Equitable Standing Exception For Derivative Suits Not Applied

In Re AbbVie Inc. Stockholder Derivative Litigation, C.A. No. 9983-VCG (Del. Ch. July 21, 2015). This Court of Chancery decision addresses the rare situation where equitable circumstances will allow an exception to the standing requirement for filing a derivative suit, which otherwise necessitates stock ownership at the time of the challenged transaction, based on Chancery Court Rule 23.1 and DGCL section 327.

The Court reasoned based on the circumstances of this case that the facts did not support an application of that equitable exception to the standing requirement, which was first articulated in the Delaware Chancery opinion of Shaev v. Wyly, 1998 WL 13858 (Del Ch Jan. 6, 1998) aff’d, 719 A.2d 490 (Del. 1998). This might be a somewhat esoteric aspect of corporate litigation but is still an important one for the right set of facts.

Chancery Addresses Dilution Claims

Capella Holding, Inc. v. Anderson, C.A. No. 9809-VCN (Del. Ch. July 8, 2015), is a Delaware Court of Chancery decision that addresses recurring corporate litigation issues that make it a useful addition to the litigator’s toolbox (even as a duplicate), for the businesslike manner in which it treats the perennial fact pattern of a co-founder and former officer/director who was both unceremoniously ousted from the company he brought into the world, and as a parting insult, they diluted his ownership interest. His claims were presented as counterclaims.

  • The only counterclaim that survived the motion to dismiss was whether an executive compensation agreement was breached, to the extent he was not given severance payments based on the company’s argument that he was fired for cause. His agreement (and his fiduciary duties while he was a director) prevented him from disclosing confidential information which he did in a lawsuit filed in Tennessee. The court doubted the strength of the claim but allowed it to survive a motion to dismiss in order to provide an opportunity for discovery on the factual issues.
  • The court treated the dilution claims as direct, instead of derivative, by reading the claims to allege the dilution of voting rights by a controller.
  • The court reasoned that there were insufficient well-pleaded allegations that the price at which the challenged recapitalization took place was unfair, and the court concluded that even if the entire fairness standard applied to the challenge, the allegations of unfairness did not suffice to survive a motion to dismiss.
  • The court’s summary of the claims against the directors and the applicable pleading standard are worth quoting:

    A classic duty of loyalty claim involves self-interested conduct, and a good faith claim (also under the loyalty umbrella) arises “where corporate directors have no conflicting self-interest in a decision, yet engage in misconduct that is more culpable than simple inattention or failure to be informed.” As a general matter, directors are presumed to make business decisions “on an informed basis, in good faith and in the honest belief that the action taken [i]s in the best interests of the company.” Even when entire fairness scrutiny would otherwise seem to apply, a plaintiff must first “make factual allegations in its complaint that, if proved, would establish that the challenged transactions are not entirely fair” to state a claim. (footnotes omitted.)

  • Regarding whether the consideration of documents outside the pleadings converted the motion to dismiss counterclaims into a motion for summary judgment, the issue was avoided because: Delaware Rule of Evidence Rule 201(b) allows the Court to take judicial notice of facts that are “‘capable of accurate and ready determination by resort to sources whose accuracy cannot reasonably be questioned.’”

     

     

Ambiguous Contract Bars Summary Judgment

In Cyber Holding LLC v. CyberCore Holding, Inc., C.A. No. 7369-VCN (Del. Ch. July 8, 2015), the Delaware Court of Chancery provides a useful exercise in contract interpretation regarding whether the buyer or the seller of a business would be responsible for certain post-closing tax liability. After applying the usual standards, the Court of Chancery concludes that there are two reasonable interpretations of the contract at issue, and even though the court is skeptical that a trial will illuminate the lack of clarity, the ambiguity requires a denial of the summary judgment motion.

