Chancery Addresses Commercially Reasonable Efforts and Denies Request to Enforce Deal

In an expedited deal litigation matter, in The Williams Companies, Inc. v. Energy Transfer Equity, L.P., C.A. No. 12168-VCG (Del. Ch. June 24, 2016), the Court of Chancery denied a request to enjoin Energy Transfer Equity, L.P. (“ETE”) from evading a deal based on its inability to obtain a tax opinion that was a condition precedent to closing on a deal with The Williams Companies, Inc. Although the facts of this case are somewhat sui generis, the legal principles addressed should have broader application, not only for deal litigation but contract litigation in general.

The court’s discussion of the concept of “commercially reasonably efforts” and “reasonable best efforts” are useful to remember. The court distinguished the two prior Chancery opinions in Hexion, highlighted on these pages previously, and WaveDivision Holdings, highlighted on these pages, in part because, on a factual level, in both of those cases the Court of Chancery found, unlike in the instant case, that a party took affirmative steps, in violation of the relevant cooperation clause, to thwart a condition to closing such as using commercially reasonable efforts, or reasonable best efforts, to obtain financing or to obtain the consent of a third party to the deal.

Short Overview of the Basic Facts

After the merger agreement between the parties was entered into, the energy market, and the value of the assets in the transaction, experienced a precipitous decline. Since a part of the consideration for Williams was $6 billion in cash, which ETE would have to borrow against its devalued assets to obtain, the proposed transaction quickly because financially unattractive to ETE as the buyer. Thus, ETE was looking for an exit from the merger agreement, although initially it had been an ardent suitor of The Williams Companies.

One of the key facts of the case was that a condition precedent to consummation of the merger was the issuance of an opinion by the tax attorneys for ETE at the law firm of Latham & Watkins. The firm was specified in the agreement, and in its sole discretion, was to issue an opinion as a prerequisite to closing, to the effect that the transaction “should” be treated as a tax free exchange under Section 721(a) of the Internal Revenue Code. Although Latham initially, at the time the agreement was signed, expected to be able to issue that opinion, after the agreement was signed something changed. Based on changing market conditions and reduced value of the stock on the tax impact, Latham disclosed that it was no longer able to issue such an opinion. One of the claims that Williams maintained against ETE was that it failed to use “commercially reasonable efforts” to secure the Latham opinion and, therefore, materially breached its contractual obligations.

The court approached the inability of ETE to obtain the Latham opinion with skepticism, amid claims that it was a ruse to allow it to back out of the deal in light of the downturn in the energy market which made the deal financially problematic. Another important fact is that the court found that the person at ETE in charge of tax issues did not accurately read or understand the terms of the deal at the time the agreement was signed, and both he and the Latham firm only realized there was a problem in issuing a the tax opinion after the agreement had been signed. Curiously there were six different tax opinions presented at trial by independent experts and tax experts connected with the deal. Some of those opinions were contradictory.

Money Quote

Notwithstanding the court’s initial skepticism and the motive that ETE had to avoid the closing, a few money quotes from the court have application far beyond this case. For example, the court reasoned that:

“Just as motive alone cannot establish criminal guilt, however, motive to avoid a deal does not demonstrate lack of a contractual right to do so. If a man formerly desperate for cash and without prospects is suddenly flush, that may arouse our suspicions. Nonetheless, even a desperate man can be an honest winner of the lottery.”

Court’s Holding

The court explained in its 58-page post-trial opinion, issued the same week that the trial ended, that Delaware is a contractarian state, and recognizes and respects provisions in contracts that favor specific performance in case of breach. But conditions precedent to a transaction must be enforced as well. The request of Williams to force the court to consummate the deal with ETE would force ETE to accept the risk of substantial tax liability which the parties did not contract for.

Key Issues

Among the key issues the court had to consider was whether the Latham firm determined “in good faith” that it was unable to issue the tax opinion. Williams argued that Latham reached a conclusion that it could not issue the opinion in bad faith and for reasons other than its best legal judgment, in order to please its client. That relates to the argument that ETE persuaded Latham not to issue the necessary opinion, which, if true, would be a breach by ETE of the requirement that it use commercially reasonable efforts to obtain the opinion.

