Delaware Corporate and Commercial Litigation Blog - Summary & Analysis from Delaware's Supreme Court & Court of Chancery

Rich v. Fuqi International, Inc., C.A. No. 5653-VCG (Del. Ch. June 12, 2013).

Issue Addressed: Should a receiver be appointed to enforce an order to hold an annual shareholders’ meeting pursuant to DGCL section 211? Answer: Yes.

Brief Background: The Court of Chancery previously ordered this company to hold a shareholders’ meeting pursuant to DGCL section 211 but the company did not comply. Some of the prior decisions involving this company were highlighted on these pages here. The court reasoned that the appointment of a receiver to conduct the meeting was less of a burden on shareholders than the imposition of monetary penalties. Despite prior decisions in this and other cases  that rejected as a defense the alleged inability to produce audited financial statements as required by SEC regulations, the company sought unsuccessfully to obtain an injunction in federal court to avoid compliance with the Court of Chancery’s prior order to hold the annual meeting.

This case is one of an increasing number of similar matters that I refer to as the “China series” of Chancery opinions involving Delaware corporations whose operations are based in China, and who appear to struggle with adherence to the formalities and standards that the Delaware General Corporation Law requires.

Johnson v. Smithkline Beecham Corp., 2013 U.S. App. LEXIS 11501 (3d Cir. June 7, 2013).

Issue Addressed: For purposes of diversity jurisdiction, should a holding company’s citizenship be defined by the activities of its limited liability company (LLC) subsidiary given that a holding company’s primary activity is to own and manage, not to operate its assets.

Short Answer: No.  The Circuit Court reaffirmed precedent dictating that the citizenship of a LLC is determined by the citizenship of the LLC’s members, not by the LLC’s activities. The Circuit Court concluded that GSK Holdings’ principal place of business is in Wilmington, DE where its board of directors reaches consensus-based investment resolutions regarding its subsidiary, GSK LLC.

The ‘nerve center’ test endorsed in Hertz Corp. v. Friend, 559 U.S. 77 (2010), dictates that a corporation’s citizenship, for purposes of diversity jurisdiction, requires the identification of the  single place that is the corporation’s actual center of direction, control, and coordination.

Players:

• SmithKline Beecham Corp. – predecessor to GSK LLC. SmithKline Beecham converted from a PA corporation into a Delaware LLC in 2009. Following the conversion, SmithKline Beecham dissolved under PA law. SmithKline Beecham’s sole shareholder is GSK Holdings.

• GSK LLC – large pharmaceutical company responsible for operating the U.S. division of GlaxoSmithKline plc, the British ‘global head’ of the GlaxoSmithKline group of companies formed in 2009.

• GSK Holdings – DE  corporation founded in 1999 that holds GlaxoSmithKline’s plc’s investments in the U.S.

Brief Background:

The Plaintiffs filed a personal injury action against Defendants alleging that the Defendants were aware of the drug’s risks and engaged in an elaborate cover-up to avoid liability. In 2011, Smithkline asserted diversity jurisdiction; in response, Plaintiffs filed a motion arguing that diversity jurisdiction was lacking and removal improper because four of the seven Defendants, plus the Plaintiff Lucier, were Pennsylvania citizens.

Like any other holding company, GSK Holdings’ role is confined to the interest it owns in its subsidiary, GSK LLC. The plaintiffs argued that GSK Holdings conducted its substantive work in Philadelphia and London and that the  board’s meetings in Wilmington, DE were mere ratifications of business decisions made elsewhere. Indeed, the GSK Holdings board received various support services from individuals in both Philadelphia and London. Nonetheless, GSK Holdings insisted that that its reached business decisions only at the board meetings, located in Wilmington.

Case Highlights:

• The Third Circuit reaffirmed the Supreme Court’s determination in Carden v. Arkoma, 494 U.S. 185, 189 (1990) which established that because unincorporated entities are not recognized as legal persons, courts must look to the citizenship of the people or corporations who comprise it to determine if diversity jurisdiction exists. The Third Circuit stressed that such a strict adherence to mechanical rules comports with the Court’s insistence on keeping jurisdictional rules as simple as possible. See *25-27. Thus, SmithKline Beecham’s formal conversion to GSK LLC emphatically changed  the “jurisdictional calculus.” See *41-42.

• The court clarified that the fact that a holding company holds an LLC rather than a corporation, does not in itself complicate the nerve center analysis. The court emphasized that Hertz only requires that it determine GSK Holdings’ center of control, not the center of direction and control for GSK LLC. *40-41.

• The court rejected the Plaintiffs’ ‘delegation theory’ which argued that GSK LLC’s principal place of business is in Philadelphia because GSK Holdings allegedly delegated managerial power to managers in Philadelphia. *35-38. The court explained that adopting the delegation theory would  reverse the Zambelli analysis which every Circuit Court faced with the question of a LLC’s citizenship has applied. See *28-31, citing Zambelli Fireworks Mfg. Co. v. Wood, 592 F.3d 412, 420 (3d Cir. 2010).  The Zambelli analysis establishes that for removal purposes, the citizenship of an LLC “is determined by the citizenship of its members.”

