Insider Trading Claim against Kohlberg Kravis Roberts & Co. Allowed to Proceed
In re: Primedia, Inc., Shareholders Litigation, Cons., C.A. No. 6511-VCL (Del. Ch. May 10, 2013).
Issue Addressed: Whether insider trading claim based on state law should be allowed to proceed despite motion to dismiss by special litigation committee.
Short Answer: Motion to dismiss denied.
Brief Background
Details of this case were previously highlighted on these pages in connection with a decision by the Delaware Supreme Court to reverse a prior ruling by the Court of Chancery in this matter, as referenced at this link. That Delaware Supreme Court decision, captioned Kahn v. Kohlberg Kravis Roberts & Co., L.P., 23 A.3d 831, 842 (Del. 2011), clarified Delaware law regarding insider trading based on the Delaware Court of Chancery’s opinion in Brophy v. Cities Service Co., 70 A.2d 5 (Del. Ch. 1949). This latest decision can be compared with the recent Chancery decision highlighted in Wayport, highlighted on these pages, and that discussed the fiduciary duty of disclosure and candor owed by directors to shareholders, which involved some factual situations akin to insider trading although those exact words were not directly used in the opinion as allegations as they were in this case in the Brophy context.
Highlights of Case
● The court describes the extensive procedural history which includes the motion to dismiss filed by the special litigation committee in connection with claims challenging the redemption, as well as an alleged usurping of corporate opportunities and the insider trading claim based on Brophy case. After that motion to dismiss was filed, the plaintiffs engaged in discovery for approximately 18 months to consider the basis for that decision and the composition of the committee, which they then used to oppose the motion to dismiss.
● The court discussed at pages 17 and 18 the hearing that it conducted prior to the appeal to the Delaware Supreme Court, and the factors that it considered pursuant to Zapata Corp. v. Maldonado, 438 A.2d 779, 788 (Del. 1981). During that hearing, the court inquired into the independence and good faith of the committee and the bases supporting its conclusions. The second step that the court engaged in during the Zapata hearing, which is a step that the court takes in its discretion, was to apply its own independent business judgment regarding whether the motion to dismiss should be granted. Even though the SLC has the burden of proving its independence and good faith and that it conducted a reasonable investigation, performing the second step of the analysis means that the committee could establish its independence and sound bases for its good faith decisions, but still have the motion to dismiss denied.
● The court recited the elements of an insider trading claim based on the Court of Chancery’s Brophy decision. See page 21.
● The court listed the different cases by the Court of Chancery which over the years took a different approach on, and had different interpretations of, an insider trading claim based on the Brophy case. See page 26.
● The Court of Chancery in this opinion explained that if it were aware that the Delaware Supreme Court decision would have allowed damages for full disgorgement under Brophy, then it would not have dismissed the Brophy claim in response to the motion to dismiss by the SLC. See page 27. Likewise, the court explained the impact of the Supreme Court decision on its application of the second prong of the Zapata analysis. See page 32.
Standing of Derivative Plaintiff Post-Merger
● The court recited the three-part test under the Delaware Supreme Court decision in Parnes to determine the standing of a derivative plaintiff to sue post-merger to challenge the fairness of the merger. See pages 36 and 37. On page 35, the court explained the basis for the claim in this case for alleging that the merger was not fair to the minority.
● The court applied the three-part test to the facts of this case in a thorough analysis to determine the standing of derivative plaintiffs post-merger. See pages 37 through 52.
● Next, however, after determining standing, the court still had to address whether or not the complaint stated a claim. That analysis was conducted from pages 52 to 60.
● The court concluded that the claims for breach of fiduciary duty against KKR based on the grounds that the merger was not entirely fair to the minority in light of the fact that no value was assigned or given to the Brophy claim, would survive a motion to dismiss, and therefore the motion to dismiss as to that claim was denied.
● The court also rejected a defense based on DGCL Section 102(b)(7) because such a defense is not available at this stage of the proceedings due to the loyalty aspect of the entire fairness claim, regardless of what the court described as “relatively insubstantial allegations of bad faith . . ..”
Chancery Declines to Enjoin Acquisition of Plains Exploration and Production Co.
In Re Plains Exploration & Production Company Stockholder Litigation, Cons., C.A. No. 8090-VCN (Del. Ch. May 9, 2013).