The court articulated the issue as whether Latham determined in “subjective good-faith” that it could issue the necessary opinion which was a condition precedent to closing. The court observed that Latham was a law firm of “national and international repute” and that is was at the very least a blow to the reputation of the firm and its tax partners that they had preliminarily advised that the deal would qualify for certain tax treatment, but had to backtrack in a way that “caused the ‘deal to come a cropper.’”

Among the six different tax experts who testified at trial about the ability to issue the necessary tax opinion that was a condition precedent, one tax law professor testified that “no reasonable tax attorney could agree with Latham’s conclusion,” but another professor testified that the conclusion of Latham that it could not issue the opinion was appropriate. Other law firms argued that although the conclusion of Latham was correct, the reasoning for that conclusion was different.

In its analysis of subjective good-faith, the court observed that it was a “substantial embarrassment to Latham” that it was not able to issue the opinion despite its initial view that it could do so, and that the reputational effects outweighed any benefit of an unethical deference to the interests of its client because “while this deal is, certainly, a lunker, Latham has even bigger fish to fry.” The court also noted a blog post from one of the Wall Street Journal’s blogs that Latham & Watkins had been a clear loser on the deal regardless of who won the litigation. See footnote 122.

Legal Principles Discussed

The court observed that the phrase “commercially reasonable efforts” was not defined in the agreement, and that even though the phrase has been addressed in other cases – – “the term is not addressed with particular coherence in our case law”. The phrase has also been articulated as “reasonable best efforts” which has been described as “good-faith in the context of the contract at issue.” Citing Hexion Specialty Chemicals Inc. v. Huntsman Corp., 965 A.2d 715 (Del. 2008), the court found that the phrase “commercially reasonably efforts” in the agreement in this case required the purchaser, ETE, to submit itself to a “objective standard to ‘do those things objectively reasonable to produce the desired’ tax opinion in the context of the agreement reached by the parties.”

The court found that the argument by Williams regarding burden of proof was wrong, and that the buyer, ETE, did not have the burden to “prove a negative.” That is, it did not need to show that its lack of more forceful action did not cause the inability of Latham to render a tax opinion. The court similarly distinguished the holding in WaveDivision Holdings, LLC v. Millennium Digital Media Sys., LLC, 2010 WL 3706624 (Del. Ch. Sept. 17, 2010). See footnote 130.

Regarding the court’s reasoning about why ETE did comply with its obligation to use commercially reasonable efforts, the court explained why the arguments of Williams were rejected. Williams argued that ETE:

“. . . generally did not act like an enthusiastic partner in pursuit of consummation of the Proposed Transaction. True. The missing piece of Williams’ syllogism is any demonstration that the Partnership’s activity or lack thereof, caused, or had a materially effect upon, Latham’s current inability to issue the [tax opinion].”

Thus, one may read the above quote as suggesting that “not being enthusiastic about closing a deal” is insufficient to breach a duty to use commercially reasonable efforts. The missing part of Williams’s syllogism described by the court is a key fact that distinguished both the Hexion case and the WaveDivision case because the non-performance allegation and the lack of best efforts allegation – – even if true – – did not contribute materially to the failure of the goal to which the “efforts clause” was directed. See footnotes 122 and 123 and accompanying text.

Postscript: Courtesy of The Chancery Daily, we understand that this decision has been appealed to the Delaware Supreme Court. The Court of Chancery facilitated this option by noting in an Order that accompanied the opinion that pursuant to Rule 54(b), this ruling was appealable although it did not conclude all issues at the trial court level.

Chancery Approves Sale of Deadlocked Company Proposed by Custodian

This post was prepared by Justin Forcier, an associate in the Wilmington office of Eckert Seamans.

Why This Case is Noteworthy: The Court of Chancery approved, with certain modifications, the recommendation of an appointed custodian for the proposed sale of a company as a going-concern in light of the company’s two directors being deadlocked. In Re TransPerfect Global, Inc., C. A. No. 9700-CB (Del. Ch. June 21, 2016).

