Courtesy of a friendly email from Professor Larry Hamermesh, one of Delaware’s favorite corporate law professors, who is also a former Delaware corporate litigator, we have the good professor’s latest scholarship on cutting edge issues regarding Delaware corporate litigation. His latest article, co-authored by Professor Michael L. Wachter, is entitled The Importance of Being Dismissive: The Efficiency Role of Pleading Stage Evaluation of Shareholder Litigation. The abstract of the article follows:
Abstract:It has been claimed that the risk/reward dynamics of shareholder litigation have encouraged quick settlements with substantial attorneys’ fee awards but no payment to shareholders, regardless of the merits of the case. Fee-shifting charter and bylaw provisions may be too blunt a tool to control agency costs associated with excessive shareholder litigation, and are in any event now prohibited by Delaware statute. We claim, however, that active judicial supervision of public company shareholder litigation at an early stage reduces the costs of frivolous litigation to shareholders by separating meritorious from unmeritorious litigation before the full costs of discovery are incurred. Using procedures and doctrines that have not previously been catalogued and appreciated as a coherent set of interrelated dynamics, the Delaware Court of Chancery has relied on the motion to dismiss as the primary procedural vehicle for accomplishing that early stage triage. Such early stage analysis depends upon consideration of essentially undisputed facts, and upon the availability of such facts to the plaintiff shareholder through sources that compensate for the problem of asymmetric access to relevant information. The motion to dismiss in representative shareholder litigation has thus come to resemble, and substitute for, the motion for summary judgment. The Delaware courts’ atypical demand for, and unusual willingness to consider, extensive facts in resolving motions to dismiss encourage defendants to supply relevant information voluntarily, on a cost efficient basis that avoids largely unlimited discovery. Where time constraints preclude disposition via a motion to dismiss, the motion for expedited discovery must necessarily come to serve the same efficiency promoting functions as the motion to dismiss, and the Court of Chancery has come to apply essentially the same level of substantive factual review of the merits encountered in resolving motions to dismiss. The result is a system in which cases are dismissed or settle at the motion to dismiss stage: from 2011 through 2014, for example, there were only four public company shareholder class or derivative suits in which the Court of Chancery resolved the case after trial. With the likely concentration of deal litigation in the Delaware courts resulting from increasingly prevalent exclusive forum charter and bylaw provisions, the motion to dismiss and the motion to expedite discovery are likely to become even more important in promoting the efficient conduct of shareholder class and derivative litigation involving public companies.
The Delaware Court of Chancery recently imposed penalties on a non-Delaware attorney for behavior during a deposition that was not in compliance with the applicable Delaware deposition standards. The letter decision in the matter styled In Re: Shawe & Elting LLC, C.A. No. 9661-CB (Del. Ch. Aug. 14, 2015), provides helpful guidance on the types of obstructionist conduct during a deposition that can be the subject of penalties imposed by the court.
Although such behavior during a deposition may be common in some fora, and in my experience is not often penalized even in Delaware, this ruling provides specific guidelines that can be used by those who have the time, money and inclination to seek enforcement of the rules against those who obstruct depositions or interfere with the questioning during a deposition by both subtle and not-so-subtle “cues” to the deponent, such as speaking objections, “questions to the defending attorney”, and the “nuclear option”–instructing the deponent not to answer a question.
Highlights of this useful ruling include the court’s reliance on the following rules:
- Court of Chancery Rule 30(d)(1) only condones an instruction to a deponent not to answer a question in three instances: (i) to preserve a privilege; (ii) to enforce a limitation on evidence based on an existing direction by the court; or (iii) to present a motion under Rule 30 (d)(3)[e.g., to seek a protective order].
- Rule 30(d)(2) provides that: “if the court finds … conduct that has frustrated the fair examination of the deponent, it may impose upon the persons responsible an appropriate sanction, including the reasonable costs and attorney’s fees incurred by any party as a result thereof.”
