In 1928, Justice Cardozo wrote the majority opinion for the Court of Appeals in Meinhard v. Salmon , 249 N.Y. 458, 164 N.E. 545 (1928), and famously described the fiduciary duty owed by one co-venturer to another as “something stricter than the morals of the market place.  Not honesty alone, but the punctilio of an honor most sensitive, is then the standard of behavior.” Justice Cardozo's articulation of the duty of loyalty imposed upon a fiduciary has endured for decades and has been cited in judicial opinions addressing the fiduciary duty owed not just by co-venturers, but in numerous other contexts.  By 2005, Justice Cardozo's opinion in Meinhard had been invoked in more than a thousand published opinions.   See Robert W. Hillman, Closely-Held Firms and the Common Law of Fiduciary Duty: What Explains the Enduring Qualities of a Punctilio? , 41 Tulsa L. Rev. 441, 445 & n.24 (2005). At the heart of the Meinhard opinion is the concept that a fiduciary has a duty of undivided loyalty and, therefore, may not exploit a corporate opportunity for his or her own self-benefit.  In Meinhard , that meant that Salmon, one of the co-venturers, could not usurp a business opportunity presented by the lease of certain real estate that included property in which both he and Meinhard shared a leasehold interest.  The court's equitable remedy was to impose a trust on the entirety of the new leasehold interest obtained by Salmon, making Meinhard an equal owner. Meinhard , 249 N.Y. at 469, 472.

The Evolution of the Duty of Undivided Loyalty

As it has evolved since Meinhard , what constitutes a “corporate opportunity” that may not be diverted by a fiduciary has been accorded a broad, amorphous definition that is, by nature, a fact-intensive inquiry.  Several reported cases require proof that the corporate entity had a “tangible expectancy” of obtaining the opportunity, which is a concept that itself is not readily definable. See, e.g. , Blaustein v. Pan Am. Petroleum & Transport Co. , 293 N.Y. 281, 300, 56 N.E.2d 705, 713-14 (1944).  As explicated by New York courts, the demonstration of a “tangible expectancy” requires more than proof that the opportunity represented an area in which the corporation had an interest or could naturally or easily expand.   See, e.g. , Lee v. Manchester Real Estate & Constr. , LLC , 118 A.D.3d 627, 627-28, 988 N.Y.S.2d 620, 321 (1st Dep't 2014); Alexander & Alexander of N.Y., Inc. v. Fritzen , 147 A.D.2d 241, 247-48, 542 N.Y.S.2d 530, 534 (1st Dep't 1989).  It is an opportunity which “the corporation needs or is seeking, or which they [the corporate directors] are otherwise under a duty to the corporation to acquire for it.”   Burg v. Horn , 380 F.2d 897, 899 (2nd Cir. 1967).  A “corporate opportunity” has also been described as an opportunity that is “necessary” or “essential” to the line of business of the corporation.   See Alexander , 147 A.D.2d at 248.  Once a “corporate opportunity” exists, New York courts have not been receptive to a fiduciary's defense of a usurpation claim based solely on the argument that the corporate entity was financially or legally unable to take advantage of the opportunity.   See id . at 247. In Alexander , for example, the plaintiff company was a property/casualty insurance broker which did not have the required license to sell life insurance policies in New York and, therefore, could not lawfully earn commissions for the sale of life insurance policies.   See id. at 243-46.  The individual defendants, who were employees of the plaintiff, were accused of diverting opportunities to sell life insurance to a competitive corporate venture.   See id.  The defendants sought dismissal of the usurpation claim on grounds including that the plaintiff was legally precluded from taking advantage of the purported diverted opportunity.   See id. at 245-46.  The court rejected that argument as the basis for dismissal since the legal inability could be remedied:

It would be imprudent to hold that employees and corporate officers could exploit opportunities solely on the grounds of the legal inability of a corporation, especially if the claimed inability may be easily eliminated . . . .

See id. at 247. Other courts have held that so long as the duty of loyalty has been breached, it “need not be proved that the corporation would have availed itself of the business opportunity but for the defendant's acts.”   Bankers Tr. Co. v. Bernstein , 169 A.D.2d 400, 401, 563 N.Y.S.2d 821, 822 (1st Dep't 1991).  In Foley v. D'Agostino , 21 A.D.2d 60, 248 N.Y.S.2d 121 (1st Dep't 1964), the First Department held that a viable claim for usurpation existed even when the opportunity was presented first to the corporation, but refused because of its apparent financial inability to exploit it.   See Foley , 21 A.D.2d at 66-68.  The court quoted the following reasoning for its decision:

Despite the corporation's inability or refusal to act it is entitled to the officer's undivided loyalty. If the two are competitive, the corporation, while not entitled to a general freedom from competition, is entitled to freedom from competition by those charged with the promotion of its interests.

Foley , 21 A.D.2d at 68 (quoting Note, Fiduciary Duty of Officers and Directors Not to Compete with the Corporation , 54 Harv. L. Rev . 1191, 1199 (1941)). In Delaware, an oft-cited jurisdiction in New York for its decisions concerning fiduciary issues, the courts have also expansively interpreted the fiduciary duty owed by directors to not pursue their own self-interest.   See, e.g. , Thorpe v. CERBCO, Inc. , 676 A.2d 436, 445 (Del. 1996) (“Once disloyalty has been established, [Delaware law] require[s] that a fiduciary not profit personally from his conduct, and that the beneficiary not be harmed by such conduct.”).

