Unocal Claim Does not Satisfy Rule 23.1

The Court of Chancery recently issued a thorough opinion explaining why a complaint that pleads a Unocal claim does not, per se, satisfy the pre-suit demand excusal requirements of Rule 23.1.  In Ryan v. Armstrong, Del. Ch., C.A. No. 12717-VCG (Del. Ch., May 15, 2017), the court addressed a claim related to the failed transaction between The Williams Companies (TWC) and Energy Transfer Equity (ETE), L.P., several Delaware decisions about which have been highlighted on these pages.

Brief Background:  The prior Delaware decisions involving TWC highlighted on these pages that addressed the failed transaction between TWC and ETE included issues much different than the one involved in this decision.  In this matter, the court addressed a claim against the directors of TWC in connection with a transaction with an entity that was affiliated with TWC, it allegedly was a transaction designed to make it more difficult for ETE to consummate a deal.  Ultimately, prior to the failed merger, TWC accepted an offer from ETE that was contingent upon the deal with the affiliated company being terminated.  As a result of that termination with the affiliated company, TWC was required to pay a $410 million break-up fee.  The claim in this case was based on the theory that it was a breach of fiduciary duties of the directors of the TWC to enter into a transaction for which they ultimately paid a break-up fee because that terminated transaction was entered into as an unreasonable defensive tactic in violation of the standard described by the Delaware Supreme Court in Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985).

Legal Analysis:  This 46-page opinion carefully examines the applicable Delaware case law and the Vice Chancellor in this opinion ultimately decides that he would not follow several prior Chancery decisions that could be read to support a different conclusion.  The opinion was based on a motion to dismiss for failure to satisfy the pre-suit demand excusal requirements of Court of Chancery Rule 23.1.  The court provided an extensive explanation of the policy underpinnings of Rule 23.1 and the case law interpreting the procedural prerequisites for derivative cases.

Notably, the court explained that this was not a case subject to the so called Corwin doctrine because the facts did not involve a fully informed, non-coerced shareholder vote that invoked the Business Judgment Rule.  Rather, this case involved a defensive measure theoretically designed by the director defendants to prevent a transaction that they initially spurned, but eventually approved, though it nonetheless eventually failed.  This derivative action seeks to recoup on behalf of the company the break-up fee and other monetary damages that allegedly were incurred by the company by the director defendants in connection with an improper defensive measure that they employed.

The primary ground on which the plaintiff argued that Rule 23.1 was satisfied, was because that he plead a viable claim for review under Unocal, and therefore, he argued that the majority of the board could not properly evaluate a pre-suit demand.

The court noted that Unocal claims are generally presented prior to a deal closing and are presented in the context of a request for preliminary injunction.  By contrast, this claim was presented after the deal was terminated, and sought damages only.

Unocal Standard:  The court ultimately did not need to decide whether Unocal applies in a damages-only action.  The court explained that Unocal requires enhanced scrutiny and is primarily a tool for providing equitable relief were defensive measures by directors threatened the right of the stockholders to approve a value-enhancing transaction.  Where the directors cannot show that a defensive measure is reasonable, a plaintiff has satisfied the first prong of the injunctive relief analysis which permits the court to impose injunctive relief to remove an unreasonable impediment to a transaction if irreparable harm and the balance requirement are also satisfied.  In other words, the court explained that enhanced scrutiny under Unocal allows injunctive relief without a showing by the plaintiff that it is probable that a defendant has breached a fiduciary duty.

Key Highlights:  This opinion provides an exemplary explanation of the requirements under Rule 23.1, as well as the interfacing between the articulation of those requirements in the Aronson and Rales cases.

The court explained that the wide deference to director decisions provided by the Business Judgment Rule does not apply in certain situations where directors take measures to fend off a potential acquisition, which raises entrenchment concerns.  The Delaware Supreme Court has explained that enhanced judicial scrutiny under Unocal applies whenever the record reflects that a board took defensive measures “in response to a perceived threat to corporate policy and effectiveness which touches upon issues of control.”  Unocal applies to a preemptive defensive measure even where the corporation was not under immediate attack.  See footnotes 81 to 83 and accompanying text.  The court discusses the progeny of Unocal and the various nuances of a well pleaded Unocal claim.

