The Delaware Journal of Corporate Law
of Widener University Delaware Law School
presents the 31st Annual Francis G. Pileggi Distinguished Lecture in Law
Title of Lecture: “Shareholder Activism: the Triumph of Delaware’s Board-Centered Model and the New Role for the Board of Directors”
Presented by: Professor Jeffrey N. Gordon
Richard Paul Richman Professor of Law, Columbia Law School;
Co-Director, Richman Center for Business, Law & Public Policy;
Co-Director, Ira M. Millstein Center for Global Markets and Corporate Ownership; Co-Director, Center for Law and Economic Studies
Friday, October 16, 2015
8:00 a.m. Breakfast; 8:45 a.m. Lecture
Hotel DuPont, Green Room
11th and Market Streets
Wilmington, Delaware 19801
One substantive CLE credit available in DE and PA
Online registration form available at delawarelaw.widener.edu/pileggi2015
For additional information or for accessibility and special needs requests, contact Rose E. Callahan at email@example.com or 302-477-2014.
The Delaware Supreme Court’s opinion in Espinoza v. Dimon, et al., No. 425, 2015 (Del. Sept. 15, 2015), addressed a certified question of corporate law from the United States Court of Appeals for the Second Circuit. Although the Delaware Supreme Court refused to provide a complete answer to the precise question presented, based on factual issues that it could not determine, the court did provide guidance for Delaware corporate litigators generally on the issue of the applicable standard used by the court to review the response by a board of a stockholder demand in order to determine whether the decision of an independent board committee considering that demand should be set aside.
The Delaware Supreme Court explained that:
Delaware law on whether a board considered a stockholder demand in a grossly negligent fashion is settled, and requires that the decision of an independent committee to refuse a demand should only be set aside if particularized facts are pled supporting an inference that the committee, despite being comprised solely of independent directors, breached its duty of loyalty, or breached its duty of care, in the sense of having committed gross negligence. The burden to plead gross negligence is a difficult one, particularly when, as seems to be undisputed here, the independent committee did a time-consuming investigation with the advice of its own advisors, and prepared a detailed written report of its investigation.
The determination of gross negligence is fact-specific under Delaware law, and because there was no adequate factual record presented, and the Supreme Court could not determine those factual issues, it could not provide a case-specific answer to the precise question presented.
In re Riverbed Technology, Inc., Stockholders Litigation, Cons. C.A. No. 10484-VCG (Del. Ch. Sept. 17, 2015). This Delaware Court of Chancery opinion is noteworthy because it provides notice to corporate litigators in Delaware that any future requests for court approval of a class action settlement, or for attorneys’ fees in connection with a class action settlement–in which the benefit is “disclosures only,” will be met with more intense scrutiny than in the past.
This short opinion, relative to other Chancery decisions, deserves a lengthy analysis and no doubt many learned commentators will provide that analysis. Some have already written about its potential for being labeled as a watershed moment or a landmark decision. See, e.g., two articles already written here and here, by respected court watchers, as well as the unparalleled expert insights and analysis provided in The Chancery Daily. For present purposes, I will highlight two or three key points that Court of Chancery observers must be aware of:
The court in this case was hesitant to approve the fee request that it ultimately allowed, but did so based in part on the reliance by the parties on the past practice of the Court of Chancery in which settlements were approved and fees were awarded when the parties negotiated a remedy in good faith that was limited to mere disclosures only. Because the settlement was consummated on that basis with a reasonable expectation that the court would approve terms as it had done in the past, the court reluctantly approved it but also provided a warning for future litigants that there were two major problems that would be subject to further scrutiny in the future that might make it more difficult to obtain court approval in the future in these types of cases.
