Delaware Litigation Lawyer & Attorney : Francis G. X. Pileggi : Corporate, Business, Commercial, Delaware Chancery Court

Sutherland v. Sutherland, 2008 WL 1932374 (Del. Ch., May 5, 2008), read opinion here.

[This is one of four opinions issued on May 5 by the Chancery Court, two of which were written by the same vice-chancellor. I hope to post on the other 3 opinions issued on May 5 by tomorrow.]

Factual background details can be obtained from the three prior decisions by the Chancery Court involving these parties, and summarized on this blog here, here and here. This latest opinion in this ongoing internecine Sutherland family squabble denied a motion to dismiss, despite the great weight often given to the recommendation of the Special Litigation Committee (SLC), on which the defendant companies relied for their motion to dismiss. The reason for rejecting the SLC's conclusions: After having considered the briefs, affidavits, limited discovery and arguments of the parties, the Chancery Court reasoned that:

"the special litigation committee [consisting of one man] has not satisfied the court that it acted in good faith and conducted a reasonable investigation."

The opinion also discusses the issue of independence, the third requirement that the SLC needs to satisfy pursuant to the decision in Zapata Corp. v. Maldonado, 430 A.2d 779 (Del. 1981), as well as closely scrutinizing whether the SLC satisfied the other requirements of good faith and reasonable investigation.

One lesson from this opinion that can be learned by "negative example" is how "not to constitute"" an SLC (if one wants to have maximum "protection") , and how "not to conduct an SLC investigation" (if one wants to increase the odds of not  having the court disregard the SLC's conclusions.)

The court noted that the SLC has the burden of establishing its good faith, reasonable investigation and independence, based on Rule 56 standards, although the review has some aspects of a Rule 12(b)(6) motion. The court also referred to the decision in Kaplan v. Wyatt , 484 A.2d 501, (Del. Ch. 1984), that requires the SLC's conclusions to be supported by a "thorough record". The court may also apply its own business judgement to the conclusion of the SLC even if the SLC satisfied all other prerequisites.

A central theme in the complaint was that the directors were allegedly using the company's assets for their own personal benefit via such things as personal use of the corporate jet, lavish personal expenses charged to the company for chartered private railroad cars, private parties, club memberships, expensive hotels, rental cars, and other examples of opulence not required by their position at the company.

I plan to add more details to this short overview tomorrow.

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Prof. Bill Sjostrom on Truth on the Market Blog posts about an article on SSRN that provides an empirical study which concludes that among those LLCs  formed outside the state of their principal place of business, more LLCs choose Delaware to form their LLC in, with suggested reasons why. Good stuff for those interested in why certain jurisdictions are chosen over others for the formation of entities.

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Prof. Bainbridge analyzes here the applicable standard under Delaware corporate law that would apply to the defensive measures taken by Yahoo to spurn the advances of Microsoft. He explains why the case of Blasius v. Atlas Corp. would not apply. Blasius imposes a heightened standard of review when the shareholder franchise is interfered with by the board. Yahoo amended its bylaws in reply to Microsoft's bid so that the date by which nominations for board members had to be submitted was delayed until 10 days after the announcement of the annual meeting (which has not been announced yet.)  Professor B. explains that the Delaware Supreme Court's decision in Stroud v. Grace supports the argument that the standard announced in Delaware Supreme Court opinion in Unocal, and not  the Blasius standard, should apply in the "Microhoo" situation where the primary purpose in any changes that impacted the shareholder franchise was related to a defense to a takeover attempt.

Prof. Ribstein has also provided several insightful posts on the situation, e.g., here.

Although not nearly as scholarly as the good professors, I was quoted here by the San Francisco Chronicle in an article in today's edition that addressed the same issues about the standards that would apply to Yahoo's actions (or inactions).

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The Delaware Chancery Court issued a clarification yesterday to lawyers in order to clarify that passwords for eFilings of pleadings and other submissions with the Court are only to be used by Delaware lawyers and shall not be "lent to" (my words) or shared with non-Delaware lawyers, nor shall non-Delaware lawyers be added to the "electronic service list" through which those who eFile documents with the court are sent notice of eFilings by other lawyers in the case.