We have previously included on these pages materials that can be used by those who are interested in the standards applicable to depositions in Delaware cases–even when those depositions are taken outside of Delaware, or when they are taken or defended by non-Delaware attorneys, as in this matter, admitted pro hac vice. See, e.g., here and here. In corporate litigation, it remains common for out-of-state attorneys to be admitted pro hac vice and to take or defend depositions in Delaware cases, but when they do so, they are still bound by the Delaware rules.
The sad reality is that parties or their counsel often do not have the time, or the client’s authorization to spend the money needed to file a motion to compel or related motion to “play policeman” when an attorney interferes with the questioning at a deposition–especially when the obstructions are not as clear-cut as they were in the instant case.
This decision was issued on the day after the court’s 106-page decision addressing substantive matters and granting a request for dissolution in this “business divorce” dispute.
In the third ruling by the Court of Chancery in the advancement action styled Holley v. Nipro Diagnostics, Inc., C.A. No. 9679-VCP (Del. Ch. Aug. 14, 2015), the court addressed a request that expenses for third-party vendors of nearly $300,000 be allocated between a criminal action in which the former CEO pled guilty, and which was not covered by a former advancement order, and an SEC civil suit for insider trading which was covered by an advancement order. The background of this case, which involved a former CEO who pled guilty to insider trading, included requests for advancement of fees and expert expenses in civil actions that the former CEO claimed were not subsumed by his guilty plea. That prior decision, referred to by the court as Holley I, was highlighted on these pages here.
In sum, this short letter ruling declines to determine that the expenses sought for third-party vendors should be allocated only to the criminal proceeding that was not covered by the advancement order. In essence, the reasoning, not unfamiliar to readers of prior Chancery decisions on this topic, was that allocation of expenses of this nature may be done at the indemnification stage, but is not something the court will inquire into at the advancement stage of a case.
In Gorman v. Salamone, C.A. No. 10183-VCN (Del. Ch. July 31, 2015), the Court of Chancery affirms the board-centric foundation of Delaware corporate law, and describes the limitation on the ability of a majority stockholder to appoint officers directly–even though a majority stockholder might have the ability to appoint board members. In sum, the majority stockholder must use her power to appoint at least a majority of board members (absent a voting agreement or other restrictions in derogation of the default rule), as the admittedly indirect manner by which she might hope to control who the officers of the corporation will be.
To put a sharper point on it, one of the key roles of a board is to appoint the officers of a corporation. Thus, the court invalidated a bylaw amendment that the majority stockholder purported to authorize, to the extent the majority stockholder attempted to usurp the board’s role.
There are many quotable excerpts from this opinion that is the latest in a series of Delaware decisions involving a struggle for control of Westech Capital Corp., and in particular, a fight pursuant to DGCL section 225 over who the proper members of the board are. See In re Westech Capital Corp., 2014 WL 2211612 (Del. Ch. May 29, 2014), reversed in part by Salamone v. Gorman, 106 A.3d. 354 (Del. 2014). The Supreme Court decision was highlighted briefly on these pages. That decision should be consulted for background facts, in addition of course, to the facts in the current opinion which largely focus on events that occurred after the Supreme Court opinion.
For present purposes, the following bullet points may entice the interested corporate litigator to read the whole opinion, which invalidated written consents based on the stricken bylaw.
- stockholders may not remove directly corporate officers–and a bylaw that purports to confer such authority would improperly interfere with one of the most important functions of the board of directors
- DGCL section 142(e) provides that any corporate vacancy shall be filled as the bylaws provide, but in the absence of such provision, the vacancy shall be filled by the board of directors
- stockholders do not have unlimited power to amend bylaws, and their ability to do so is not coextensive with the board’s concurrent power. Moreover, DGCL section 141(a) grants prerogatives to the board that limit the power of stockholders to interfere with board powers. See also DGCL section 109
- Money quotes are provided on page 12 and footnote 25 that describe the “director primacy” theory of Delaware corporate law which prohibits the stockholders from directly managing the business and affairs of the corporation–without specific authority in either the statute or the certificate of incorporation.