The court explained that Unocal, like Revlon, is not a “duty” per se – – rather it is a standard of review.  Nonetheless it does not change the fact that a duty of loyalty violation is required to recover damages where a board is protected by an exculpatory charter provision.

The court cited the recent Delaware Supreme Court decision of In re Cornerstone Therapeutics, Inc., Stockholder Litigation, 115 A.3d 1173, 1175 – 76 (Del. 2015), for the proposition that whether Revlon or Unocal or the entire business standard or the Business Judgment Rule applies, a plaintiff seeking only monetary damages must still plead non-exculpated claims against the director who is protected by an exculpatory charter provision to survive a motion to dismiss.

Bottom Line:  The court in this case reasoned that the inference of an entrenchment that arises under Unocal falls short of demonstrating a disabling interest that raises a “substantial likelihood of liability” of directors such that pre-suit demand would be excused as required under Rule 23.1.

Importantly, the author of this decision explained that other decisions from the Court of Chancery that found pleadings invoking Unocal claims sufficient to excuse demand under Rule 23.1 would not be followed in this ruling.  The court explained that the Supreme Court decision in Cornerstone cannot be squared with a per se rule that defendant directors are incapable of evaluating a demand solely because a well plead Unocal claim exists.  The court explained further what is necessary in order for specific pleadings to demonstrate that a majority of directors were motivated by entrenchment, or other non-corporate considerations – – as well as what the Delaware decisions have defined as “a substantial likelihood of liability” such that the director would be disabled from considering a non-exculpated claim to the extent that pre-suit demand would be excused under Rule 23.1.  See footnote 153 and accompanying text.

In conclusion, the Unocal claims did not plead sufficient particularized facts that implied a substantial likelihood of liability for damages arising out of those actions on the part of a majority of the directors.  Therefore, Rule 23.1 pre-suit demand was not excused and the case was dismissed.

Scholarship on Duties of Corporate Officers

Professor Lyman Johnson, whose scholarship on corporate law has been cited in Delaware court opinions, and frequently referred to on these pages, has published a paper on the implications and consequences of the paucity of Delaware case law on the duties of corporate officers–especially when compared to the plethora of case law defining the contours of the fiduciary duties of corporate directors.

This topic was the subject of a post on these pages not long ago, referring to work by Prof. Megan Shaner. This topic was also the subject of prior comprehensive articles by Prof. Johnson, as well as by Prof. Larry Hamermesh and Gil Sparks. See, e.g., Lawrence A. Hamermesh & A. Gilchrist Sparks III, Corporate Officers and the Business Judgment Rule: A Reply to Professor Johnson, 60 Bus. Law. 865-876 (2005). Many of these articles are cited in the new paper linked below from Prof. Johnson.

Prof. Johnson’s paper entitled: Dominance by inaction: Delaware’s long silence on corporate directorswas based on his presentation at a two-day symposium held at UCLA Law School a few months ago, which which was highlighted on these pages. Yours truly was the moderator on the panel at UCLA Law School which also featured, in addition to Prof. Johnson, Dean Gordon Smith of Brigham Young University Law School and Prof. Christine Hurt, also of BYU Law School.
Papers from the two-day symposium will be published as chapters in a book that will be edited by Professor Stephen Bainbridge, who organized the symposium. That book will be titled:  Can Delaware Be Dethroned? Evaluating Delaware’s Dominance of Corporate Law, S. Bainbridge, ed., Cambridge University Press.  An abstract of the paper follows:

With the adoption of Delaware’s general incorporation statute in 1899, and New Jersey’s ill-fated (and short-lived) turn toward a more regulatory approach to corporate law, Delaware triumphed in the corporate chartering business. Delaware’s ascendance in the corporate law market has endured for over a century, notwithstanding state competitors and the looming presence of — and occasional intervention by — the federal government on certain corporate law subjects. Various explanations are provided as to why Delaware continues to dominate, and various assessments have been offered as to whether, overall, Delaware’s corporate law jurisprudence is beneficial or detrimental for investors. These explanations and assessments typically focus on what Delaware has done well over the years to retain its prominence, not on what, deliberately or fortuitously, it has failed to do.