Here is  the text of the short admonition that was emailed to Delaware lawyers yesterday. This, of course, is of great practical importance to any lawyer who serves as local counsel for the large number of out-of-state lawyers from around the country who practice in Chancery Court.

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An all-day seminar yesterday at Widener University Law School featured leading members of the judiciary as well as practitioners and academics who proposed changes to Delaware corporate  law on (or about)  the 40th anniversary of the last major overhaul of the Delaware General Corporation Law in 1967 (although minor updates have been made each year since then.)  Unlike most other jurisdictions, Delaware recognizes practitioners and academics from other states as  being well-versed enough about Delaware law that their opinions are respected in terms of their suggestions for changes in our law. Indeed, the last major revision in 1967 of the DGCL was done under the scholarly direction of University of Virginia Law Professor Ernest Folk.

Here is a post I did recently on the current issue of the Delaware Lawyer magazine which contains articles with many suggested changes by several of the panel members at yesterday's seminar.

Here is a list of the topics covered at yesterday's seminar along with the panel members' names and an overview of the purpose of the seminar.

I am attempting to provide a link to the materials because the volume of topics addressed is too much to cover in a blog post, but among the suggestions I though most notable were those made by Ted Mirvis of the Wachtell Lipton firm in New York, who proposed 2 changes to the DGCL as follows (and I am only paraphrasing):

1. All claims related to the DGCL or regarding fiduciary duties, shall be brought in the Delaware Chancery Court; and

2. Rulings regarding the exercise by directors of their fiduciary duties in change of control cases should be contextual only and should not be the subject of a per se rule.

Professor Faith Stevelman Kahn of New York Law School suggested that for policy reasons, a mandatory forum selection clause would not be advisable--even if permissible by applicable law to do so.  Professor Elizabeth Nowicki of Tulane University Law School argued that Section 102(b)(7) should be "gutted" (my word) in order to give directors a negative incentive (or in her words, "fear of punishment") that would scare them into better observance of their duties.

During a luncheon speech, Vice Chancellor Leo Strine, Jr. provided insights during a 40-minute presentation that I cannot do justice to in the short space appropriate to this forum, but one nugget I wrote down in my notes (and this is only a paraphrase that runs the risk of being taken out of context), is his suggestion that even though Congress has the authority to increase their regulation of corporate governance, they should not engage in "selective intervention" into the corporate governance arena while still leaving the hard work to the states of enforcing fiduciary duties on a case-by-case basis.

Many other luminaries offered suggestions about how to change the DGCL to keep up with the global competition in the 21st Century, and I hope to add more details about the symposium later.

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Madison Real Estate Immobilien-Anlagegesellschaft Beschrankt Haftende Kg v. Kanam USA XIX Ltd. Partnership, 2008 WL 1913237 (Del.Ch., May 01, 2008), read opinion here. (Yes, that is the correct spelling of the unusual and long case name.) Before I address the substantive parts of the opinion, allow me three brief introductory comments about this recent Chancery Court decision involving the denial, after trial, of a demand by a limited partner for books and records of a limited partnership. ( This opinion may not have the type of sexy issues that makes headlines like the recent Yahoo and Microsoft dance, but this case provides answers to the type of quotidian issues that most business litigators need to have in their toolbox.)

First, unlike most cases under DGCL Section 220, an added dimension of "books and records demands" involving alternative entities, as in this case, is the separate governing agreement that often provides a separate basis to demand documents--separate from any statutory right. Delaware cases have established that those agreements may appropriately either expand or expressly limit statutory rights to books and records, but here is the burning question for inquiring minds:

If the claim is based entirely on an agreement, and not the statute, must the requesting party still have a "proper purpose" which is a requirement of the statute, even if it is not stated as a prerequisite in the agreement? In this case, the court presented both sides of the argument thusly:

 Here, the Partnership Agreement does not impose a proper purpose requirement on a limited partner's inspection right. Therefore, Madison generally need not state a proper purpose to enforce its contractual inspection right.