- Thus, bylaws may not control specific substantive (as opposed to procedural) business decisions.
- If a majority stockholder wants to appoint or remove a corporate officer, she must do so only through her ability to appoint board members. Otherwise, she would compromise the board’s core functions and duties–which include appointment of corporate officers. See footnote 35.
Status Quo Orders
- Status quo orders are common in Section 225 battles for board composition, but such an endeavor may be akin to “musical chairs” to the extent it may not be predictable who the court will temporarily maintain in place as a board member. For example, is it the board who was seated “just before the music stopped” or “after the music stopped”, if the “music stopping” is akin to who filed suit asking for the status quo order–or who took unilateral self-help action just before filing suit.
- The prerequisites for obtaining a status quo order, which are close cousins to the prerequisites for a TRO or related injunctive relief, are itemized on page 20 and noted in footnote 49 and 51
UPDATE: The “father” of the director primacy theory of corporate law, Professor Stephen Bainbridge, who has published extensively on the topic, provides commentary about this case and its reference to his theory. As readers will recall, Prof. Bainbridge is often cited in corporate decisions of Delaware courts, but curiously he was not cited in the instant ruling.
A recent Delaware Supreme Court decision that provides independent directors with a new basis to be dismissed from lawsuits against them, was highlighted in my latest article published in Directorship, the magazine of the National Association of Corporate Directors. The case is styled: In re Cornerstone Therapeutics Inc. Stockholder Litigation, No. 564, 2014; Leal et al. v. Meeks et al., No. 706, 2014, opinion issued (Del. May 14, 2015). Highlights of the case previously appeared on these pages.
The Chancery opinion in Andrikopoulos v. Silicon Valley Innovation Company, LLC, C.A. No. 9899-VCP (Del. Ch. July 30, 2015), addressed the priority of an advancement claim in the context of a receivership under Delaware law. Bottom line: The court ruled, on this issue of first impression, that the claims for advancement in this case are not entitled to administrative priority, and should be treated as pre-petition, unsecured claims without administrative priority.
The odd procedural context of this case is not likely to be replicated often for the average practitioner of corporate or commercial litigation, but the court does refer to some of the well-known and frequently applied Delaware principles and Delaware policy regarding advancement for directors and officers. I suggest that this opinion may be most useful to those dealing with the priority of claims generally in receiverships under Delaware law, as well as bankruptcy lawyers to the extent the court refers to bankruptcy by analogy to a receivership, and cites to many decisions of bankruptcy courts that have dealt with advancement under Delaware law (though the decision refers to some courts that conflate the concepts of advancement and indemnification–which is not uncommon among some courts and lawyers alike.)
The ABA Journal is conducting its annual contest of the top legal blogs in the U.S. This hyperlink brings you to the ABA survey page. The full explanation from their website follows:
Blawg 100 Amici
We’re working on our annual list of the 100 best legal blogs, and we’d like your advice on which blogs you think we should include.
Use the form below to tell us about a blog—not your own—that you read regularly and think other lawyers should know about. (Please note that law blogs in the Blawg 100 Hall of Fame are not eligible for this year’s list.) If there is more than one blog you want to support, feel free to send us additional amici through the form. We may include some of the best comments in our Blawg 100 coverage. But keep your remarks pithy—you have a 500-character limit.
Friend-of-the-blawg briefs are due no later than 11:59 p.m. CT on Aug. 16, 2015.
About Blawg 100 Amici
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But please know that we discourage amici from:
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There is no specific criteria that a blogger can meet to be guaranteed a spot on the Blawg 100. And we think our list would suffer if there were. A blog’s whole can be greater than the sum of its parts, and a blog that never fails to post that daily update, has a beautiful design and an unwavering topical focus can very often have less of an impact than another blog that is less consistent on all fronts.
