Supreme Court Underscores Delaware Policy on Advancement for Directors and Managers

The Delaware Supreme Court explains in this short opinion the public policy supporting the expedited nature of advancement proceedings for officers and directors of corporations, and managers of LLCs. Trascent Mgmt. Consulting, LLC v. Bouri, No. 126, 2016, 2016 WL 6947014 (Del. Nov. 28, 2016).

Although the principles discussed in this opinion are not new, the result of the case is a predictable rejection of a defense to payment by an entity of advancement of fees incurred by former officers, directors and managers. This is an essential topic in corporate litigation for executives of companies and the lawyers who represent them.  We include this decision on these pages, as it is the most recent Supreme Court pronouncement on an exceedingly important topic, and we cover on this blog the key decisions in the area. The most noteworthy aspect of this opinion is the court’s explanation of the public policy reasons in support of advancement and the need for prompt resolution of such claims in the Court of Chancery.dollar-941246_1280

In this case, a former manager of an LLC sought advancement for fees incurred in connection with defending a claim by his former employer. His employment agreement and the LLC agreement both contained nearly identical language providing for the right to advancement. The company attempted to defeat the advancement claim by alleging that the manager who was seeking advancement procured his position by fraud and that the agreements providing for advancement were based on fraudulent inducement. The court acknowledged the Delaware LLC Act’s analogue to DGCL section 145.

The court found that the company’s defenses were based on plenary claims. This opinion affirmed the Court of Chancery’s decision to prevent such plenary claims from impeding the prompt resolution of the advancement claim for several reasons. First, whether the allegations of fraud were ultimately successful was an issue to address in connection with indemnification in a separate and subsequent proceeding. Whether indemnification was appropriate was not a defense to advancement in the interim. Second, the court explained that a party cannot escape an otherwise valid contractual provision by arguing that the underlying contract was fraudulently induced or invalid for some reason unrelated to that provision. In addition, the court emphasized that advancement proceedings are summary in nature, and Delaware courts do not countenance attempts to delay the proceedings by addressing plenary claims.

In-House Counsel as CEO’s Partner

Ben W. Heineman Jr., the former General Counsel for General Electric Co. and now a Senior Fellow at Harvard Law School, presented the 32nd Annual F.G. Pileggi Distinguished Lecture in Law earlier this week, and as Frank Reynolds of Thomson Reuters writes, he talked about a book he recently published in which he argues that the role of a corporation’s in-house counsel should be independent enough to allow the general counsel in particular to serve as both a partner to management and a guardian for shareholders. In sum, in-house counsel must be prepared to quit, or be fired, which could mean forfeiting millions of dollars in stock options, in order to maintain the independence that is necessary to perform the role correctly.

Delaware Supreme Court Addresses Recoupment and Setoff

The Delaware Supreme Court addressed the related but distinct defenses of recoupment and setoff, and the statutes of limitations that applied to them, in the context of an appeal from a Court of Chancery decision which decided claims and counterclaims based on overlapping agreements related to multiple entities. In Finger Lakes Capital Partners, LLC v. Honeyoye Lake Acquisition, LLC, No. 42, 2016 (Del. Nov. 14, 2016), the court found that 10 Del. C. Section 8120 precluded setoff for certain amounts owed that were outside the statute of limitations, which were presented in response to the complaint filed in the case. See Finger Lakes Capital Partners, LLC v. Honeyoye Lake Acquisition, LLC, 2015 WL 6455367 (Del. Ch. Oct. 26, 2015).

One reason why this 9-page opinion is notable, is that there are not many Delaware decisions that cover these important topics. In the nearly 11 years that I have covered key corporate and  commercial decisions on this blog, we have highlighted only a handful of cases that have addressed these two defenses. Another indication of this short decision’s blogworthy status is that the court found it necessary to cite to a 1906 decision and a legal encyclopedia–both signs of the paucity of case law in Delaware on these two defenses.