Chancery Has Jurisdiction to Enjoin Potentially Unconstitutional Statute

chancerysealThe recent Delaware Court of Chancery decision in Doe v. Coupe, C.A. No. 10983-VCP (Del. Ch. July 14, 2015), clarifies the basis for equitable jurisdiction needed in order for the Court of Chancery to hear a claim that the state should be enjoined from enforcing an unconstitutional statute, in connection with a declaratory judgment action. Thus, the court denied a motion to dismiss, even if arguably the Delaware Superior Court might have jurisdiction over some part of the claim.

This ruling is useful for two reasons: (i) it delineates those types of declaratory judgment actions that seek an equitable remedy such that they do not need to be filed in Delaware’s separate court of law, the Superior Court, which is the state’s trial court of general jurisdiction; and (ii) it recognizes that the Court of Chancery can be a forum to address the constitutionality, based on the state constitution, of state statutes, which the state can be enjoined from enforcing if such statutes are found unconstitutional. This decision did not, however, address the merits of the constitutionality issue.

Nonetheless, I view this decision as an invitation for litigants to consider the Court of Chancery, more frequently known for corporate litigation, as an option for certain types of civil rights litigation. See, e.g., Doe v. Wilmington Housing Authority, a recent Delaware Supreme Court decision interpreting Section 20 of Article I of the Delaware Constitution.

See generally, recent Chancery opinion highlighted on these pages that also addressed the types of declaratory judgment actions that may be heard in Chancery, instead of Superior Court, but which reached a different conclusion than the instant case. See 10 Del. C. Section 6501, et seq. (The Declaratory Judgment Act)

Chancery Rejects Two Separate M&A Settlements on Same Day

Two rejections by the Delaware Court of Chancery last week, on the same day, of two separate proposed settlements of two unrelated class actions challenging a merger, were reported by The Chancery Daily, Professor Bainbridge and Alison Frankel of Thomson Reuters. The two cases are Acevedo v. Aeroflex Holding Corp., et al., C. A. No. 9730-VCL transcript (Del. Ch. July 8, 2015), and In Re InterMune Inc. Stockholder Litigation, C.A. No. 10086-VCN (consol.) hearing (Del. Ch. July 8, 2015). In the InterMune case, the court reserved judgment and asked for additional submissions instead of an outright rejection.

The concern expressed by both vice chancellors was that the wide-ranging “intergalactic releases” agreed to by the corporations were given in exchange for what the court viewed as questionable value to the extent the “benefit for the class” was not quite an even quid pro quo, even though the corporations were happy to grant the releases so that the lawsuit could be settled and the deal consummated. The court, however, when asked to approve a settlement, must independently decide that the class is not waiving more claims than it should be waiving in exchange for the benefit that it supposedly is receiving from the settlement.

These two judicial events may signal a sea change to the extent they may be a sign that proposed class action settlements (and the attorneys’ fees that come with them), may not be approved in the same manner as they have been in the past–perhaps as part of a judicial effort to discourage the filing of lawsuits in over 90% of major deals (and the implication that over 90% of major deals don’t suffer from legal infirmity, so many of those suits are likely not the strongest on the merits.)

Much more can be written about the potential significance and ramifications of these rulings in connection with commentary and cases appearing on these pages about the high number of suits filed in connection with mergers, and what the judiciary can do about it. This may be an indication of what the Delaware Court of Chancery can do to regulate this type of corporate litigation. Of course, Delaware wants to discourage so-called junk cases, but as the Aeroflex transcript reveals, it cannot always be determined at the outset of a suit whether the claims will be supported by later discovery. The challenge is not to “throw the baby out with the bathwater”, and discourage meritorious suits as well.

Fraud and Fiduciary Duty Claims Survive Against Seller of Business

In an article for the current issue of the Delaware Business Court Insider, I discussed a recent opinion by the Delaware Court of Chancery that denied a motion to dismiss claims against the seller of a business. Those claims included allegations of fraud and breach of fiduciary duty. The article appears below.