This chapter addresses Delaware’s remarkable silence on a central aspect of corporate governance: the various legal issues associated with executive corporate officers. Unlike the case with corporate directors, where Delaware has resolved a host of issues over many decades, Delaware has yet to provide an answer to certain basic questions pertaining to officers. These include: whether the business judgment rule applies to officers; what the applicable standard of care is for officers; why, if officers are employees and agents of the company and not of shareholders, investors can bring direct actions; the nature and contours of officer disclosure and oversight duties; whether officers may consider noninvestor stakeholders; and whether the Unocal and Revlon standards apply to officers.

This statutory and case law silence, however puzzling and long-running, and whatever its reasons — which are described–has served Delaware well. By not articulating legal rules that some might regard as too lax and others as too severe, but instead saying very little at all, Delaware has allowed the subject of officers to largely be addressed in other ways. These include board of director interactions with officers via ex ante employment agreements and ex post severance arrangements, increased federal regulation and sanctioning of certain officer-related conduct, litigation conducted outside Delaware, but relatively little Delaware litigation that promulgates clear rules. This chapter addresses these various dimensions of Delaware’s sparse law on officers, the reasons for the scarcity, and how silence on such an important subject has contributed, ironically, to Delaware’s historical preeminence. At the same time, Delaware’s eventual resolution of officer-related issues is unlikely to weaken its now long-established hegemony.

Johnson, Lyman, Dominance by Inaction: Delaware’s Long Silence on Corporate Officers (2017). Can Delaware Be Dethroned? Evaluating Delaware’s Dominance of Corporate Law, S. Bainbridge, ed., Cambridge University Press; U of St. Thomas (Minnesota) Legal Studies Research Paper No. 17-09; Washington & Lee Legal Studies Paper Forthcoming. Available at SSRN: https://ssrn.com/abstract=2964033

 

Court Rules That Decision by an Independent Auditor is Not an Arbitration Award

Justin M. Forcier, an associate in the Delaware office of Eckert Seamans, prepared this overview.

A recent Chancery decision provides guidance regarding when the decision by an independent party appointed to resolve post-closing adjustments can be used as an arbitration award that can be turned into a judgment of the court.  Fraud claims in the context of a non-reliance clause are also addressed.  EMSI Acquisition, Inc. v. Contrarian Funds, LLC, et al., C.A. No. 12648-VCS (Del. Ch. May 3, 2017).

Background:  In 2005, Defendants acquired their interests in EMSI Holding Company (“EMSI” or the “Company”) through a non-judicial restructuring in 2005.  After several unsuccessful attempts to sell their interests in EMSI, in 2015, Defendants circulated a Confidential Information Memorandum (“CIM”) to potential buyers.  The CIM contained an optimistic outlook for EMSI despite its historic financial difficulties.

Plaintiff EMSI Acquisition, Inc. (“Plaintiff”) entered negotiations to purchase the Company.  Defendants used the reported EBITDA of $10.2 million for the trailing 12 months, and Plaintiff purchased EMSI from Defendants for $85 million based on that calculation.

However, after the closing, Plaintiff alleges to have discovered that the Company’s projections were greatly overstated and the financials were manipulated to appear more profitable.  Plaintiff asserted two claims against Defendants: (i) that the contractual limits on indemnification in the SPA should be disregarded based on Defendants’ fraudulent representations; and (ii) the findings of an independent auditor should be confirmed by the court as an arbitrator’s award pursuant to the Delaware Arbitration Act.

Court’s Holding:  The court declined dismissal of Plaintiff’s fraud allegation.  The SPA was ambiguously drafted regarding the level of risk Plaintiff assumed in the purchase and it had adequately pled fraud pursuant to Rule 9.

However, the court held that the auditor’s findings could not be confirmed as an arbitration award because that would be contrary to the plain language of the agreement.