Court Limits Director’s Access to Corporate Records

A corporate director’s access to corporate records was restricted by the Delaware Court of Chancery in a recent corporate litigation decision that I discussed in my latest regular column that appears in the current edition of the publication of the National Association of Corporate Directors, called DirectorshipThe Court’s decision in Bizzari v. Suburban Waste Services, Inc., based on DGCL Section 220, was  also previously highlighted on these pages.

Annual Distinguished Lecture in Law

The Delaware Journal of Corporate Law of Widener University Delaware Law School presents the 32nd Annual Francis G. Pileggi Distinguished Lecture in Law

Can General Counsels be Independent: Resolving the Partner-Guardian Tension

Ben W. Heineman, Jr.
Senior Fellow at Harvard Law School’s Program on the Legal Profession and its Program on Corporate Governance; Senior Fellow at the Belfer Center for Science and International Affairs at Harvard’s Kennedy School of Government; Lecturer in Law at Yale Law School; and former GE Senior Vice President—General Counsel

Friday, November 18, 2016
8:00 a.m. Breakfast; 8:45 a.m. Lecture
Hotel DuPont, du Barry Room
11th and Market Streets
Wilmington, Delaware 19801

Encore presentation 11 a.m.
Widener University Delaware Law School

One substantive CLE credit available in DE and PA
Online registration form available at above hyperlink
For additional information or for accessibility and special needs requests, contact Carol Perrupato at caperrupato@widener.edu or 302-477-2178.

Prior Lectures have been highlighted on these pages.

Court Explores the Nuances of Rule 59(f)

Justin M. Forcier, an associate in the Delaware office of Eckert Seamans, prepared this overview of a Delaware Court of Chancery decision that explores an attempt at a “second bite of the apple” in corporate and commercial litigation: a motion based on Rule 59(f) when one is not happy with a court ruling. AM General Holdings LLC v. The Renco Group Inc., C.A. No. 7639-VCS (Del. Ch. Nov. 10, 2016).

Background:  Instead of moving for reargument under Rule 59(f), the Renco Group (“Renco”) filed a Motion to Alter, Amend or Revise the Court’s Order Granting Partial Summary Judgment (the “Motion”).  Renco cited “fundamental legal errors” as its basis for the Motion.  In a letter opinion, the Court denied the Motion for two independent reasons.  This is the latest in a long series of opinions in this litigation.  On August 22, 2016, the Court of Chancery issued a Memorandum Opinion that was previously highlighted on these pages.

Analysis: First, the Court noted that the Motion was procedurally improper, because it had been filed 15 days following the issuance of the Memorandum Opinion.  Pursuant to Rule 59(f), all motions for reargument must be filed within five days of the Court’s opinion.  The Court noted that a motion under Rule 59(f) is the proper procedural avenue to attempt to correct “legal errors.”  And Renco could not circumvent Rule 59(f)’s five-day time limit by styling its Motion as a “motion to alter” rather than a “motion for reargument.”

In addition, and more fundamentally, the Court denied the Motion because it has not yet entered a judgment.  The August 22, 2016 Memorandum Opinion dismissed only a portion of Renco’s breach of contract claims.  Therefore, Rules 59(e) and 60(b) are improper tools because Renco sought a reconsideration of an interlocutory order that is not yet final.

Second, the Court rejected the Motion on its merits.  In its August Memorandum Opinion, the Court concluded that Renco’s claims were time barred and it could not invoke the discovery rule or equitable tolling to overcome that bar.  In its Motion, Renco argued that the Court was requiring it to assume a duty to inquire whether its business partner, MacAndrews AMG (“AMG”), was complying with its contractual obligations and also that the Court improperly concluded that equitable tolling applied only in instances where the contracting parties had a fiduciary relationship.  The Court rejected both of these assertions.