Background: On August 13, 2015, the Court appointed a custodian, in light of a deadlock, to oversee a judicially ordered sale of TransPerfect Global, Inc. (“TPG”). That 104-page memorandum opinion was highlighted on these pages. Although there are three stockholders in TPG, they are deadlocked because two of the stockholders, Philip R. Shawe (“Shawe”) and his mother, Shirley Shawe (“Ms. Shawe” and collectively “the Shawes”), own 49% and 1% respectively, and the other 50% is owned by Elizabeth Elting (“Elting”).

Analysis: The August 2015 opinion required the custodian to present the Court with a proposed plan to sell TPG as a going concern in order to maximize stockholder value. Although the company was profitable, the Court found in the 2015 opinion that the requirements of both § 226(a)(1) and § 226(a)(2) were satisfied and, therefore, the appointment of a custodian to break the deadlock was appropriate. The opinion also directed the custodian to evaluate several different options for the sale, including: (1) limiting the possible bidders to only Shawe and Elting in a “Texas shoot out” auction format; (2) an open auction that would allow any interested bidder to participate; or (3) any other option that the custodian felt was appropriate to achieve maximum value.

The custodian presented five options for a sale. Those recommendations were: (1) a division of TPG into two distinct entities with Elting retaining 100% ownership in one of the entities and the Shawes retaining 100% ownership in the second; (2) conducting an initial public offering; (3) the purchase of one stockholder’s shares by the other stockholder; (4) a board auction process involving strategic bidders and financial bidders; and (5) a modified board auction process led by the existing stockholders where third-party investors would be solicited to either partner with the current stockholders or purchase TPG.

The custodian recommended that the fifth option, the modified board auction, would be most likely to produce the greatest value for the stockholders, because it would allow each stockholder to bid for control of TPG, and also allow third parties to participate.

Elting did not object to the proposal of a modified board auction. Shawe, however, objected to the proposal for two reasons. First, the Shawes asserted that a better option would for each stockholder to prepare a range of values of what TPG is worth, and then limit the bids in the first round of the auction to the existing stockholders. Then, if neither bid fell within the predetermined range of value, a “go-shop” process would be implemented to allow third parties to bid in a second round. However, the “winner” of the first round would retain a matching right that could be exercised in the second round.

The Court rejected the Shawes’ proposed alteration. Observing the fact that TPG has not historically had an annual budgeting process and the Shawes and Elting have submitted vastly divergent estimates of TPG’s value, the Court stated that the “proposal appears designed to cause needless delay and to suppress rather than to maximize stockholder value.”

Second, Shawe opposed non-competition and non-solicitation provisions the custodian proposed to include in the modified board auction plan. Shawe objected to this proposal because he argued that unless a stockholder has engaged in wrongdoing, these restrictive covenants would improperly deprive the stockholder of property rights without compensation. Specifically, the selling stockholder would be deprived of the right to pursue the occupation of his or her choice. And, Shawe argued, that since the current stockholders are not restricted from competing with TPG or soliciting any of its business or employees once they have left, placing such a restriction on post-ownership opportunities would not maximize stockholder value

The parties identified three cases where the Court considered imposing non-competition restrictions in a judicially ordered sale. In two cases the Court declined to include such restrictions, citing the same concerns raised by Shawe. In the third, a non-competition restriction was put in place to address specific threats by a 50% stockholder made while that stockholder was a member of the board and were viewed as undermining the sales process in order for the stockholder to avoid paying the amount that a fair bidding process would obligate him to pay.

The Court agreed with Shawe that the added restrictions should not be included in the proposed plan. The Court stated:

I agree with Shawe that it would not be appropriate to impose non-competition or non-solicitation restrictions on a selling stockholder as a condition of the sale of [TPG] absent evidence of wrongdoing. It stands to reason that TPG would be worth more to a buyer if Shawe and Elting were subject to post-employment restrictions on their ability to compete or to solicit customers and employees than it would be without those protections, but the purpose of the sale process is to maximize the value of [TPG] as it is and not to derive a hypothetically higher value based on contractual protections [TPG] may not currently possess.

Finally, Ms. Shawe contended that a third-party sale would create “‘a thorny allocation issue’ concerning the derivative claims Shawe previously pressed against Elting, which were dismissed with prejudice in the August 2015 post-trial memorandum opinion.” The Court rejected this objection because while derivative claims are corporate assets that are relevant in determining value, any hypothetical value those claims possess here “can be considered and taken into account by anyone who bids to acquire [TPG] and the incremental value attributable to such claims, if any, would be shared by the stockholders in proportion to their ownership interest in TPG.”.