Litigants are now on notice regarding the following two points: First, the release negotiated in connection with the consideration provided was extremely broad. The breadth of that release has sometimes been referred to in the past as inter-galactic. Footnote 20 observed however, that whether it was inter-galactic or, perhaps merely “solar-systemic, Jovian or just global, it is a broad release of existing claims arising from the merger, known and unknown.” The court was very concerned that the release extended far beyond the necessary scope of the modest claims made in proportion to the release granted. The court noted that many recent Chancery decisions expressed the same concern about overly broad releases. See footnote 21 (listing those recent Chancery decisions).
The court observed that: “The breadth of the release is troubling. It is hubristic to believe that upon this record I can properly evaluate, and dismiss as insubstantial, all potential Federal and State claims. If it were not for the reasonable reliance of the parties on a formerly settled practice in this court, which I have found above, the interests of the Class might merit rejection of a settlement encompassing a release that goes far beyond the claims asserted and the results achieved.” See slip op at 15.
A second notable aspect of this case that also provides notice for future litigants, was the request for attorneys’ fees in the context of what the court referred to as a “peppercorn amount of benefit.”
The court conducted the classic analysis of the prerequisites for seeking approval of attorneys’ fees in connection with the settlement of a class action, and the factors, well known to readers of this blog, the court will consider based on the Sugarland case. The requested fees of $500,000 were discounted to an approved amount of $329,881.61. The court discounted the fee request in “consideration of the modest benefit conferred” albeit after considerable effort. The parties engaged in expedited discovery including two depositions and document requests. Based on a January 15 amended complaint and a motion to expedite filed on Feb. 15, the parties reached an agreement on Feb. 26 in principle.
The court provided thoughtful reasoning in connection with the public policy considerations and the “near-ubiquity” of litigation in connection with public company mergers. See footnote 29. It remains safe to say, based on this decision, that fee requests in connection with settlements of class actions when the benefit is mere additional disclosure will be subject to more increased scrutiny in the future – – which will likely to result in reduced, if any fee awards, depending on the circumstances, at least for requests presented to the author of this opinion.
Courtesy of Frank Reynolds of Thomson Reuters, we have highlights of the American Conference Institute’s two-day D&O Liability Insurance conference, that addresses recent developments in corporate litigation, including Delaware court decisions, that have an impact on the insurance industry. An excerpt from Frank’s article, hyperlinked above, should be of interest:
Corporate and insurance law specialists have long paid close attention to litigation and legislative developments in Delaware, where two-thirds of the nation’s Fortune 500 companies are incorporated and most shareholder legal battles are fought.
A recent Delaware Chancery Court ruling held Dole Foods CEO David Murdock and his general counsel personally liable for $148 million for conspiring to cheat the shareholders in a buyout — even though the company’s directors followed the rules for negotiating a fair deal. In re Dole Food Co. Stockholder Litig.; In re Appraisal of Dole Food Co., Nos. 8703 and 9079, 2015 WL 5052214 (Del. Ch. Aug. 27, 2015).
In a rare denial of a claim for advancement, the Delaware Court of Chancery in the opinion styled Charney v. American Apparel, Inc., C.A. No. 11098-CB (Del. Ch., Sept. 11, 2015), rejected the claims by a former chairman and CEO (and founder), based on the provisions for advancement in the company’s charter and in an indemnification agreement.
Why this Case is Noteworthy
Although generally speaking it has been rare, at least in the past few years, for a Chancery decision to deny a claim for advancement, this is the second decision in as many weeks that has denied such a claim. In the decision last week, highlighted on these pages here, another unrelated Chancery decision also denied an advancement claim that arose after the term of office of the former officer had been terminated. [The Chancery Daily, an exemplary publication that tracks Chancery cases in more detail than any other, also grappled with a description of what would otherwise be a rare event, compared with cases over the last few years–except for the occurrence twice in two weeks.]
This opinion involves a familiar fact pattern that includes a founder and former CEO/chairman who is forced out of the company, and then seeks advancement. The claims in this case arose after the term of the CEO had ended. Similar to claims for advancement that have been denied in other cases based on a dispute regarding the former officer’s employment agreement, this dispute arose out of a separate agreement that addressed conduct occurring after the position of the former director and CEO had ended.