• The court elaborated that the various corporate functions provided from Philadelphia and London were merely intended to inform or facilitate the investment resolutions made by the GSK Holdings board in Wilmington, DE. See *52-53. In so concluding, the court explicitly noted that it was neither carving out a holding-company exception to Hertz nor holding that the location of board meetings will invariably determine a holding company’s citizenship. See *54, ft 21.

Additional Arguments Rejected:

• Platiffs’ fall-back argument in their efforts to defeat diversity jurisdiction was that although SmithKline Beecham converted to GSK LLC and dissolved as a PA entity, PA law preserves its citizenship for diversity jurisdiction purposes. The court accorded that SmithKline Beecham’s dissolution as a Pennsylvania corporation did not, standing alone, destroy its Pennsylvania citizenship. See *61-63. But, that since SmithKline Beecham did not simply dissolve, but also domesticated itself under Delaware law by converting to a DE LLC (GSK LLC),  under DE law, all of SmithKline Beecham’s debts, liabilities and duties laid with GSK LLC. *63-64. Thus, for purposes of establishing diversity jurisdiction, SmithKline Beecham’s Pennsylvania citizenship was moot.

We appreciate the assistance of our summer intern, Stephenie Reimer, in preparing this post.

Israel Discount Bank of New York v. First State Depository Company, LLC, C.A. No. 7237-VCP (Del. Ch. May 29, 2013). Several of the prior Chancery decisions in this case were highlighted on these pages here,  here and here.

Issue Addressed:  Did the defendant depository bank breach the agreement by releasing collateral and interfering with the plaintiff’s consent, inspection, and removal rights?

Short Answer: Yes.

Brief Discussion:  This is a post-trial decision regarding a dispute involving banks and the handling of loan collateral consisting of rare coins and bullion. The Court’s comment in footnote 2 of the opinion on the nature of the dispute sets the tone:

Because this case involves businesses that, by their nature, should keep accurate and up-to-date records, the recitation of facts should be simple. Unfortunately, that is not the case. A major reason is that the central figure in this dispute … is an unscrupulous businessman who used his businesses, [the defendants], to move around assets in the equivalent of a three-card monte scheme to serve Defendants’ ends and without regard to [plaintiff’s] rights.

Plaintiff, Israel Discount Bank of New York (“IDB”) lent money to Republic National Business Credit LLC (“Republic”) as part of a revolving credit agreement. Republic then issued loans to various entities and took an interest in collateral for those loans, IDB, in turn had an interest in the same collateral as a result of IDB’s security interest in Republic’s assets. In 2006, Republic asked IDB to have the collateral transferred to defendant First State Depository  (“FSD”) because FSB offered better pricing.  IDB, Republic and FSB entered into a bailment agreement requiring that, upon receiving written notice from IDB, FSB would refrain from releasing the collateral without the written authorization from IDB.  However, despite adequate notice, FSB, without consulting with IDB, released the collateral to the defendant Certified Assets Management, Inc. (“CAMI”) (CAMI has the same owner as FSB) and a large amount of the collateral was never returned to FSB.

IDB filed suit alleging that FSD breached the bailment agreement by releasing collateral without IDB‘s authorization and refusing to allow IDB to inspect and remove the collateral. IDB also alleged that CAMI converted the collateral by wrongfully exercising dominion and control over it without IDB’s authorization. Defendants counterclaimed and sought a declaratory judgment that, among other things, FSD never sold, traded, or offered to sell or trade its customers’ property.  In addition, the defendants raised a “legion of defenses” that included laches, and the doctrine of election of remedies.

The Court found that FSD breached the bailment agreement by releasing collateral and interfering with IDB’s consent, inspection, and removal rights. The Court found that CAMI improperly converted the collateral when it took possession of the collateral and did not return it.  The Court also found that defendants, among other things, misled the Court and IDB as to the whereabouts and value of the collateral, delayed the litigation and asserted frivolous motions, and advanced multiple theories that had “minimal grounding in fact and law,”  Accordingly, the Court awarded to IDB its attorneys’ fees and expenses under the bad faith exception to the American Rule.

National Industries Group (Holding) v. Carlyle  Investment Management LLC, Del. Supr., No. 596, 2012 (May, 29, 2013).

Issues Addressed: Enforceability of a forum selection clause, and the prerequisites to vacate a judgment under Court of Chancery Rule 60(b)(6).