However, the Chancery Court in this case goes on to allow that:

Under the “improper purpose defense,” however, a court may deny a partner's request for access to a partnership's records when:

(i) neither the explicit contractual provision in a partnership agreement nor statutory language negate the notion that a partner must have a proper purpose, and (ii) the partner denying another partner access to partnership business records can show that the partner seeking access is doing so for a purpose personal to that partner and adverse to the interests of the partnership considered jointly. FN96
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FN96. Bond Purchase, L.L.C. v. Patriot Tax Credit Props., L.P., 746 A.2d 842, 857 (Del. Ch.1992).

See also footnote 36 and related text in this opinion for the court's reliance on Section 220 cases by analogy in order to determine proper purpose. Accord,  Donald Wolfe and Michael Pittenger, Corporate and Commercial Practice in the Delaware Court of Chancery, at 8-107, Section 8-6[a][2] (2007).

Second, as was mentioned in a recent Chancery opinion here, there are not as many Delaware decisions regarding "books and records demands" involving alternative entities, as compared with those under Section 220 for corporations. Thus, this opinion should be noted for its membership among a relatively sparse population. Professor Larry Ribstein, one of the nation's leading scholars on alternative entities, has written extensively on the topic of "uncorporations" in general and comparisons with the corporate form in particular. See, e.g., here.

Third, it is notable that after a trial and extensive briefing (read: considerable expense), the request for books and records in this case was denied. As has been mentioned on these pages frequently, one should not assume that a request for books and records will be either inexpensive or easy. See generally, Professor Bainbridge's comments here about recent proposed legislation in the U.S. Congress that would require states to make more information publicly available about the ownership of all entities.

 Now, onward to more specifics of this case with apologies if my introductory remarks dwarf my discussion of the details of the opinion. This demand for books and records in this case was based on both Section 17-305 of the Delaware Revised Uniform Limited Partnership Act as well as the terms of the Partnership Agreement itself.

The court relied extensively on two prior cases to address the issue of whether the plaintiff in this case had a "proper purpose" for requesting the documents. Madison Ave. Inv. Partners, LLC v. Am. First Real Estate Inv. Partners, L. P. (Madison I ), 806 A.2d 165 (Del. Ch.2002) and BBC Acquisition Corp. v. Durr-Fillauer Medical, Inc., 623 A.2d 85 (Del. Ch.1992).

One of the issues in this case was whether the primary purpose for the records was to prepare for a tender offer. The court found the BBC case, supra, to be closer to the facts of this case and determinative of the outcome. The plaintiff in this case was an investment vehicle comprised mostly of German nationals who invested in retail real estate, often for the purpose of making tender offers. The prior Chancery Court decision in Madison I, supra, ruled that the simple fact that a limited partner is in the business of making tenders offers, does not , ipso facto, disqualify that party from establishing a proper purpose.

Contrariwise, however, the prior Chancery Court decision in BBC, supra, held that where the primary purpose was not to value one's own current interest, but rather to determine whether to increase an offering price to buy the whole company, and if so, by how much--that primary purpose was not reasonably related to one's interest as a shareholder, and thus, was not a "proper purpose" as is required in order to successfully pursue a books and records claim.

So too, in this case, the court concluded that the evidence demonstrated that the primary purpose for seeking books and records was for the purpose of making a tender offer, which was not a proper purpose, based on the BBC case, supra.

The court also relied on the defenses available at Section 17-305(b) which allows documents to be withheld if they are trade secrets and/or if they are the subject of confidentiality agreements with third-parties (even if, as here, they are oral agreements).

As for the strictly contract claim discussed above, the court determined that the language relied upon was not ambiguous enough to resolve doubts against the drafter, but that the language in the document  providing for "books and accounts" did not include the documents sought by the plaintiff--even if a "proper purpose" requirement was not superimposed on the contract claim.