The Delaware Court of Chancery recently allowed claims involving breach of fiduciary duty and fraud against the sellers of a business to survive a motion to dismiss. The business provided non-legal administrative services to law firms and their mortgage lender clients in connection with mortgage foreclosures in a number of Western and Midwestern states. The organizational structure of the businesses was relatively complex and involved overlapping entities. The causes of action were seven in number and the court described the multiple motions to dismiss by the defendants as including a “somewhat dizzying array of arguments and counter-arguments.”

The 61-page opinion in CMS Investment Holdings LLC v. Castle, C.A. No. 9468-VCP (Del. Ch. June 23, 2015), provides an extensive description of the facts. In essence, the claims for breach of the LLC agreement, breach of the implied covenant of good faith and fair dealing, unjust enrichment, breach of fiduciary duty, fraudulent transfer and related claims were based on an alleged scheme to deprive the purchaser of receiving the benefit of its bargain. In particular, the LLC that was created to receive the fees generated for administrative services was not being utilized in the manner intended by the parties. For example, instead of the fees being paid to the LLC, the defendants retained the fees for themselves, leading to the LLC’s default on its debt obligations. Moreover, instead of helping the LLC to restructure, the defendants allegedly ushered it into insolvency and then bought the most valuable assets of the company from the LLC’s receivership, the opinion said.

Several important legal principles and analyses with wide practical application are discussed in this opinion. For example, the court discusses the criteria to determine when a claim should be considered direct or derivative. The court explained that the following questions inform the determination: (1) who suffered the alleged harm (the corporation or the suing stockholders individually); and (2) who would receive the benefit of any recovery or other remedy (the corporation or the stockholders individually). However, courts have long recognized that the same set of facts can give rise to both a direct claim and a derivative claim. In this case, the court found that the claims were at least dual claims that have both direct and derivative aspects, and thus were allowed to proceed on that basis.

The court described the types of fiduciary duty claims that could be derivative in nature and also noted several types of direct claims for infringement of a stockholder’s right that are direct in nature, such as an infringement of the right to vote and the right to enforce contractual restraints on the authority of a board pursuant to the charter, bylaws or provisions of the Delaware General Corporation Law. Compare NAF Holdings LLC v. Li & Fung (Trading) Ltd., 2015 Del. LEXIS 310 (June 24, 2015), a recent Delaware Supreme Court decision that held individual contractual rights are direct and not derivative even if a corporation might be a beneficiary of that contract.

The Chancery opinion in CMS includes a helpful articulation of the implied covenant of good faith and fair dealing, and an explanation of why and how, based on the facts of this case, that claim survived a motion to dismiss. The court emphasized the temporal focus as being critical in the analysis of such a claim. Thus, the court addressed what the parties would have agreed to themselves had they considered the issue in their original bargaining positions at the time of contracting.

The court provided a useful description of an unjust enrichment or quasi-contract claim juxtaposed with a breach of contract claim, and explained how those two claims can be pleaded in the alternative in the same complaint. Based on the facts of this case, the court reasoned that the unjust enrichment claim would proceed in the alternative.

Likewise, the court explained how a breach of a contractually-defined fiduciary duty claim can be pleaded compared to a conventional breach of contract claim. The court emphasized that a cause of action for aiding and abetting can only survive in connection with the former claim.

The court explained that the terms of the LLC agreement in this case did not eliminate all the fiduciary duties that could be eliminated under the LLC Act. The court observed that for those fiduciary duties that were not waived by the LLC agreement, there was a factual issue regarding whether the managerial responsibilities of certain of the individual defendants rose to the level that would impose upon them the default fiduciary duties provided for in the LLC Act.

In allowing a breach of fiduciary duty claim to proceed, and to survive a motion to dismiss, the court noted that there may be some situations where simply resigning from the board, without taking other action, may in some circumstances support a claim for breach of fiduciary duty.

