had all the flavor of an insider trading claim” and was factually unsupported. Accordingly, the court dismissed Count II with prejudice for failure to state a claim.

Having dismissed Count II, the court then considered whether it had subject matter jurisdiction over any of Plaintiffs’ remaining claims. The parties conceded Counts IV through VI were legal in nature, but argued that Counts I and III were either equitable in nature or seeking equitable relief – both Plaintiffs and Defendants wanted to litigate in the Court of Chancery.

The court considered in turn whether Counts I and III were equitable in any manner, ultimately finding that neither fit the bill so as to invoke the court’s subject matter jurisdiction. It found Count I to be a “legal claim seeking a legal remedy” because the tort of conversion is typically viewed as a legal claim. To invoke subject matter jurisdiction for conversion in a court of equity, a plaintiff has to demonstrate that the claim involves fiduciary wrongdoing or seeks damages that are difficult to assess or relief that is equitable in nature. The Trusts failed to establish either of these things and therefore could not establish subject matter jurisdiction. The court found Count III had an adequate remedy of law because unjust enrichment is traditionally a legal claim[A1]  and the Trusts sought only money damages under this theory.

The court then declined to exercise its discretion to consider Plaintiffs’ remaining claims under the cleanup doctrine. The cleanup doctrine provides that if any one of a plaintiff’s claims provides an equitable hook for subject matter jurisdiction, then a court of equity may choose to exercise jurisdiction over the other non-equitable, legal claims in that case.

Here, Plaintiffs’ only equitable claim had been dismissed with prejudice. Given that the only equitable claim in the complaint was dismissed at such an early stage of the proceedings, the court found no reason to retain jurisdiction over the remaining legal claims. Instead, the court held that the claims “should be litigated where they belong, in a court of law.” As a result, the remaining legal claims were dismissed for lack of subject matter jurisdiction, subject to the Plaintiffs’ right to transfer the legal claims to Delaware Superior Court under 10 Del. C. § 1902.

This decision reinforces that the cleanup doctrine will not always provide a jurisdictional hook for the assertion of legal claims in the Court of Chancery and that attorneys should look closely to ensure that the equitable claims asserted are supportable before filing suit in the Court of Chancery.

*Holly Habyan, a summer associate at McCarter & English not yet admitted to the bar, contributed to this alert.

[View source.]