The highlights of this decision that would be applicable to the widest range of readers interested in this type of corporate litigation, include the following: First, in order to understand this decision, a few key facts need to be considered. The specific provisions interpreted by the court in this case included different criteria for benefits afforded to current as opposed to former directors and officers. Moreover, the coverage provided to former directors and officers was not coterminous with the advancement provisions that apply to current directors and officers. Whether or not that was a drafting error or an intentional exclusion, it was nonetheless fatal to the claim by the former founder and CEO/chairman in this case.
The foregoing interpretation was buttressed by the terms of DGCL § 145(e) which also makes an important distinction between current and former officers, and allows a corporation more latitude to provide advancement to current officers, but allows more conditions to be imposed on the benefit granted to former directors and officers. See Slip op. at 14-16.
DGCL § 145(f) allows a separate agreement to be the basis for advancement but nonetheless, the indemnification agreement and the provisions of advancement in this case failed to provide coverage for advancement.
The court conducted an extensive discussion of the condition that the suit against the officer be filed “by reason of the fact” of his official position, and found that the claimant might otherwise satisfy that prerequisite, but based on the facts of this case the court found that the claims arose after the term of the plaintiff as an officer and director had concluded. See footnote 42.
Key Takeaway: As noted in the Chancery decision of Sept. 5, 2015, highlighted on these pages and linked above, the following important principle in this case needs to be remembered for those interested in this aspect of Delaware corporate law: notwithstanding the allowance under DGCL § 145(f) for contract-based advancement rights, the advancement right granted in that contract will be limited by the requirement that it not exceed the boundaries of–and that it satisfy the minimum standards imposed by–DGCL § 145(a) and § 145(b).
In Carlyle Investment L.L.C. v. Moonmouth Company S.A., C.A. No. 7841-VCP (Del. Ch. Sept. 10, 2015), the Delaware Court of Chancery grants the rare motion to strike a part of the complaint that the court considers scandalous or impertinent pursuant to Court of Chancery Rule 12(f). See Slip op. at 45-46.
In addition, the court addresses other topics of interest to corporate and commercial litigators:
- comparison of the concepts of collateral estoppel; stare decisis and “law of the case”.
- whether claims made in the complaint were in violation of a prior release, and if non-signatories of the release were bound in light of being affiliated with signatories.
- one of the documents called for the application of English law, but the parties did not provide sufficient citation to controlling English authority, so the court applied Delaware law.
- the court also addressed issues of Dutch law and New York law, in particular the impact on contract interpretation under New York law of punctuation and grammar rules
The Court of Chancery recently reiterated its expectations of Delaware discovery conduct at a hearing in Medicalgorithmics S.A. v. AMI Monitoring, Inc., C.A. No. 10948-CB (Transcript). Notable among the Court’s comments at the hearing were:
- The Court stressed the importance of attorney review of documents before production, saying that, absent a “quick-peek” agreement, attorney involvement should be the default. The sampling and filtering techniques employed in lieu of attorney review were insufficient. The Court indicated that, in this situation, where an expedited schedule was agreed to by the parties, rather than required by the Court, the parties should have approached the Court and requested that discovery deadlines be modified once they realized that it was not feasible to properly review documents to ensure they were relevant and non-privileged before production.
- When relying on references to documents as a response to an interrogatory under Court of Chancery Rule 33(d), the answering party must either refer to specific Bates numbers or provide a narrative response. It is not sufficient to state that the documents in which the information is contained have been produced and force the other side to locate them.
- A new, Delaware-compliant privilege log was ordered to be produced to replace a log that did not contain the appropriate categories of information, although it declined to deem the privilege waived as to those documents that were improperly listed.
- The Court reiterated the default rule that plaintiffs who file suit in Delaware should be made available for deposition in Delaware, absent agreement to the contrary.
The Court acknowledged this to be one of the occasions on which an award of costs, including attorneys’ fees, associated with bringing the motion was warranted.