In the concluding section, the court addressed a claim pursuant to the Delaware Uniform Fraudulent Transfers Act and allowed the claim for actual and constructive fraud to proceed pursuant to Sections 1304 and 1305 of the act. The court explained that the underpayment or diversion of fees that were properly payable to the LLC supported a claim that those actions were actually, or reasonably appeared to have been, made intentionally to hinder the interests of the plaintiff as a holder of equity and debt in that LLC, for less than reasonably equivalent value, while the LLC was in financial distress.

The court also emphasized that the DUFTA also allows principles of law and equity to supplement its statutory provisions, which formed an additional basis for the court’s refusal to dismiss those claims.

In sum, this opinion efficiently distills complicated facts and a plethora of claims and defenses involving important principles and statements of Delaware law that have widespread applications.

 

 

Interfacing of DGCL Section 141(e) and the Business Judgment Rule

Professor Stephen Bainbridge, one the nation’s leading corporate law scholars, who is often cited in Delaware opinions, addresses the titular issue in a blog post today, and invites commentary. Specifically, the good professor begins the discussion as follows:

I’m pondering the relationship between the business judgment rule and Section 141(e) of the Delaware General Corporation Law. As I understand it, the business judgment rule is a broader defense than is 141(e). In other words, it is possible for directors to be unable to rely on an expert opinion, thus losing the statutory defense, but still have made a sufficiently informed to get BJR protection. But is the converse true? Imagine a board that was grossly negligent in gather information, but did get expert advice from a properly chosen expert and the board made sufficient inquiry of that expert to satisfy the requirement that they rely in good faith. Would the board be protected by 141(e) even though the business judgment rule would not protect them? Logically, it would seem that the answer must be yes if 141(e) is to have independent role, but the case law I’ve found provides no clear answer. Thoughts?

Chancery Dismisses Claim of Excessive Compensation

thFriedman v. Dolan, C.A. No. 9425-VCN (Del. Ch. June 30, 2015), is a Delaware Court of Chancery decision that should be read by anyone who thinks they should be able to challenge allegedly excessive compensation packages granted to members of a family in a family-controlled company. This ruling granted a motion to dismiss claims related to a quite generous executive compensation package awarded to family members of a family that controlled a publicly traded company. The worth and qualifications of the family members who received the outsized wages were alleged to be have been disproportionate to the amounts they were paid. The court’s reasoning in a 37-page letter ruling was summarized thusly:

compensation decisions are not the expertise of trial judges, and the Court should not second-guess an independent compensation committee’s business decisions that are not irrational. The Court also lacks a principled way to evaluate a director’s decision to accept a position and her performance as a director. Although the amount of compensation and board composition raise some concern, that concern does not justify judicial intervention into that thicket here.

The Court relied on the bedrock Delaware principle that an independent and disinterested compensation committee is entitled to the deference of the business judgment rule. In addition, DGCL section 157(b) supports deference to the board in their valuation of stock options in the absence of fraud.

The Court declined to inquire into the fitness of a director to serve or whether lack of perfect attendance at meetings or less than stellar qualifications were a basis to allow claims to proceed. Predictably, despite the large amount of compensation involved, in part due to evidence of comparable compensation for similarly situated company executives, the claims for waste were also rejected.

Supreme Court Interprets Advance Notice Bylaws

Hill International, Inc. v. Opportunity Partners L.P., , Del. Supr., 305, 2015 (Del. July 2, 2015). This Delaware Supreme Court opinion should be read by anyone interested in the latest iteration of Delaware law on advance notice bylaws. A few bullets points about this decision should help readers decide if they want to read the whole ruling linked above.