Analysis:  First, the court stated that dismissal would only be appropriate for Plaintiff’s fraud claim if the SPA’s risk allocation could only be interpreted one way.  The SPA contained a non-reliance clause that disclaimed any reliance on extra-contractual actions—except in the case of fraud.  However, Defendants pointed to a “notwithstanding clause” that they argued removed the limitations on indemnification for fraudulent actions for extra-contractual actions.  Any fraud within the four corners of the document, Defendants argued, was capped by the non-reliance clause.

Instead, Plaintiff pointed to a competing notwithstanding clause and argued that this more-specific notwithstanding clause that expressly disclaims ‘“all limitations on remedies or recoveries”’ must prevail over the more general notwithstanding clause.  Noting the SPA’s inconsistency, the court concluded that the SPA is ambiguous and dismissal was not appropriate pursuant to Rule 12(b)(6).

Next, the court held that Plaintiff properly pled fraud pursuant to the heightened standard of Rule 9.  Plaintiff was able to plead knowledge of the alleged fraud by providing a chart in the complaint that listed the names and/or titles of each person who made a fraudulent statement, the alleged statement or action by each person or entity, and the dates of those statements or actions.  The court held that since Plaintiff was able to adequately plead knowledge, the rest of the requirements for fraud were easily met.

Nonetheless, the court dismissed Plaintiff’s second claim that the findings by an independent auditor should be confirmed as an arbitration award.  The SPA contained language that said a Settlement Auditor would resolve any disputes regarding the calculation of net working capital.  And although Delaware law favors arbitration, parties cannot be forced to arbitrate the merits of their claims.

The SPA specifically states a Settlement Auditor would be ‘“acting as an expert and not an arbitrator.”’ Therefore, any holdings that confirmed the independent auditor’s findings as an arbitration award would violate the plain language of the SPA, and the court dismissed count II of Plaintiff’s complaint.

Chancery Enforces Advancement Rights of Former Directors

thA recent decision from the Delaware Court of Chancery provides another reminder of the difficulty in defending against a claim for advancement of fees and expenses by former officers and directors. Specifically, the opinion in Davis v. EMSI Holding Company, C.A. No. 12854-VCS (Del. Ch. May 3, 2017), is the latest in a long line of cases that rejects the argument that advancement should be denied because a former officer and director was not sued “by reason of the fact” that he was a former officer and director.  This case is an example of how rarely that requirement for advancement is found lacking. Cf. two recent exceptions to the vast majority of decisions on this point in the Charney and Leiberman cases, highlighted on these pages.

These highlights from the decision in the Davis case are for advanced readers of advancement law in Delaware and will focus on the most distinguishing characteristics of this opinion.  The three failed defenses involved the interpretation of the provisions of a stock purchase agreement (SPA) which had an indemnification clause which it was unsuccessfully argued included a waiver.

Another failed argument was that the claims for advancement were not preserved under the SPA.  Those two fact-specific arguments are somewhat sui generis and not likely to be applicable to many other cases.

But the third and most important failed defense was that the former officers were not entitled to advancement because the claims in the underlying action did not satisfy the prerequisite for advancement that they were brought “by reason of the fact” that the claimants were former officers and directors.

Key Bullet Points Most Applicable to the Majority of Advancement Cases

  • The court explained the limitations of the often misunderstood opinion in Cochran v. Stifel Financial Corp., 2000 WL 1847676 (Del. Ch. Dec. 13, 2000), aff’d in relevant part, 809 A.2d 555 (Del. 2002). In that case, the court concluded that a corporate officer was not entitled to indemnification on a claim that he failed to repay a promissory note because the suit was not brought against the officer in his “official capacity” or by reason of the fact that he was an officer of the company.
  • The court explained that the attempts by the company in this case “to invoke Cochran as a means to avoid its advancement obligation is just the latest example of a corporate defendant attempting to broaden that decision beyond its intended reach and beyond its own rationale.” See footnotes 36 and 37. See also footnote 43.
  • In order for the narrow reasoning in Cochran to apply to defeat an advancement claim, the claim at issue must have “clearly involved a specific and limited contractual obligation without any nexus or causal connection to official duties.” See footnote 66. By contrast, if a claim for breach of fiduciary duty might also be an overlapping breach of an agreement, that will not be a failure of the requisite nexus of “official capacity.”
  • In addition, the court rejected a “hyper-technical” defense based on “undue formalism” to the extent that there was a complete rejection of the advancement claim–when it was initially presented to the company–which would have made the request for a specific amount of fees unproductive. That is, if there is a complete rejection of any acknowledgement to a right for advancement, then it will not be a defense that a specific amount of fees was not requested

