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DBCI: Travis Ferguson on Chancery Court’s Equitable Jurisdiction to Compel Transfer of Escrowed Funds

In the August 2, 2017 edition of the Delaware Business Court Insider, LRC associate Travis Ferguson writes on how three recent decisions by Delaware courts have addressed the appropriateness of equitable relief to acquire funds held in escrow post-closing of a transaction in Chancery Court’s Equitable Jurisdiction to Compel Transfer of Escrowed Funds.

Chancery Court’s Equitable Jurisdiction to Compel Transfer of Escrowed Funds

By Travis J. Ferguson

Three recent decisions by Delaware courts have addressed the appropriateness of equitable relief to acquire funds held in escrow post-closing of a transaction. In all three decisions, the Delaware courts (the Court of Chancery twice and the Superior Court once) concluded that the Court of Chancery’s equitable jurisdiction provided the most “certain, prompt, complete, and efficient” relief.  A common thread among these three cases is their reliance on a 2013 transcript ruling in SecNet Holding, LLC v. Potash, C.A. No. 7781-VCP (Del. Ch. Apr. 2, 2013) (TRANSCRIPT).  In SecNet, the Court of Chancery ordered a non-party escrow agent to release $750,000 held in an escrow account, concluding that even if the plaintiff could obtain a judgment for the funds in escrow in a court of law (i.e., damages), the equitable power to enforce that judgment rests with the Court of Chancery (i.e., specific performance).  Therefore, a legal remedy would be inadequate and not as certain, prompt, complete or efficient as an equitable remedy.

In the most recent case relying on SecNet—United BioSource LLC v. Bracket Holding Corp., 2017 Del. Ch. LEXIS 85 (Del. Ch. May 23, 2017)—Chancellor Bouchard held that the Court of Chancery had equitable jurisdiction to hear a breach of contract dispute where a plaintiff sought specific performance compelling the defendant to transfer a tax refund held in escrow.  Chancellor Bouchard set forth the well-established rule that the Court of Chancery obtains equitable jurisdiction only three ways: (1) one or more of the plaintiff’s claims for relief is equitable in character, (2) the plaintiff requests relief that is equitable in nature, or (3) subject matter jurisdiction is conferred by statute.  Toward that end, Chancellor Bouchard noted that the Court of Chancery conducts a “practical analysis of the adequacy of any legal remedy” in an effort to limit the “formulaic ‘open sesame’” claims for equitable relief.

In evaluating the sufficiency of a legal remedy in United BioSource, Chancellor Bouchard found that an order of specific performance compelling the defendant to direct its non-party subsidiary to forward the tax refund it held in escrow to the plaintiff would be a more “certain, prompt, complete, and efficient” remedy than an award of damages at law.  The Court based its finding on the defendant’s inability to demonstrate how the plaintiff could “enforce its judgment as to the sum held” by the escrow agent under a damages award against the defendant because that award would have no legal effect on the separate legal entity escrow agent.

Another example of the Court of Chancery invoking its equitable jurisdiction when presented with a claim seeking specific performance of the terms of an escrow agreement is the East Balt LLC v. East Balt US, LLC, 2015 Del. Ch. LEXIS 150 (Del. Ch. May 28, 2015) decision.  In East Balt, the parties had entered into an asset purchase agreement placing a portion of the purchase price in escrow to indemnify the defendant from potential losses arising post-closing.  A dispute arose concerning distribution of the funds and the plaintiff filed an action in the Court of Chancery.  The defendant moved to dismiss the complaint for lack of subject matter jurisdiction, pursuant to Court of Chancery Rule 12(b)(1), arguing that money damages was an adequate remedy at law.  However, Vice Chancellor Noble held, relying on SecNet and Xlete, Inc. v. Willey, 1977 Del. Ch. LEXIS 196, at *1 (Del. Ch. June 6, 1977), that the Court of Chancery’s equitable powers to specifically enforce escrow agreements provides more “certain, prompt, complete or efficient” relief than an award of damages or declaratory relief issued by the Superior Court. It was explained that “[f]unds are placed in escrow to provide a convenient source of money that may be owed” and this purpose is frustrated if a damages award for those funds requires “enforcement of declaratory relief through a law court’s contempt powers[.]”

The inverse situation arose in Haney v. Blackhawk Network Holdings, Inc., 2017 Del. Super. LEXIS 63 (Del. Super. Feb. 8, 2017) where Judge Davis transferred an action out of the Superior Court’s Complex Commercial Litigation Division to the Court of Chancery so the plaintiff could obtain the more “certain, prompt, complete, and efficient” equitable relief.   In Haney, a dispute arose between the parties that led the escrow agent to withhold disbursement of the funds and resulted in the filing of a declaratory judgment action in Superior Court.  Relying on Vice Chancellor Noble’s decision in East Balt and Vice Chancellor Parson’s decision in SecNet, Judge Davis found that the seller’s complaint sought, in essence, specific performance to compel the escrow agent to transfer the funds.  Issuing declarations as to the parties’ rights regarding the remaining escrowed amounts would not be provide any “certain, prompt, complete, and efficient” relief because the escrow agent was not a party to the action and there was no guarantee that the escrow agent would comply with Judge Davis’ order.  As Judge Davis noted, if the escrow agent did not disburse the funds upon judgment in the plaintiff’s favor, the plaintiff would then need to go to the Court of Chancery to obtain an order requiring the transfer of the escrowed funds.  Accordingly, Judge Davis granted to motion to dismiss for improper venue and transferred the case to the Court of Chancery.

It is quite common to see provisions in purchase agreements calling for funds to be held in escrow for distribution post-closing. When a dispute arises between the parties about the proper allocation or distribution of such escrowed funds, the parties often limit their focus to obtaining an award of money damages.  However, simply seeking money damages may not provide “certain, prompt, complete, and efficient” relief because often the escrow agent is not a party to the action.  The United BioSource, East Balt, and Haney decisions clarify that an equitable mechanism exists to recover money damages via an order specifically enforcing the terms of an escrow agreement to compel the transfer of escrowed funds.  Parties may be well served by expanding their understanding of the issues to incorporate equitable relief—thus invoking the Court of Chancery’s subject matter jurisdiction—to actually recovery the money damages they seek.

Travis J. Ferguson is an associate at Landis Rath & Cobb, where he concentrates on Corporate Litigation, Corporate Bankruptcy and Restructuring, and Bankruptcy Litigation. He can be contacted at 302-467-4412 or at ferguson@lrclaw.com.

Reprinted with permission from the August 2, 2017 issue of the Delaware Business Court Insider. © 2017 ALM Media Properties. Further duplication without permission is prohibited.