The Court of Chancery rejected a request for post-trial intervention under Court of Chancery Rule 24, in the matter styled Shawe v. Elting, et al., C.A. No. 9686-CB (Del. Ch. Sept. 2, 2105). Rule 24 is a useful rule to be familiar with for corporate and commercial litigation in general.
This is the third decision in this case in about as many weeks. The prior two decisions were highlighted on these pages here. [The post-trial opinion is being appealed to the Delaware Supreme Court.] The court applied federal cases interpreting the federal counterpart to Delaware Court of Chancery Rule 24, and the four factor test used by the federal courts. This decision was somewhat predictable in that the request for intervention was made over a week after a 104-page post-trial opinion was issued in a matter involving several consolidated cases.
The decision observes that the party seeking intervention in this case, after trial, had counsel who attended pre-trial court proceedings and the trial of the matter. The proposed intervenor had a one percent interest in the company that was owned 49% by her son. The other 50% was owned by a third party. A key point made by the court was that the proposed intervenor knew for a very long time that the derivative claims were subject to a defense of unclean hands and acquiescence for actions taken, or not taken, by her son. If she had an argument to make about those defenses, she should have made them more promptly. Motion to Intervene denied.
In the recent Chancery decision of Lieberman v. Electrolytic Ozone, Inc., C.A. No. 10152-VCN (Del. Ch. Aug. 31, 2015), the court rejected claims for advancement by former officers and directors who sought to have their former company pay for the attorneys’ fees they incurred in defending a suit brought against them by the company for whom they served as corporate officers. This Delaware opinion is noteworthy for two main reasons. I highlight the following two points based on my perspective as the author of an annually updated chapter in a book published by the ABA that provides an annual review of the key decisions from Delaware and around the country on the topic of advancement and indemnification of directors and officers.
First, it remains rare, in general, for claims for advancement to be rejected by Delaware courts, especially based on a failure to satisfy the prerequisite of DGCL Section 145 that the actions for which the former directors or officers are being sued is “by reason of the fact” of their position as a former director. Regardless of what an “ordinary” meaning of that phrase might suggest, the reality is that prevailing case law interprets that phrase to mean “almost anything”, in my view, but this case is an exception from the norm. And it is an exception that other Delaware decisions have recognized when the dispute is based on an employment contract–though the distinction between an employment dispute and a claim asserted “by reason of the fact” that the defendant was a corporate officer or director is not always “black and white”.
Second, as a matter of public policy, statute and case law, this decision makes clear that a provision in a contract is not enforceable if it purports to allow a former director or officer to have her attorneys’ fees paid in connection with a lawsuit–even if she is not successful in the claims she makes in the lawsuit. In this case, the court refused to enforce a provision in the parties’ agreement that provided that the company was required to pay for attorneys’ fees in any suit seeking advancement–even if the claimant lost–as long as the claims were made in good faith. Not so, according to this Delaware opinion, addressing this important nuance of corporate and commercial litigation. See footnote 48-49 and accompanying text.
- A few important facts that may distinguish this case from many other advancement cases, include: (i) the focus of the conduct of the former director and officer was a period of time after their employment was terminated; (ii) the claims were based on an alleged breach of their employment agreement that prohibited disclosure of certain proprietary information and also had a non-compete provision.
- A key fact that may distinguish this case from many others, is that the claims that the former officers were defending were held to be “confined to post-termination actions and do not depend on Plaintiffs’ use of corporate authority or position”. See footnote 42. This conclusion was not impacted by what claims the former company “could have” but did not assert, based on the same facts.
- The decision rejected an argument that if the current employers were providing advancement, the former officers did not have “standing” to seek advancement from their former employer. But the court noted at footnote 17 that Delaware case law has recognized the ability of a party to seek advancement from more than one source when one obligor has refused to honor its obligations.