Issues Addressed: Were Revlon duties of the board breached due to the absence of a special committee and pre-market check in connection with the sale of the company, and (ii) were disclosure obligations breached due to alleged omissions in the proxy statement.
Short Answer: No to both based on the facts of this case.
Brief Overview
This case addressed the claims that the duties of the directors in connection with the sale of the company, based on the seminal Delaware Supreme Court decision in Revlon, were breached. The Revlon duties of a board, in essence, are fiduciary duties that require the directors to get the best price for the company when it is determined to be for sale, and the procedures employed by the board in connection with the sale or merger will be scrutinized to determine if they were consistent with the board’s obligations. This case recited the contours and parameters of those obligations, but reiterates that there is no formal script or procedures that the directors need to follow. Certain types of procedures and processes have been addressed over the many years that Revlon has been applied, however, and this opinion builds on that extensive jurisprudence.
Select Highlights of Legal Rulings
This decision provides additional guidance on two points in particular: Neither: (i) absence of a special committee, nor (ii) the absence of a pre-market check, will, per se, amount to a violation of Revlon duties. Of course, this finding needs to be tethered to the facts of this case which include a board that: (i) was experienced in the oil and gas industry, (ii) was adequately involved in the negotiations, and (iii) had 7 out of 8 directors who were independent and disinterested.
More to follow later, but in the meantime an expert overview of the case has been provided by Frank Reynolds at this link. Frank edits the Westlaw Journal: Delaware Corporate for the Thomson Reuters’ Legal News & Analysis.
Court Declines To Dismiss Caremark Claims Against Directors Of Delaware Corporation Based In China
Rich v. Chong, C. A. No. 7616-VCG ( Del. Ch., April 25, 2013).
Issue Addressed: Whether a motion to dismiss Caremark claims in a derivative action against directors of a Delaware Corporation can proceed where the plaintiff shareholder made a demand on the board but the board failed to respond to the demand for over two years.
Short Answer: Yes. A prior decision in this dispute on a motion to compel a stockholders’ meeting is addressed [here]
Brief Overview
The Court of Chancery denied a motion to dismiss a derivative complaint alleging breaches of fiduciary duty brought by Defendant Fuqi International, Inc. and its directors. The plaintiff, George Rich, a stockholder of Fuqi, had made a demand asking the corporation to prosecute claims against its officers and directors for violating their Caremark duties. Because the individual Defendants not only failed to respond to the demand over the next two years, but allegedly took actions making a meaningful response to the demand unlikely if not impossible, the Court found that the plaintiff could pursue a derivative action, notwithstanding Court of Chancery Rule 23.1.
Background
Fuqi was formed as the result of a reverse-merger transaction involving Fuqi BVI and VT Marketing Services, Inc. in November 2006. Fuqi initially reported very strong growth but then three and one-half years after it was created, Fuqi announced that its fourth quarter 10-Q and 10-K for 2009 would be delayed because it had discovered “certain errors related to the accounting of the Company’s inventory and cost of sales.” On September 8, 2010, Fuqi announced that the SEC had initiated a formal investigation into Fuqi, related to its failure to file timely periodic reports, among other matters. Fuqi subsequently released additional negative information about its accounting errors, lack of internal controls, and mismanagement of corporate resources.
Plaintiff Makes Demand on Board
On July 19, 2010, plaintiff made a demand to the Fuqi Board asking the board of directors to “take action to remedy breaches of fiduciary duties by the directors and certain executive officers of the Company” as well as to “correct the deficiencies in the Company’s internal controls that allowed the misconduct to occur.” While Fuqi never responded to the demand, the directors formed a “Special Internal Investigation Committee” which the board authorized to retain experts and advisors to investigate whether the claims in the demand were meritorious. However, the plaintiff contended that the Special Committee “never conducted any investigation or any other activity during its short-lived existence.” By March 2012, the Special Committee effectively ceased to exist.
Although there was no evidence that the Special Committee performed any investigation, the Audit Committee did begin an investigation into Fuqi’s accounting problems. Unfortunately, whatever progress the Audit Committee made in uncovering and correcting the problems ended when Fuqi management failed to pay the fees of the Audit Committee’s outside legal counsel, forensic specialists, and auditor. Because the Audit Committee had failed to complete its audits of years 2009, 2010, and 2011, Fuqi did not file any audited financial statements for over three years. In March 2012, Fuqi represented to the SEC and to the Court of Chancery that it is unable to estimate when it will file its audited financial statements.