The Court held that it correctly denied Renco’s attempts to invoke the time of discovery exception.  In its Memorandum Opinion, the Court made clear that there were “red flags” that AMG was potentially breaching the agreement between the parties.  However, the Court noted, when those facts are coupled with the contractual rights for which Renco bargained to access AMG’s books and records, the case falls outside of the limited scope of cases that Delaware courts allow for the discovery rule.

Lastly, the Court also concluded that it properly denied Renco’s ability to invoke equitable tolling.  The Court stated that the Memorandum Opinion focused on a lack of a fiduciary relationship between Renco and AMG because that is what Renco focused on in its opposition to AMG’s motion for summary judgment.  The Court stated that it did not matter whether Renco based its argument on a fiduciary or contractual relationship—it was not blamelessly ignorant and cannot invoke equitable tolling.

New ABA Ethics Rule on Political Correctness

In my latest ethics column for the publication of the American Inns of Court, The Bencher, I highlight a new ethics rule recently adopted by the American Bar Association that addresses what some refer to as political correctness. The ABA’s change to the Model Rules of Professional Conduct for lawyers will next be considered by each of the 50 states. Each state will decide on its own whether to adopt this most recent change to the model rules, in whole or in part.

Voluntary Corporate Financiers Cannot Seek Fee Awards

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

A recent Delaware Court of Chancery ruling clarified that only parties or counsel have standing to seek legal fees as an award for a successful result in certain cases. Judy v. Preferred Communication Sys., Inc., C.A. No. 4662-VCL (Del. Ch. Sept. 19, 2016)

Background:  Preferred Spectrum Investments, LLC (“PSI”) sought the recovery of attorneys’ fees and expenses totaling $20 million from Preferred Communication Systems, Inc. (the “Company”) for the funding of Michael Judy’s (“Judy”) litigation against the Company.  After a long and tortuous history that resulted in several federal prison sentences, PSI approached the Company in an attempt to transfer control to PSI from its current management.  When that offer was refused, PSI sought to initiate a lawsuit to obtain a court-ordered meeting of the stockholders where PSI would seek to replace the Company’s leadership and take over control.  However, PSI was not a stockholder of the Company.  Therefore, PSI used Judy as the plaintiff.  No formal agreement between PSI and Judy regarding litigation funding was ever formed.  Yet, PSI was funding the litigation.  The court entered its final decision on the merits in March 2013, which was upheld by the Delaware Supreme Court that following May.  Two-and-a-half years later, PSI moved through Judy to reopen the case and intervene so it could file a fee application.  In its application, PSI sought approximately $20 million, which is based on the value of the Company’s licenses, or alternatively, $4,958,056.43, representing expenses PSI claims to have incurred.

A prior decision in this case highlighted on these pages, related to the right of an attorney to retain a file of a client who has not paid

Analysis: The court began its analysis by stating the well-known maxim that, generally, parties are responsible for paying their own legal fees unless a contractual or statutory right, or other exception, otherwise exists.  One such example is the common benefit doctrine, which dictates that those who have benefited from litigation should share in the expense.

To prevail under the common benefit doctrine, a party must show: (1) the action was meritoriously filed; (2) an ascertainable group received a substantial benefit; and (3) a causal connection existed between the litigation and the benefit.  Importantly, since the common benefit doctrine is rooted in the court’s power to do equity, the court can deny the application of the doctrine even when a litigant has satisfied all of the elements.

First, the court determined that PSI lacked standing to assert such a claim for fees.  PSI was not a plaintiff nor its counsel.  Instead, PSI was a gratuitous financier that funded the litigation without any formal agreement with Judy.  And Delaware law is clear: “only a litigant or its counsel has standing to seek a fee award.”

Second, PSI lacked standing to seek a fee award under the common benefit doctrine because the litigation it funded was part of an effort to take over the Company.  Here, the primary goal was the advancement of PSI’s personal interests in obtaining control of the Company.  This objective is at odds with the purpose of the common benefit doctrine, because the primary purpose for the litigation was self-serving.  Therefore, any benefit bestowed upon the Company and its shareholders is purely incidental.