Chancery Rejects Derivative Claim Against LLC

A recent Court of Chancery opinion is notable as a reminder that the same requirement of pre-suit demand futility in the corporate context is also required to be satisfied as a prerequisite to asserting a derivative claim in the LLC context. Dietrichson v. Knott, C.A. No. 11965-VCMR (Del. Ch. April 19, 2017).

Background: This matter involved two 50/50 members of an LLC.  One of those members filed claims alleging that an unauthorized salary was taken by the other member and that the other member misappropriated the proceeds of an asset sale.

Key Takeaways

The court explained that the claims regarding improper compensation and misappropriation of company assets were derivative in nature based on the criteria described in the Delaware Supreme Court’s Tooley decision, and that because pre-suit demand futility was not established, the claims were dismissed.  The court also referred to Section 18-1001 of the Delaware LLC Act and Chancery Rule 23.1 for the requirements of pre-suit demand applicable in the LLC context.

The court reasoned that the claims of excessive compensation and dissipation of company assets are inherently derivative, and the facts of this case did not allow them to qualify as “dual-natured.” Only in exceptional circumstances can a claim be both direct and derivative.

In addition to dismissing the claims for failure to satisfy the prerequisites of derivative claims, the court dismissed an unjust enrichment claim based on the well-known principle that when a complaint alleges an express, enforceable contract that controls the parties’ relationship, a claim for unjust enrichment will be dismissed.

Chancery Grants Section 220 Demand

The Court of Chancery issued an important decision a few days ago for those who need to understand the latest nuances of Delaware law involving DGCL Section 220.  Readers of these pages for the last 12 years have seen highlights of a plethora of rulings supporting the view that demands pursuant to Section 220 are not for the faint of heart.  Rumors of the death of Section 220, however, have been greatly exaggerated, in light of the ruling in Rodgers v. Cypress Semiconductor Corporation, C.A. No. 2017-0070-AGB (Del. Ch. April 17, 2017).

Background: A former CEO of the company involved in this case sought books and records to investigate allegedly excessive compensation paid to the executive chairman of the board, and also alleged that the chairman violated the Code of Business Conduct and Ethics of the company.  The company defended the claim based on the argument that the former CEO’s stated purpose was not the true purpose, and that the true purpose for the request was not proper.  The company also denied the Section 220 demand based on the argument that there were no claims for non-exculpated allegations.

Key Takeaways

The most noteworthy aspects of this opinion are the following:

·     The court explained that there remains a very high threshold to establish that the “true improper main purpose” of a demand is something other than the stated primary purpose.

·     The court recited the prerequisites for a demand under Section 220 such as having a proper purpose and having a credible basis for claims to support the purpose to investigate wrongdoing.  In this post-trial opinion, the court found the testimony of the claimant credible that his primary purpose was proper.  Those primary purposes included investigation of wrongdoing such as a conflict of interest in violation of the company’s Code of Business Conduct and Ethics, as well as a desire to communicate with other stockholders and attempt to persuade the board to make changes.

·     The court distinguished the decision of the Delaware Supreme Court in Southeastern Pennsylvania Transportation Authority v. AbbVie, highlighted on these pages.  Specifically, AbbVie stands for the position that when the sole purpose for a Section 220 demand is to investigate wrongdoing of an exculpated claim, a Section 220 demand will be denied.  By contrast, in this matter, derivative litigation to pursue claims of an exculpated nature were not the sole motivation to investigate wrongdoing.  The other proper purposes included communication with stockholders and evaluation of suitability of members of the board to continue to serve.