  • The original notice of the annual meeting did not provide a precise date; rather, it described the meeting to be held “on or about” June 10.
  • Not until a date certain was made public, were various timetables and deadlines triggered–especially because the actual date certain of June 9 was different than the first date given as “on or about June 10″
  • The Supreme Court based its analysis on contract interpretation principles applied to the applicable provisions of the bylaws, which of course are treated as a contract within the framework of the Delaware General Corporation Law.
  • The procedural posture was an appeal from the Court of Chancery’s grant of a mandatory injunction preventing the company from conducting business at the annual meeting other than adjourning the meeting, which allowed the court to consider more fully the arguments that the company improperly refused to consider nominees for two director positions that the company argued were not timely submitted in accordance with the advance notice bylaws
  • No security was required by the Court of Chancery when the mandatory injunction was imposed and the last footnote of this opinion “dodges” that issue in some respect by finding that the issue was not adequately presented in order for it to be considered on appeal. Nonetheless, in dicta  Delaware’s high court, in a panel decision, observed that, in essence, the Court of Chancery was not in error on that point for reasons explained in the final footnote of the decision.
  • After the June 5 injunction was ordered, based on a complaint and motion for preliminary injunction filed on May 14, the Court of Chancery granted a partial final judgment under Rule 54(b) on June 16, at which time an expedited appeal was filed with the Supreme Court, which held oral argument on July 1. This decision of July 2 affirming the Chancery decision deserves to be exalted as an example of very fast decision making in a formal written opinion, after full briefing, on complicated issues of corporate litigation (by both the Court of Chancery and the Supreme Court.)

Dispute on Advancement of Fees to Corporate Directors; Court Requires Discussion During a Meal

Advancement of fees to corporate directors has been the focus of many decisions of Delaware’s Supreme Court and Court of Chancery that have been highlighted on these pages over the last ten years. Both the statute and the cases that interpret them are often counterintuitive and one of the more vexing aspects of corporate litigation.

The point of this post is to feature a recent Order from the Court of Chancery that presented a novel approach to advancement disputes which one member of the Court referred to as the bane of his existence. Courtesy of The Chancery Daily, a highly respected subscription service that covers every aspect of activity in the Delaware Court of Chancery in an unparalleled manner, we have an Order in the matter of Colaco v. Cavotec Inet US, Inc., C.A. No. 10925-VCL, Order (June 1, 2015), which required counsel to meet and confer over “lunch or dinner” in order to try to resolve any disputes regarding the fees to be advanced. Brilliant idea in my view. That Order also provides for a procedure that the lawyers and parties need to follow to “tee up” and otherwise refine and clarify issues that arise in connection with the amount of fees that are payable.

A major issue that often arises, even when advancement has been ordered, is what fee amounts are payable when work performed may not be easily allocated, for example when some parts of litigation are covered by advancement and some are not.

The Chancery Daily reported today that the Court entered another Order in this case on June 29, 2015, requiring the parties, if they could not agree on the amount of fees to be paid, to follow the procedure outlined in the June 1 Order (including meetings over a meal), and failing that, to submit the dispute over the amount of fees to a Special Master to be suggested by the parties.

In addition to the court rulings that I have outlined on this blog, and the chapter I recently wrote on the topic for a book published by the ABA, last year I presented a PowerPoint on the topic at the American Bar Association’s Business Law Section meeting in Los Angeles, as the Chair of the Indemnification and Advancement Committee.

Supplement: In reply to this post, Kevin LaCroix, author of the highly-regarded and widely-read blog called The D & O Diary, sent me the following anecdote about the value of a “meet and confer over a meal” that a federal judge he clerked for often “ordered” in business disputes before him, which often resulted in a negotiated resolution:

… a lot of things could be worked out if people just talked to each other. I clerked for a federal district court judge after law school, Richard L. Williams in the Eastern District of Virginia, based in Alexandria, Virginia. Whenever he had a business case in his court, he would ask the parties whether the principals had spoken to each other about the case without their lawyers present. Everyone would look stunned and say no. He would then order the principals to go around the corner to Portner’s, a local restaurant, to tell the hostess that they had been sent there by Judge Williams to meet there, and that they required a private room. (The people at Portner’s were very accustomed to this.). The judge would then adjourn the court until after lunch. Nine times out of ten the principals would come back after lunch with big smiles on their faces and with the news that they had managed to settle the case. The lawyers hated it but everyone else, including the principals (and the folks at Portner’s) loved it.