As a secondary argument, PSI claimed that it was entitled to recover the fees and expenses it spent under the doctrine of quantum meruit.  A claim of quantum meruit, as the court explained, is quasi-contract claim that allows a party to recover the value of its services if: (1) the party performed the services with the expectation of payment; and (2) the recipient should have known that payment was expected.

First, the court found that PSI could not satisfy the first element—that the services were performed with the expectation of payment.  PSI failed to document any repayment scheme with Judy.  Instead, PSI simply paid the fees and costs without first protecting itself by entering into a contract.

Second, neither PSI nor any of its stockholders had any reason to believe that PSI was expected to pay for the litigation.  On several occasions PSI represented to the Company’s shareholders that the litigation it was pursuing through Judy would be “free of cost to [them].”  Therefore, the Company and its investors could not realistically be considered to have known that payment was actually expected.

 

Chancery Provides Practice Tip

In a recent letter ruling, the Delaware Court of Chancery provided a practice tip for those engaged in litigation before the court who seek an extension of the word-limit for briefs: Don’t present the court with a “Morton’s Fork.” That is, don’t make the court choose between two equally unappealing alternatives by waiting until the last business day before the brief is due. In a prior opinion in the Hermelin case highlighted on these pages, at the famous footnote 19, the court explained the difference between other somewhat similar expressions, like Hobson’s Choice, that can easily be conflated. Kandell v. NivC.A. No. 11812-VCG (Del. Ch. Oct. 14, 2016).

Court Imposes Costs and Fees, Sua Sponte, in Connection with Motion to Compel

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

A recent Chancery decision provides practical tips for litigators regarding the use of general objections in response to interrogatories and document requests. In addition to striking numerous objections, the seller of a company (“Seller”) was recently awarded, sua sponte, costs and fees incurred in connection with a motion to compel discovery, as well as costs and fees incurred for the meet and confer prior to the motion. The court cautioned parties against using broad general objections to discovery requests and provided guidance on how to properly identify documents in replying to interrogatories when using Rule 33(d).Glidepath Ltd. v. Beumer Corp., C.A. No. 12220-VCL (Del. Ch. Oct. 6, 2016) (TRANSCRIPT)(Order). [N.B. Eckert Seamans represented the Seller that filed the motion.]

Background: Seller filed a cause of action against the buyer of a company (“Buyer”) for breach of an earn out agreement relating to a joint venture. During discovery, Buyers raised several general objections to Seller’s document requests. Buyers also utilized Rule 33(d) to incorporate documents into their interrogatory answers.

Analysis:
I. Replies to Document Requests
The court reviewed each contested response and gave detailed instructions to Buyers’ counsel. The court noted that general objections that lack any specificity are unhelpful. For example, according to the Court, a party objecting to a document request must explain why “something is ‘improper,’ why you think it is ‘overly broad as to time and content,’ why you think it is ‘unduly burdensome or oppressive,’ why you think something is ‘vague or ambiguous’ . . . and why you think it’s not relevant, immaterial, or otherwise not reasonably calculated to lead to admissible evidence.” Simply listing those general objections without further explanation is not enough.
Similarly, the Court explained that when a party objects to a document request because it believes the documents sought are publicly available or already in the possession of the seeking party, those documents must be “specifically” identified so that the opposing party knows which documents are being referred to.
Along the same lines, when a party is objecting to answers that are outside of a specific time period, it is important for the objecting party to explain why it thinks the chosen time period is appropriate and to specify a time period that is acceptable.