Brief Background

This case involved a dispute between two sophisticated entities. One was based in Kuwait and one in the U.S. The parties’ forum selection clause required disputes to be litigated exclusively in the courts of Delaware. When the Kuwaiti company sued the U.S. company, Carlyle Investment Management, in Kuwait, Carlyle sued in the Delaware Court of Chancery seeking an injunction to bar the suit in Kuwait. The strange part of this case is that the Kuwaiti company ignored the Delaware proceedings, based on its position that there was no jurisdiction over it, and allowed a default judgment to be entered against it. Then, a year later, the Kuwaiti company tried to have the judgment against it vacated. After it sought to vacate the judgment, it admitted that it was aware of the proceedings in Delaware. Bad strategy.

The Supreme Court upheld the default judgment.  The Court of Chancery opinion was highlighted on these pages at this link.

Key Takeaway: Forum selection clauses in an agreement between sophisticated parties will be upheld in Delaware, as a general principle. Although, there still must be equitable jurisdiction for the Court of Chancery to hear a case, because the parties cannot confer that by contract. Nonetheless, Delaware’s high court found that there was equitable jurisdiction in this matter.

As a practice tip, in order to avoid the issue of equitable jurisdiction, a forum selection clause should allow for any court in Delaware to be the forum for disputes, as compared to naming a particular court. There are many other nuances about a forum selection clause issue in this decision, as well as an exploration of the deep roots on which the court’s reasoning is based, including U.S. Supreme Court opinions. This decision is must reading for those who need to know the latest Delaware law on forum selection clauses.

As an added bonus, Delaware’s high court discusses the requirements for vacating a default judgment under Court of Chancery Rule 60(b)(6). Hint: Not a good idea to ignore the proceedings and then wait a year before seeking to vacate.

Supplement: Frank Reynolds of Thomson Reuters provides helpful commentary about the case at this link.

Norton v. K-Sea Transportation Partners, L.P., Del. Supr., No. 238, 2012 (May 28, 2013). This Delaware Supreme Court decision is the second in consecutive business days that addresses the concept of good faith in the contractual context. See SIGA Technologies, Inc. v. PharmAthene, Inc., highlighted on these pages. (Photo: Supreme Court Building in Dover.)

Issue Addressed: Did provision of LP agreement that provided for the presumption of good faith, bar claims based on an alleged conflict of interest? Short Answer: Yes.

Brief Background

The Court of Chancery’s opinion in this case was highlighted on these pages and provides more background details. This opinion is a relatively short and pithy 28 pages in the slip opinion format and readers interested in this topic should read the whole thing. At this time I will simply provide a bare bones overview. In essence, the context was a merger of K-Sea Transportation Partners L.P. and Kirby Corporation. The LP’s general partner (GP) held incentive distribution rights (IDR) which had value separate from the interests of the common unitholders. With affiliates, the GP controlled the LP.

The plaintiff, Norton, claimed that the GP had a conflict of interest when deciding to approve the merger due to compensation payable to the GP, for the IDR, that was not payable to the other unitholders. A Conflicts Committee hired independent financial and legal advisors, and unanimously recommended the merger to the full board, which also approved it.

Bullet Points from Court’s Legal Analysis

• The high court recited fundamental Delaware contract interpretation principles, such as the following gem: “A meaning inferred from a particular provision cannot control the agreement if that inference conflicts with the agreement’s overall scheme.” See footnote 23 and related text.
• The truism was underscored that the Delaware LLP Act gives maximum effect to the principle of freedom of contract and also allows the parties to expand, restrict or eliminate any fiduciary duties a partner may owe–except that the implied duty of good faith and fair dealing cannot be eliminated from the LP agreement. See Section 17-1101 (a) and (c).
• The court construed the LP agreement to waive all fiduciary duties and replace them with a contractual fiduciary duty which merely required the GP to “reasonably believe that its action is in the best interest of, or not inconsistent with, the best interests of the Partnership.”
• Importantly, the parties did not raise on appeal, and the high court did not address, the discussion by the Court of Chancery about how the presumption of good faith contained in the agreement interfaced with the implied duty of good faith and fair dealing. See footnotes 62 and 67.
• Although the facts supported an inference that the GP “may not have” acted in good faith, and extracted an excessive amount for its IDRs at the expense of the limited partners, section 7.10(b) of the LP agreement provided a “conclusive presumption” that the GP acted in good faith if the GP relies on a competent expert’s opinion as to matters the GP reasonably believes to be within that person’s expertise. The court found that the fairness opinion relied on by the GP satisfied this provision of the agreement.
• If the unitholders were not happy with the terms of the merger, they still had an opportunity to vote against it. Thus, the court explained that their remedy was “the ballot box, not the courthouse”. They should have realized that their remedies were otherwise limited due to the waivers and restrictions in the agreement that bars claims for breach of fiduciary duty that would apply, for example, in the corporate context.
• Delaware’s high court also rejected claims against the board members of the GP, reasoning that there was no cognizable claim against them for causing the GP to take an action that did not breach the GP’s duties under the LP agreement. See footnote 66.