 In any event, some classic contract interpretation principles were reiterated and warrant quotation:

Limited partnership agreements are contracts the courts construe like any other contract.FN80 Under Delaware law, contract construction is a question of law.FN81 When interpreting a contact, the court strives to determine the parties' shared intent, “looking first at the relevant document, read as a whole, in order to divine that intent.”FN82 As part of that review, the court interprets the words “using their common or ordinary meaning, unless the contract clearly shows that the parties' intent was otherwise.”FN83 If the contractual language is “clear and unambiguous,” the ordinary meaning of the language generally will establish the parties' intent.FN84 A contract is ambiguous, however, when the language “in controversy [is] reasonably or fairly susceptible of different interpretations or may have two or more different meanings.”FN85 Under the doctrine of contra proferentem, ambiguities in a contract will be resolved against the drafter. FN86
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FN80.See Arbor Place, 2002 WL 205681, at *3. The court in Arbor Place cited Elf Atochem N. Am., Inc. v. Jaffari, 727 A .2d 286, 290-91 (Del.1999), for the proposition that: “ ‘The policy of freedom to contract underlies both the [LLC] Act and the LP Act.... The basic approach of the [LLC] Act is to provide members with broad discretion in drafting the Agreement and to furnish default provisions when the members' agreement is silent.’ “ Id.

FN81.Rhone-Poulenc Basic Chems. Co. v. Amer. Motorists Ins. Co., 616 A.2d 1192, 1195 (Del.1992).

FN82.Matulich v. Aegis Comm'ns Group, Inc., 2007 WL 1662667, at *4 (Del. Ch. May 31, 2007) (citing Kaiser Aluminum Corp. v. Matheson, 681 A.2d 392, 395 (Del.1996)); Brandywine River Prop., Inc. v. Maffet, 2007 WL 4327780, at *3 (Del. Ch. Dec. 5, 2007).

FN83.Cove on Herring Creek Homeowners' Ass'n v. Riggs, 2005 WL 1252399, at *1 (Del. Ch. May 19, 2005) (quoting Paxson Commc'ns Corp. v. NBC Universal, Inc., 2005 WL 1038997, at *9 (Del. Ch. Apr. 29, 2005)).

FN84.Brandywine River, 2007 WL 4327780, at *3.

FN85.Rhone-Poulenc, 616 A.2d at 1196. Ambiguity does not exist simply because the parties do not agree on a contract's proper construction. United Rentals, Inc. v. Ram Holdings, Inc., 2007 WL 4496338, at *15 (Del. Ch. Dec. 21, 2007).

FN86.See Twin City Fire Ins. Co. v. Delaware Racing Ass'n, 840 A.2d 624, 630 (Del.2003); Bond Purchase, L.L.C. v. Patriot Tax Credit Props., L.P., 1999 WL 669358, at *3 (Del. Ch. Aug. 16, 1999).

UPDATE: Here is a scholarly analysis of the case and related commentary by Professor Larry Ribstein, one of the leading experts in the country on LLCs and other "uncorporations".

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The Harvard Law School Corporate Governance Blog has graciously added my name to their masthead as a "Guest Contributor", in light of the several prior posts I have written on their blog, as well as one that will appear shortly based on my summary  I posted here of a recent Delaware opinion applying Caremark principles to an officer (as opposed to a director) of a company.

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Weichert Co. of PA v. Young, 2008 WL 1914309 (Del. Ch., May 1, 2008), read opinion here.  In this Chancery Court decision the court reviews objections to a fee application pursuant to a fee shifting provision in an agreement. The pro se defendant lost the argument that he violated his covenant not to compete. Even though the monetary award was only about $7,500, the fee request was about $90,000. The court awarded the whole amount requested, finding it reasonable under the applicable case law (see footnote 7), as well as under Rule 1.5 of the Delaware Lawyers' Rules of Professional Conduct.

 The underlying facts of the case can be found in the court's prior decision that was summarized here.

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Here is the formal policy announced today for public access to administrative records of the Delaware Court of Chancery.

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