II. Replies to Interrogatories
In addressing the objected-to interrogatories, the Court explained specificity is also important when a party invokes Rule 33(d) as part of a reply. Rule 33(d) allows a party to answer an interrogatory by referencing business records that the requesting party could inspect when the burden of review is equal on the parties.. By way of example, the court stated, “No. 14 stated: ‘Identify all communications, including, but not limited to solicitations or negotiations You had with any third-party from 2014 to the present relating to . . . systems and/or services.”’ Buyers answered, ‘“[Buyer] will produce its non-privileged, responsive documents within its custody, control, or possession; the remainder of the interrogatory is objected to.”’

The court explained that it is not enough state that a party will produce everything in its possession, because that is a more proper rely to a document request. Instead, when relying on Rule 33(d) to answer an interrogatory, the party must identify, with greater specificity, the documents it is relying on.

Practice Tips from Court’s Ruling
1. Rule 33(d) requires some measure of specificity when referring to documents to answer interrogatories. Simply referring generally to the documents to be produced is not enough; and
2. General objections to discovery requests that lack any specificity or fail to inform the requesting party as to which discovery requests are subject to the general objections, and which are not, are not helpful to the parties or the Court and should be discouraged as they may be stricken. .

The following general objections to document requests and interrogatories were stricken by the court:

1. The Defendants object to the Interrogatories to the extent the Interrogatories, or the instructions and definitions incorporated therein, are contrary to or purport to impose obligations on and to require procedures of the Defendants beyond those required by the Delaware Court of Chancery Rules, or the case law interpreting them;
2. The Defendants object to the Interrogatories to the extent the Interrogatories, or the instructions and definitions incorporated therein: (a) are improper; (b) are overly broad as to time and content; (c) are unduly burdensome or oppressive; (d) are vague or ambiguous; (e) are unreasonably cumulative or duplicative; or (f) seek information that is not relevant to the claim or defense of any party, is immaterial, or is otherwise not reasonably calculated to lead to the discovery of admissible evidence;
3. The Defendants object to the Interrogatories to the extent the Interrogatories, or the instructions and definitions incorporated therein, call for the production of documents or information that are publicly available, previously provided to the Plaintiffs by the Defendants, or otherwise already in the Plaintiffs’ possession, custody, or control or are available from sources that are more convenient, less burdensome, or less expensive, or from sources that are as readily available to the Plaintiffs as to the Defendants;
4. The Defendants object to the Interrogatories to the extent the Interrogatories, or the instructions and definitions incorporated therein, are duplicative and repetitive of each other.
5. The Defendants object to the Interrogatories to the extent the Interrogatories, or the instructions and definitions incorporated therein, call for the identification of “all” persons with knowledge or “all” documents of a broad classification or pertaining to a specific subject, to the extent such language is overly broad, unduly burdensome, oppressive, vague, and ambiguous;
6. The Defendants object to the Interrogatories to the extent the Interrogatories, or the instructions and definitions incorporated therein; and
7. The Defendants object to the absence of a defined time period for the Interrogatories as being overbroad, unduly burdensome, and not reasonably calculated to lead to the discovery of admissible evidence. Subject to an agreed upon ESI Production protocol, and an agreement regarding appropriate custodians and search terms, the Defendants will produce documents generated or dated during the agreed upon time period that are responsive to the portions of the Interrogatories to which the Defendants do not otherwise object.

The following Responses to Interrogatories were rejected by the court:

INTERROGATORY:

Identify all communications, including, but not limited to solicitations or negotiations You had with any third-party from 2014 to the present relating to baggage handling systems and/or services.
ANSWER:
Subject to the General Objections and in accordance with Rule 33(d), Defendant . . . will produce its non-privileged, responsive documents within its custody, control, or possession; the remainder of this Interrogatory is objected to on the ground that it is not reasonably calculated to lead to the discovery of admissible evidence.

INTERROGATORY:

Identify all other companies in which [Buyer] acquired an ownership interest (e.g., through a stock or membership purchase agreement, merger, etc.), which contained an Earnout provision.
ANSWER:
The Defendants object to this Interrogatory on the ground that it is not reasonably calculated to lead to the discovery of admissible evidence.

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