·     The court rejected the argument that the true purpose of the Section 220 demand in this matter was to pursue a personal vendetta and to assist in an ongoing proxy battle by the claimant.  The court cited to cases finding that it is a high hurdle to prevail on an argument that the primary purpose, contrary to the stated purpose of a claimant, is personal animosity or other improper motives.  See cases cited at footnotes 30 and 31.

·     The court described the importance of a confidentiality agreement to limit the use of the documents obtained, to minimize the risk that the data would be used for the purposes of a proxy contest, although application to the court could be made for seeking approval to use the information for other purposes in the future.

Chancery: Creditor Has No Standing to Sue LLC Derivatively

The Delaware Court of Chancery recently addressed the attempts of a creditor to sue the controlling members of an LLC for breach of fiduciary duty and related claims in connection with allegations that those members deceived the creditor into lending money on false pretenses.  In Trusa v. Nepo, C.A. No. 12071-VCMR (Del. Ch. April 13, 2017), the court determined that the creditor had no standing for such claims – – nor did a power of attorney provide a basis for standing.

Background: The creditor involved in this matter was verbally seduced into making an investment in the LLC and was made to believe that his investments would be secured.  One of the provisions in the loan documents was a power of attorney that allowed for certain default remedies.  After the LLC defaulted on the loans, the creditor learned of various dishonest dealings and misrepresentations regarding the status of the company and what the funds were used for.

Before the Chancery suit was filed, a complaint was filed in the Delaware Superior Court and a default judgment was entered.  This Chancery suit was brought claiming that the managing members breached their fiduciary duties.  The creditor also sought a dissolution of the LLC in addition to asserting fraud and related claims.

Key Legal Principles

The most noteworthy aspect of this decision is the court’s holding that a creditor has no standing to bring derivative claims on behalf of an LLC for breach of fiduciary duty, based primarily on Section 18-1002 of the Delaware LLC Act.  Together with Section 18-1001 of the Act, it remains unambiguous that only members and assignees can assert derivative claims on behalf of an LLC.  Prior opinions by Chancery and the Delaware Supreme Court endorsed the foregoing interpretation of the Act.  See CML V, LLC v. Bax (“Bax I”) 6 A.3d 238 Del. Ch. 2010) aff’d CML V, LLC v. Bax (“Bax II”), 28 A.3d 1037, 1043 (Del. 2011), highlighted on these pages.  See also In Re Carlisle Etcetera LLC, 114 A. 3d 592, 604 (Del. Ch. 2015) (explaining that although they are barred from derivative actions, creditors have adequate remedies at law to protect their interests such as liens on assets. This case also addresses equitable dissolution.)

The court also explained that the creditor’s power of attorney does not and cannot provide standing that is otherwise denied for derivative claims attempted by him.  The court observed that such a contrary argument ignores the fact that the power of attorney is expressly limited to pursuing remedies provided in the loan agreement.

No Standing for Dissolution Either

Regarding the dissolution claims, Section 18-802 of the Act limits a request for dissolution of an LLC to either a member or a manager.  The creditor in this case likewise failed to establish standing for his request for dissolution.  Section 18-203(a) of the Act provides 7 ways that a certificate of cancellation of an LLC may be filed.  The ability to file such a certificate did not help this creditor because only after dissolution and winding up of an LLC may a creditor seek appointment of a trustee or a receiver in connection with a prior dissolution.

Regarding the extreme remedy of “equitable dissolution,” the court found insufficient facts in the record to justify such an exercise of the court’s authority.

Fraud Claim Fails

The court emphasized the truism that: a simple breach of contract cannot be bootstrapped into a fraud claim.  For example, the court quoted from prior case law holding that: “a party’s failure to keep a promise does not prove the promise was false when made, and that the plaintiff did not adduce evidence showing that the defendant intended to renege as of the time it made the promise.”  See footnote 94 (citation omitted). 

The fraud claims also failed to satisfy the particularity requirements of Rule 9(b).