- A discussion of prior Delaware cases in the opinion addresses the requirement that the claims for which advancement is sought be brought “by reason of the fact” that the plaintiffs were former directors or officers. See footnotes 18-22 and accompanying test. Regardless of those discussions and the “test” for that prerequisite, it remains rare that a company can successfully argue that the test is not met. This case serves as a rare exception to that observation.
- The opinion distinguished a case at footnote 38, which held that when a former officer was charged with wrongfully retaining proprietary information while he was still employed, and allegedly conspired to breach his fiduciary duties while he was an officer, unlike the current case, those facts satisfied the “by reason of the fact” test. See also footnote 25-28 and accompanying text.
The Delaware Court of Chancery in Kerbawy v. McDonnell, C.A. No. 10769-VCP (Del. Ch. Aug. 18, 2015), addresses whether written consents of stockholders were effective in replacing the board members of the company involved. The case features the interplay between DGCL § 225 and § 228 in this corporate litigation over control of the company. DGCL § 228 is the provision that allows written consent of stockholders in lieu of a meeting and without prior notice to the minority stockholders. DGCL § 225 is the provision that allows for summary proceedings on an expedited basis to determine who the proper directors of a company are, for example, when there is a dispute about the results of an election or, as in this case, the validity of written consents of stockholders purporting to remove directors or elect directors, or both.
This case provides a playbook of sorts on how to take control of a board via written consents.
Highlights from 59-page Post-Trial Decision
DGCL § 228(a), unless otherwise provided in the Certificate of Incorporation, allows stockholders to take action by written consent that might otherwise be taken at an annual or special meeting of stockholders. The written consent is effective “without a meeting, without prior notice and without a vote.” The written consents must be signed and bear the date of signature of each stockholder who signs the consent. Action by written consent is effective only if the required number of consents are delivered within 60 days of the earliest date of consent. See § 228(c).
The court observed that when a majority of stockholders have executed written consents to remove a board, the burden of proving that a director should not be removed or that an election is invalid, rests with the party challenging its validity. This is a heavy burden, especially in light of “the importance Delaware law places on protecting the stockholder franchise, which has been characterized as the idealogical underpinning upon which the legitimacy of the director’s managerial power rests.” See footnote 115.
The parties did not dispute the validity of the consents on technical grounds, but rather the argument was made that the court should set aside the otherwise valid consents on equitable grounds, based on allegations that: (1) the consents were based on misleading disclosures; (2) they were based on the misuse of confidential information; and (3) they were procured by tortious interference with an applicable agreement.
- The court emphasized that a minority stockholder does not owe a fiduciary duty in general nor a duty of disclosure in particular.
- Although directors of Delaware corporations have a duty to disclose fully and fairly all material information within the board’s control when seeking shareholder action, a party who is neither a director nor an officer, controlling stockholder or member of the control group has no such obligation. The court distinguished cases cited at footnote 118 where equitable relief was available for failure to disclose material facts in soliciting consents.
- The court explained that: “Just as Delaware law does not require directors-to-be to comply with fiduciary duties, former directors owe no fiduciary duties.” See footnote 127 (discussing the theoretical basis of the duty of disclosure).
- But, if the written consents were procured by misleading disclosures, as opposed to the absence of any required disclosure, that fact could support an equitable claim to set those consents aside. One takeaway that a skeptic might extract from this opinion is that consent solicitations might more easily be performed by a person without a fiduciary duty.
- The court describes the limited scope of a § 225 action and the limited relief available in such an action in light of its status as an in rem proceeding. See footnotes 148 through 149.
- The court found that the sharing of confidential information that the fiduciary should have not shared was not ideal, but no harm was shown from the sharing of that information such that it would impact the analysis to set aside the written consents on an equitable basis.
- DGCL § 228 enables stockholders to act independently of the board, and allows them to act without prior notice, and without discussion. By definition, that allows for a “secret compilation of consents” which might otherwise surprise the board when the board members learn of it.
- In sum, there was no breach of fiduciary duty, fraud or other wrongdoing that “so inequitably tainted the election” for the court to intervene.