That said, please keep these criteria in mind when submitting Blawg 100 amici:
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The Delaware Court of Chancery’s opinion in Fox v. CDx Holdings, Inc., C.A. No. 8031-VCL (Del. Ch. July 28, 2015), addresses a complex set of facts relating to the liability resulting from the intentionally inaccurate valuation of a spin-off in order to avoid tax consequences to the controlling stockholders, which wrongly minimized the value of stock options.
There are a number of eminently quotable insights and observations in this 82-page decision that could easily be the subject of a lengthy synopsis, but for busy readers who would prefer highlights until they can devote more time to reading the whole opinion, I offer a few selected bullet points that should be of interest to corporate and commercial litigators:
- In addition to reciting important concepts of Delaware law, the Court provides insight into what might motivate a person who sold a business, that he founded, for $7 billion dollars over a decade before the facts giving rise to this case, to risk the ignominy described in the opinion in order to avoid paying taxes in connection with the spinoff of a subsidiary of his new company.
- The Court found that: (i) the company breached the applicable agreement that required the board to determine the fair market value of a share of common stock–which impacted the value of options that the plaintiff owned; and (ii) the determination of FMV was not a good faith determination and “resulted from an arbitrary and capricious process.”
- The Court reasoned that Grant Thornton, in essence, copied the valuation report of another major accounting firm, and provided a valuation report in an intentionally low amount that the controlling stockholder requested in order to avoid his tax burden. The Court explained in detail why it reached the conclusion, somewhat startling, that the valuation by one of the country’s leading accounting firms, was done “not in good faith” and was the result of an “arbitrary and capricious” process. Footnote 21 cites to other Delaware opinions that have critiqued misleading and incorrect reports of other iconic firms.
- The board was required to make the determination of FMV but instead the majority stockholder did so. The Court emphasized that “director primacy” is the foundation of the DGCL even if there is a controlling stockholder, and that the board cannot shirk its duties in the face of a controlling stockholder. That is:
Although some controllers and boards may act this way [i.e., letting the controlling stockholder displace the board], Section 141(a) of the Delaware General Corporation Law (the “DGCL”) establishes ―the bedrock statutory principle of director primacy.” Klaassen v. Allegro Dev. Corp., 2013 WL 5967028, at *9 (Del. Ch. Nov. 7, 2013). “[D]irector primacy remains the centerpiece of Delaware law, even when a controlling stockholder is present.” In re CNX Gas Corp. S’holders Litig., 2010 WL 2291842, at *15 (Del. Ch. May 25, 2010).
- The Court explained that an option is not a stock, and holders of an option are not stockholders. The rights of an option holder are based on the document that created the option.
- The following quote is an example of insights the Court provides, with citations to scholarly journals, regarding what motivates people, other than greed, to breach their duties:
I reach these conclusions about Martino and Halbert reluctantly. Other aspects of their testimony were credible, and I am not suggesting that either is inherently bad or malicious. Like all of us, they are multidimensional. Martino appears to have had a respectable career, and he testified to other instances when he has done the right thing. Halbert has achieved great things and, at least through Caris, devoted much of his time and treasure to improving the lives of others. But humans respond to incentives, and powerful incentives can lead humans to cross lines they otherwise would respect. This is particularly true when the transgression can be rationalized, the benefits are immediate and concrete, and the potential costs are distant, conditional, and readily discounted by the chance of detection and the possibility of a successful defense or settlement. (citations omitted)
- For example, the Court quotes from articles that define the psychological explanation of “hindsight bias”, to explain why the wrongdoers in this case may have tried to justify their actions in forcing an artificially low valuation:
“Hindsight bias has been defined in the psychological literature as the tendency for people with outcome knowledge to believe falsely that they would have predicted the reported outcome of an event.” Hal R. Arkes & Cindy A. Schipani, Medical Malpractice v. the Business Judgment Rule: Differences in Hindsight Bias, 73 Or. L. Rev. 587, 591 (1994). “[S]tudies have demonstrated not only that people claim that they would have known it all along, but also that they maintain that they did, in fact, know it all along.” (citations omitted)
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.
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.’”