Conclusion: The Court accepted a modified board auction that allows third-party bidders to participate in the judicially ordered sale of TPG over objections that advocated for a two-tier auction process and valuation concerns. However, the Court refused to impose non-competition and non-solicitation provisions on a selling stockholder because there was no evidence of any wrongdoing.

Chancery Imposes Attorneys’ Fees for Bad Faith Litigation

This post was prepared by Justin Forcier, an associate in the Wilmington office of Eckert Seamans.

In James v. National Financial, LLC, C.A. No. 8931-VCL (Del. Ch. June 3, 2016), the Court of Chancery held that the defendant and its counsel are jointly and severally liable for costs and attorneys’ fees of more than $331,000 as a result of bad faith litigation tactics. The Court held in an opinion dated March 16, 2016, that a cash-advance loan was invalid due to its draconian terms and awarded costs and fees. This latest opinion determined the amount of fees and costs for which National and its counsel were jointly and severally liable.

Key Issue: When will the Court award legal fees for bad faith litigation.

Background: Under the terms of the contract, James was advanced $200, but the total repayments after one year added up to $1,820. The March opinion left the parties to propose a fee schedule. After the parties failed to agree, James made her application for fees.

Court’s Reasoning: First, the Court held that James was entitled to an award for all of her costs and fees for the entire litigation pursuant to the Truth in Lending Act (“TILA”). The Court added, however, that “[a]ssuming for the sake of argument that TILA did not authorize the Fee Award to extend beyond the TILA claim, James remains entitled to all of her fees and costs under the bad faith exception to the American Rule.” Reiterating the narrow exception to the American Rule, the Court stated:

[A]n award of fees for bad faith conduct must derive from either the commencement of an action in bad faith or conduct taken during the litigation, and not from conduct that gave rise to the underlying cause of action. Further, the bad faith exception applies only in extraordinary cases, and the party seeking to invoke that exception must demonstrate by clear and convincing evidence that the party from whom fees are sought acted in subjective bad faith. Our courts have not settled on a single definition of bad faith litigation conduct, but have found bad faith where parties have unnecessarily prolonged or delayed litigation, falsified records, or knowingly asserted frivolous claims. Further, we have recognized the bad faith exception where a party is found to have misled the court, altered testimony, or changed position on an issue.

James, 2016 WL 3226434, at* 1–2 (Del. Ch. June 3, 2016) (quoting RBC Capital Mkts., LLC v. Jervis, 129 A.3d 816, 877 (Del. 2015)) (quotation marks, alterations, and footnotes omitted).

National’s bad faith conduct began at the very beginning of the case when it moved to compel arbitration. National knew James opted out of arbitration because it used the opt-out argument to move for dismissal in an action James brought against National in federal court. For this, the Court issued sanctions.

Next, National failed to comply with a discovery order when it turned over a spreadsheet containing loan information that was incomplete and inaccurate. National failed to include all of the loan history information in the spreadsheet as it was required to do.

James then had to move for an emergency temporary restraining order because she alleged the CEO of National appeared at her home and threatened her. Although National contested the factual allegations, it stipulated to the temporary restraining order.

Five months later, National again disregarded a second discovery order by again failing to produce accurate loan information. As a remedy, the Court deemed the disclosed APRs “were incorrect and fell outside of the tolerance permitted by TILA.”

Through a pre-trial conference and trial testimony, it became clear to the Court that National concealed even more evidence during discovery. During discovery, James requested all of the documents that related to her loan. National failed to identify as a source of information an electronic loan management system it used to keep a record of all its loans, including James’s loan. It also failed to produce the requested records from that database. Nor did National ever produce its records of James’s payment history.

Finally, after National’s witness testified about a system used to keep notes on its loans, James specifically requested those notes. National produced a printout. The printout was not marked to indicate that it had been redacted, but it contained occasional odd white spaces. One week before trial, National produced a second printout of the same notes. However, the second printout contained the names of the employees who entered the notes—something that had been secretly redacted on the first printout. The Court observed that the first printout contained other information that was not contained in the second printout and vice versa.