The Recent Delaware Chancery Court Decision

Against the background of jurisprudence relating to the duty of undivided loyalty owed by a fiduciary, the recent decision after trial by Vice Chancellor Montgomery-Reeves in McKenna v. Singer , C.A. No. 11371-VCMR, 2017 WL 3500241, at *1 (Del. Ch. 2017), is particularly striking.  In McKenna , the Delaware Chancery Court dismissed the breach of fiduciary duty and usurpation claims asserted by plaintiffs Thomas McKenna and Garrett McKenna against defendants Daniel Singer and David Singer.   See McKenna , 2017 WL 3500241, at *1.  The Singers were brothers and co-owners of an energy distribution business, Singer Energy Group, LLC.   See id. at *2.  The Singers formed Green Energy Companies with the McKennas with the intent of finding an investor who would provide capital to enable Green Energy Companies to establish a lending platform to finance the conversion of oil burners to gas burners throughout the Northeast, with the conversions being effectuated by Robison Energy, LLC, a subsidiary of the Singers' energy distribution business.   See id. at *1-2.  Ultimately, the investor and co-defendant Westport Capital (“Westport”), declined to invest in Green Energy Companies, but instead formed a venture with the Singers, in which the Singers contributed Robison Energy, LLC, and Westport contributed capital to enable the venture to proceed with financing of conversions from oil to gas.   See id. at *1, *5-6. The McKennas were not partners in the new venture and declined offers of employment.   See id. at *1, *8-9.  Following the formation of the venture between Westport and the Singers, the McKennas brought suit alleging that the Singers usurped an investment opportunity which did not include the McKennas as participants.   See id. at *1.  The primary reason for the court's rejection of the McKennas' claims was the evidence that the plaintiffs had unclean hands at the beginning of the formation of their venture with the Singers.   See id. at *1, *13-15.  The Singers' willingness to partner with the McKennas in pursuit of the venture was based on material misrepresentations made by the McKennas about their qualifications, their ability to raise capital and financing, the lending platform they claimed they previously created, and the underwriting they claimed they performed.   See id. at *1, *13-15.  These misrepresentations included Thomas McKenna's claim that he has previously established a lending platform for an energy company when he had never done so, and Garrett McKenna's claim that he had underwritten millions of dollars of loans when he had never done so .   See id. at *1, *3, *14-15, *21.  Garrett McKenna also represented that his prior employer was a potential investor in the new venture, but failed to disclose that he had been fired by that employer.   See id. at *3, *14-15, *21. Based on this evidence, Vice Chancellor Montgomery-Reeves rejected the McKennas' claims arising from the alleged breach of fiduciary duty since the formation of the venture was the result of their own misrepresentations:

The Singers and the McKennas executed the REF operating agreement and formed Green Energy Companies in part because of the McKennas' misrepresentations.  The Singers had no experience in finance and wanted to partner with experts. The McKennas now seek to enforce the equitable fiduciary duties that attached when they formed REF and Green Energy Companies.  But the doctrine of unclean hands bars that attempt. The McKennas' misrepresentations have an “immediate and necessary” relationship to the formation of REF [and Green Energy Companies] and the McKennas cannot now seek to enforce the fiduciary duties that attached in part because of their misrepresentations.

Id. at *15. Vice Chancellor Montgomery-Reeves also found that, even without unclean hands, the opportunity presented by the investment proposed by Westport was never an opportunity in which the venture created by the McKennas and the Singers had a tangible expectancy because it was a startup with no assets that were of interest to Westport:

The Westport opportunity relied primarily on the Singers' contribution of Robison Energy.  The only Green Energy Companies asset in which Westport and the Singers were interested was the Green Energy Companies name.  In the end, however they decided to pursue the oil-to-gas conversion finance business with a different name to avoid negotiating with the McKennas. As such the Singers and Westport did not take any asset or opportunity in which Green Energy Companies or REF had and interest or expectancy, and none of the Defendants had any duty to reject Westport's investment.

Id. at *18. Vice Chancellor Montgomery-Reeves' decision is the first case this author has come across in New York or Delaware that establishes a defense against a claim of breach of fiduciary duty based on the misrepresentations of the co-venturer at the outset of the relationship.  Simply put, a co-venturer cannot claim corporate usurpation where their own misrepresentations induced their partners to enter into the venture with them in the first instance.

Conclusion

The duty of undivided loyalty eloquently described by Justice Cardozo in Meinhard remains powerful precedent.  But the existence of unclean hands at the outset of a venture properly leaves the co-venturer without an equitable remedy.  Certainly, the duty that fiduciaries owe to each other requires honesty and fair dealing at the outset of the relationship. Moreover, a startup company with no assets is less likely to be able to establish a tangible expectancy in an investment opportunity which requires the contribution of capital. Fred D. Weinstein is a litigation partner at the law firm of Kurzman Eisenberg Corbin and Lever, in White Plains and Manhattan. He was trial counsel for the Singers and Singer Energy Group, in McKenna v. Singer, one of the cases discussed in this article. Jeffrey Peters, an associate at the firm, provided assistance in editing.