Material Omission

The court found that the claim that a material omission amounted to fraud was not adequately alleged for several reasons.  The court explained that in an arm’s length negotiation: “where no special relationship between the parties exists, a party has no affirmative duty to speak and is under no duty to disclose facts of which he knows the other is ignorant even if he further knows the other, if he knew of them, would regard them as material in determining his course of action in the transaction in question.”  See footnotes 96 and 97. 

The court further reasoned that a fraud claim cannot start from an omission in an arm’s length setting.  Rather, if a party chooses to speak then he cannot lie, and “once the party speaks, it also cannot do so partially or obliquely such that what the party conveys becomes misleading.”  See footnotes 98 and 99. 

Review Standard for Director Compensation Decisions

The important Chancery opinion styled In re Investors Bank Corp. Inc. Stockholder Litigation, Cons. C.A. No. 12327-VCS (Del. Ch. April 5, 2017), could serve as a roadmap for directors who want to know how to structure decisions they make on their own compensation based on stockholder ratification such that it will be subject to the deferential standard of the business judgment rule as opposed to the default standard of entire fairness that would generally apply to an inherently self-dealing transaction such as voting on one’s own compensation.  This 36-page decision is must reading for any director making a decision about their own compensation, and who seeks to have a deferential review standard applied if that decision is challenged.

Chancery Instructs on Best Practice for Motion to Compel and Need to be Forthcoming with Document Production

Alexandra D. Rogin, an Eckert Seamans associate, prepared this overview.

In a recent transcript ruling in the case styled Doctors Pathology Servs., PA v. Gerges, C.A. No. 11457-CB, transcript (Del. Ch. Feb, 15, 2017), Chancellor Bouchard provides additional guidance to attorneys seeking to file motions to compel discovery in the Delaware Court of Chancery.  This ruling should be considered in conjunction with the Court’s opinion last month in the In Re Oxbow case covered here, which discussed key litigation rules in connection with granting a motion to compel discovery responses.

Background: The plaintiff brought suit against a former employee and the employee’s new medical practice for tortious interference and misappropriation of trade secrets. The plaintiff filed a motion to compel and for sanctions regarding the defendants’ discovery responses.  Upon hearing oral argument, the Court detailed the proper content of a motion to compel and noted concerns over the failure to be upfront with document production.

Court’s Analysis: The Court explained that a discovery-related motion to compel should specifically identify the discovery requests at issue by number. In filing the motion with the Court, the moving party should also attach copies of the requests and the opposing party’s responses.  It is not proper to simply attach the parties’ meet and confer correspondence and ask the Court to determine exactly what the problems are without additional explanation.  Instead, the motion itself must identify the discovery requests at issue and explain the grounds for seeking the information.

Despite the Court’s concerns with the content of the motion at issue, Chancellor Bouchard did address the plaintiff’s complaint that documents expected to be in the defendants’ possession were produced by third parties, but not by the defendants. The Court explained that if true, the plaintiff’s allegations suggest that the defendants were not entirely forthcoming with document production.  Withholding discovery until information is revealed by third parties would put the defendant “in a very bad spot when this litigation is concluded.”

If documents expected to be contained in the defendant’s files were not produced until third parties revealed the information, it would “bring[] into question fundamental issues of his credibility.” Thus, counsel was advised to inform the defendant of those potential consequences.

On a related note, the parties were required to be forthcoming with access to documents that had been produced with discovery responses. Passwords should be provided expeditiously to unlock encrypted documents, or those files should be produced in hardcopy format.

The Court also reminded the parties that they are required to abide by their confidentiality agreement in producing documents to potential experts. For many reasons, it would be a bad idea to ask the client to pass on confidential documents to an expert rather than exchange confidential discovery directly between counsel and the expert.

Conclusion: The Court explained that its “bottom line” was that the parties should be forthcoming and cooperative with document production. Without more specific details in the motion to compel, such as the exact deficiencies in enumerated replies, the Court could not provide additional guidance on issues related to interrogatory responses.  Because the motion at issue was missing necessary content, although some concerns could be addressed on oral argument, sanctions were not warranted.

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