After three separate, inconsistent attempts to explain the second printout, the Court stated that it “was a false record that National submitted with the apparent intention to mislead the tribunal.”

Conclusion: The Court held that James was entitled to the full amount sought. And in light of the seriousness of the misconduct by National and its counsel, the two were held to be jointly and severally liable for the fee award.

 

Another Recent Chancery Opinion Fuels Skepticism About Section 220’s Usefulness

Why this Case is Noteworthy: The Court of Chancery’s opinion in Laborers’ District Council Construction Industry Pension Fund v. Bensoussan, C.A. No. 1123-CB (Del. Ch. June 14, 2016), is the second decision from the Court of Chancery in two months that provides a reasonable basis for skepticism about whether, as a practical matter, plaintiffs’ attorneys should wait for the results of a Section 220 action before filing a plenary derivative suit. This case involves the popular Lululemon brand of athletic apparel, and allegations of insider trading at the company.

Overview: This opinion needs to be viewed in the context of a Chancery opinion issued last month styled In Re Wal-Mart Stores, Inc. Delaware Derivative Litigation, in which the court found that Delaware derivative litigation was barred due to a prior dismissal in another state of a derivative suit that was filed involving similar claims. The plaintiffs in that related litigation in another state, that was dismissed with prejudice, did not use Section 220. In the Wal-Mart case, as in the instant case, the Delaware plaintiffs waited until their Section 220 claims were litigated before filing their plenary action. By that time however, the litigation that was filed earlier in another jurisdiction, and which was not delayed by Section 220 demands, was dismissed. The Court of Chancery in this case found that the additional information that was obtained through the Section 220 action was not a sufficient reason to avoid the principles of issue preclusion, and claim preclusion, that prohibited the Delaware case from proceeding.

Readers should closely review the 40-page decision, but among several highlights include the following:

Procedural Background:

This litigation was preceded by two separate Section 220 actions. In one of those actions, after trial, the court largely rejected the request for books and records under Section 220. In the other Section 220 action that preceded this litigation, the court ordered the production of some documents but still a motion to compel was required because of a dispute about attorney/client privilege. That dispute resulted in a written opinion that was highlighted on these pages here. See In Re Lululemon Athletica Inc. 220 Litigation, Cons. C.A. No. 9039-VCP (Del. Ch. Apr. 30, 2015).

That decision on Section 220 issues was rendered approximately two years after the first Section 220 litigation was filed in Delaware as a prelude to the instant decision in the plenary case. My comments at the above link regarding the Section 220 opinion, and the shortcomings of Section 220 in general, apply here as well.

Key Takeaway:

The court found that simply because the plaintiffs and their counsel in the New York litigation did not first file a 220 action, or wait for a 220 action to conclude, that fact alone did not, ipso facto, make the plaintiffs in that derivative case inadequate representatives for that litigation. See page 32 and footnote 69 – 70 and accompanying text. See also footnote 75 referring to the Delaware Supreme Court opinion in Pyott, highlighted on these pages, which held that not using Section 220 prior to a derivative action does not create an irrebuttable presumption of inadequacy of representation.

Chancery Explains that Special Litigation Committee Must Only Include Board Members

Why This Case is Important: The Court of Chancery opinion in Obeid v. Hogan, C.A. No. 11900-VCL (Del. Ch. June 10, 2016), will be cited often as a reference guide for fundamental principles of Delaware corporate law including the following: (1) even in derivative litigation when a stockholder has survived a motion to dismiss under Rule 23.1, for example, in which demand futility is an issue, pursuant to DGCL Section 141, the board still retains authority over the “litigation assets” of the corporation, and if truly independent board members exist, or can be appointed, to create a special litigation committee (SLC), it is still possible for the SLC, under certain circumstances, to seek to have the litigation dismissed; (2) if an LLC Operating Agreement adopts a form of management and governance that mirrors the corporate form, one should expect the court to use the cases and reasoning that apply in the corporate context; (3) even though most readers will be familiar with the cliché that LLCs are creatures of contract, the Court of Chancery underscores the truism that it may still apply equitable principles to LLC disputes; (4) a bedrock principle that always applies to corporate actions is that they will be “twice-tested,” based not only on compliance with the law, such as a statute, but also based on equitable principles.

The facts of this case are recited in a comprehensive manner in the court’s opinion, along with scholarly analysis, but for purposes of this short blog post, I will provide bullet points.

Key Points:

  • This opinion provides a roadmap for how a board should appoint a special litigation committee with full authority to seek dismissal of a derivative action against a corporation. See pages 30 to 32.
  • The LLC agreement in this case imported the language of Section 141(c) of the Delaware General Corporation Law regarding the composition of a special litigation committee of the board. This LLC agreement adopted a form of governance that mirrored the management of a corporation and included a board of directors. Therefore, the court applied a corporate law analysis, see footnote 5, including an exemplary explanation of the seminal Delaware Supreme Court decision in Zapata that articulated the controlling corporate law principles in connection with special litigation committees. See page 16.
  • The Zapata case was applied to explain that even if a majority of the board is disqualified by lack of independence, it can still delegate its power to a disinterested committee with full board power to decide to move to dismiss a derivative suit filed against the corporation. This may require that additional members of the board be appointed, if possible, who are truly independent. See pages 22 and 23.
  • The court explained that the SLC has the burden to demonstrate its independence and good faith and that it conducted a reasonable investigation. Moreover, the court has discretion to make its own judgment regarding the soundness of the decision of the SLC. See pages 24 and 25. This opinion provides an excellent explanation of the concept of the SLC.
  • This may be somewhat controversial in some circles, but the court explained its reasoning for why it still has the power and authority to apply equitable principles to LLC disputes. See page 11 at footnote 2. See also a recent article on this topic by Prof. Mohsen Manesh, entitled “Equity in LLC Law“, which addresses this concept and includes a discussion of another recent Chancery decision, In Re Carlisle, Etc.,  announcing the same principle.
  • The foregoing reminder of the court’s equitable powers is related to a bedrock principle that all corporate acts are “twice tested,” based on compliance with both the law and equity. See footnote 12 and accompanying text.

In closing, we are happy to note that the scholarship of a very good friend of this blog, and nationally recognized corporate law scholar, Professor Stephen Bainbridge, was cited in this court opinion at footnote 16. It is not uncommon for Professor Bainbridge’s scholarship on corporate law issues to be cited by the Delaware courts, but it is still worth noting. [In addition to this case, the good professor was also cited in another Chancery decision recently, in the matter styled: Pell v. Kill, No. 12251-VCL, 2016 WL 2986496, at *16 (Del. Ch. May 19, 2016).]

Supreme Court Upholds Chancery’s Advancement Ruling

The Delaware Supreme Court in Andrikopoulos v. Silicon Valley Innovation Co., LLC, No. 490, 2015 (Order) (Del. June 8, 2016), affirmed the Chancery decision which was highlighted here, and which determined that the decision of a receiver to deny advancement rights was not in error, and that claims for advancement were appropriately treated as other unsecured claims without priority. Delaware’s high court supported the discretion of the receiver to use other funds to pursue litigation against the former officers but not to approve payments for advancement. This is a somewhat unusual context of a receivership under Delaware law as compared to bankruptcy.

Frank Reynolds of Thomson Reuters has penned a helpful article that provides highlights of the recent oral argument, shortly after which the court entered a terse order with its ruling. (The Supreme Court Building in Dover is shown at right, in a photo from the court’s website.)

Chancery Awards Advancement to Non-Party

For those of us who follow the decisions of the Delaware courts on the right to advancement of fees for officers, directors and others who have been sued in their official capacity, a recent decision within the past week or so from the Delaware Court of Chancery should be of interest. In Thompson v. Orix USA Corp., C.A. No. 11746-CB (Del. Ch. June 3, 2016), the court determined that a former CEO was entitled to advancement rights even though he was not named as a party in the underlying lawsuit.

Most arguments opposing advancement fail when they challenge the satisfaction of the requirement that the underlying suit was brought “by reason of the fact” that the claimant was sued in their corporate capacity, but the charter of Orix USA, one of the two entities involved, provided advancement not only for officers and directors, but also for employees who were sued “by reason of the fact” of that status. This is an unusually broad provision that made it easy for the court to avoid the more common issue of whether the claims being made were based on status of the claimant as an officer or director. The court found that the misappropriated information, which was alleged to have been taken in the underlying action, was accessible to all employees and, therefore, it was not necessary to establish that the corporate powers of an officer and director were used to misappropriate that information.

The applicable language in the charter that provided for advancement also made it easy to argue that it was not necessary that the former directors and employees be named parties in the underlying lawsuit because the charter only required that they be “involved in” litigation even if they were not named as a party. The court found that there was a sufficient basis to establish that the claimants were incurring expenses in connection with depositions and document production that satisfied this requirement even if they were not named parties.

The specific language of the corporate charter involved, as well as a separate LLC agreement that provided relevant rights in light of claims related to that affiliated entity, were dispositive to the extent that they provided for broader rights than are typically allowed in most advancement disputes. These dispositive documents on which the rights were based allowed the court to distinguish several prior advancement decisions cited in footnotes 25, 26 and 30. For example, the court distinguished Paolino v. Mace because even though an employment agreement was involved in that decision, the causal nexus test used to interpret the “by reason of the fact” requirement, was still satisfied. The court reasoned that the requirement is satisfied where, as here: “a claim against a director or officer [or in the instant case, an employee], is for matters relating to the corporation . . . even if the individual is a party to an employment agreement.” This is meant to separate advancement claims from disputes only related to an employment agreement.

Also, because the plaintiffs were not parties to the litigation for which they sought advancement, they needed to allocate their expenses that they incurred as opposed to the expenses for the entity that was sued, and for which advancement expenses were not allowed.

The court also made a distinction between the language in the charter of one of the entities involved, which only required that a person “be involved in” a proceeding, with a separate LLC agreement. That separate agreement was also relevant because the plaintiffs were also claiming an entitlement to advancement under that LLC  agreement which had a requirement that the person claiming advancement be either “threatened to be made a party”, or merely be one who was “threatened” with a lawsuit. The court found a sufficient basis to conclude that those requirements were met. The court also awarded fees on fees as is customary for those portions of the advancement claim that succeeded.

More Directors and Officers Subject to Lawsuits in Delaware

We previously highlighted on these pages a Delaware Supreme Court decision in Hazout v. Tsang, that expanded the orthodox interpretation of a Delaware statute with the net result of making it easier to sue in Delaware an officer or director who has agreed to serve in that capacity for a Delaware entity. Now, readers have the benefit of an expanded article I wrote on the case that appears in the current edition of the national publication of the National Association of Corporate Directors, called Directorship.

Postscript: Professor Bainbridge graciously links to this post.

Delaware Supreme Court Addresses Direct v. Derivative Claims

CITIphoto-Suzanne-Plunkett-150x150The difference between a direct claim by a stockholder against a corporation as compared to a derivative claim, is a subtlety that even the most astute corporate litigator cannot always easily discern. Many Delaware court opinions have addressed the nuances that distinguish between such claims–and to make it more interesting for everyone the Delaware Supreme Court has stated that some claims are both derivative and direct. This week, the Delaware Supreme Court addressed the issue again, considering a matter it accepted upon certification by the U.S. Court of Appeals for the Second Circuit.

In Citigroup Inc., et al. v. AHW Investment Partnership, et al., No. 641, 2015, 2016 WL 2994902 (Del. May 24, 2016), Delaware’s high court explained that because the claims did not involve corporate governance or fiduciary duty issues, that Delaware law did not apply to the direct versus derivative conundrum. Frank Reynolds of Thomson Reuters has a more detailed article about this case.

Chancery Addresses Nuances of Advancement Claim

For those of us who follow the latest developments in the law of advancement claims for directors and officers, a recent transcript ruling should be of interest, due to circumstances not often addressed in advancement decisions that we have highlighted on these pages for the last decade. Courtesy of Kyle Wagner Compton of The Chancery Daily fame, we bring you highlights of a recent decision in the pending case of Eric Pulier v. Computer Sciences Corp., et al., C.A. No. 12005-CB, hearing (Del. Ch. May 12, 2016), heavily borrowing from the unparalleled reporting of TCD‘s indispensable coverage of all things Chancery, as I have not yet obtained the transcript. Based on what I have seen so far, this may warrant inclusion in my annual ABA book chapter in which I note key decisions on advancement and indemnification. A key issue addressed in this case was whether the claimant was an officer as that term is defined in the applicable bylaws.

TCD alerted us to the following highlights, which are in large part from Kyle Wagner Compton of TCD (though any errors are my own).

The issue was not the usual argument about whether the former officer was acting in a corporate capacity, but instead: whether plaintiff is in fact a “covered” or “indemnified” person subject to advancement and indemnification under defendant’s bylaws. The analysis depended in part on Nevada law, because defendant is a Nevada corporation, and in part on the wording of defendant’s bylaws regarding who qualified as a “vice president” or other officer.

The claimant was the founder and CEO of the acquired company, called ServiceMesh, which defendant — Computer Sciences — acquired for a few hundred million. Plaintiff was kept on to manage his former company as a division of the acquiring company, essentially continuing his pre-existing CEO role, and given the title of Vice President.  The plaintiff was not elected by the board of directors, and thus not entitled to advancement and indemnification under Computer Sciences’ bylaws. The acquiring company sued plaintiff for taking actions as a D&O of the acquired company before closing that weren’t discovered until after closing.  There are two potential bases for advancement: the acquired company’s bylaws for acts taken in the capacity of D&O of the acquired company before closing, and defendant’s bylaws for acts taken in the capacity of Vice President after closing.

Given the nature of his role, one might easily assume that one holding the title of Vice President would be considered an officer of the company.  There is other evidence, such as his being identified as a member of Computer Sciences’ “executive team.”  But Nevada law, which governed the application of the acquiring company’s bylaws, specifies that you can only be a corporate officer in a manner specified in the company’s bylaws, and Computer Sciences’ bylaws specify that officers must be elected by the board of directors.

Other claims, however, were governed by the former company’s bylaws which did not have that prerequisite of election by the board to qualify as an officer for purposes of advancement claims. The Chancellor concluded that five out of seven claims asserted against plaintiff related to acts taken as D&O of ServiceMesh, his prior company, and the court held that he was entitled to advancement for 80% of his expenses based on ServiceMesh’s bylaws.  Based on the prerequisites of the bylaws of the acquiring company controlled by Nevada law, however, the court held that the plaintiff was not entitled to advancement for post-closing acts where his only basis for advancement was under the Computer Sciences’ bylaws.

Takeaway:  This case exemplifies the risk of not being aware that notwithstanding: (a) one’s hiring as a consequence of an acquisition of a company that one founded; (b) assuming responsibility for the management of that business as a division of the acquirer; (c) performing the same types of duties performed as CEO before the acquisition; and (d) with a title like Vice President that is at least nominally an officer-like title, it is still possible based on the terms of a bylaw or other controlling document, to not qualify as an “officer” for purposes of advancement. Thus, those officers and directors who remain in the service of an acquiring company, and the lawyers who advise them, need to be aware of this issue.

Also courtesy of The Chancery Daily are links to the bylaws involved in this case. Amended and Restated Bylaws of Computer Sciences Corp., Feb. 7, 2012 and Amended and Restated Bylaws of ServiceMesh, Inc., Nov. 14, 2011.

Supplement: Keith Paul Bishop published an article about this case in The National Law Review, kindly linking to this post, and providing insights into the Latin roots of the word “vice” as a helpful supplement to the issue in this case about who qualified as a “vice president”.

POSTSCRIPT: Coincidentally, a somewhat similar issue was addressed at a hearing recently in a separate case before another member of the Court of Chancery. In Aleynikov v. The Goldman Sachs Group, Inc., C.A. No 10636-VCL (Del. Ch. April 28, 2016), after a hearing, the court took under advisement an advancement issue certified to it by the U.S. District Court for the District of New Jersey. The issue turned on whether the person seeking advancement, who was given the title of  Vice President by Goldman Sachs, was an “officer” as that term was defined for purposes of being entitled to advancement pursuant to the applicable governing documents. The recent Chancery hearing was the latest iteration of long-running litigation involving several courts in several states, as reported in Law360 in an article on April 28, 2016. We will be watching closely for the court to render its published opinion in this case, and we will be certain to provide highlights.

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