Motion to Dismiss – Rule 23.1
Court of Chancery Rule 23.1 permits a stockholder to pursue an action on behalf of a corporation derivatively, where “the corporation . . . [has] failed to enforce a right which may properly be asserted by it . . . ” Rule 23.1 requires a stockholder to make (or justify excusal of) a demand to the board of directors before the stockholder may bring a suit derivatively. A stockholder must allege with particularity “the efforts, if any, made by the plaintiff to obtain the action he desires from the directors . . . and the reasons for his failure to obtain the action or for not making the effort.” Once the stockholder makes a demand, the board has an affirmative duty to evaluate the demand and to determine if the litigation demanded is in the best interest of the stockholders. Where the board has not responded to a demand, the plaintiff satisfies the rule, and may proceed, upon raising a reasonable doubt that the board’s lack of a response is consistent with its fiduciary duties.
Because Fuqi did not formally reject the plaintiff’s demand, the Court was required to determine whether the plaintiff had pled particular facts creating a reasonable doubt that the Fuqi Board’s lack of a response was acting in good faith and with due care in investigating the facts underlying the Demand to assess whether the plaintiff has satisfied Rule 23.1 and may proceed derivatively. The Court noted that the plaintiff had alleged the following: (1) he made a demand; (2) Fuqi took steps to begin an investigation; (3) that investigation appeared to have uncovered some amount of corporate mismanagement; (4) Fuqi did not act on the information that it uncovered; (5) the Special Committee appointed by the Board to investigate the demand ended without making a recommendation; (6) by failing to pay the advisors to the Audit Committee, the company deliberately abandoned the investigation, and has taken no action through the Audit Committee for at least 12 months; and (7) the independent directors have left the company, some in protest of management’s actions. Based upon those allegations, the Court found that the plaintiff had pled with particularity facts that create a reasonable doubt that the Fuqi board acted in good faith in investigating the plaintiff’s demand.
Motion to Dismiss Caremark Claim – Rule 12(b)(6)
Plaintiff alleged that Fuqi’s directors were liable for Caremark violation in failing to oversee the operations of the corporation. In its Motion to Dismiss, Fuqi argued that the Complaint failed to plead facts that show that the directors “consciously and in bad faith failed to implement any reporting or accounting system or controls.” Under 12(b)(6), when considering a defendant’s motion to dismiss, a trial court must accept all well-pleaded factual allegations in the complaint as true, accept even vague allegations in the complaint as “well-pleaded” if they provide the defendant notice of the claim, draw all reasonable inferences in favor of the plaintiff, and deny the motion unless the plaintiff could not recover under any reasonably conceivable set of circumstances susceptible of proof. The Court noted that “[a] Caremark claim is “possibly the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment.”
Under Delaware Supreme Court precedent, there are two possible scenarios in which a plaintiff can successfully assert a Caremark claim: (a) the directors utterly failed to implement any reporting or information system or controls, or (b) having implemented such a system or controls, consciously failed to monitor or oversee its operations thus disabling themselves from being informed of risks or problems requiring their attention. Under either scenario, a finding of liability is conditioned on a plaintiff’s showing that the directors knew they were not fulfilling their fiduciary duties. “Where directors fail to act in the face of a known duty to act, thereby demonstrating a conscious disregard for their responsibilities, they breach their duty of loyalty by failing to discharge that fiduciary obligation in good faith.”
Fuqi Had No Meaningful Controls in Place.
While the Court noted that Fuqi had some sort of compliance system in place, it appeared to have be “woefully inadequate.” The Court needed only to look at Fuqi’s own press releases to see detailed evidence of Fuqi’s problems including: “(i) incorrect carve-out of the retail segment from the general ledger; (ii) unrecorded purchases and accounts payable, (iii) inadvertent inclusion of consigned inventory, (iv) incorrect and untimely recordkeeping of inventory movements of retail operation; and (v) incorrect diamond inventory costing, unrecorded purchases and unrecorded accounts payable.” Moreover, there were allegations that the board ignored the following warning signs: (i) the board knew that it had problems with its accounting and inventory processes by March 2010 at the latest, because it announced that the 2009 financial statements would need restatement at that time; (ii) Fuqi acknowledged the likelihood of material weaknesses in its internal controls; and (iii) Fuqi received a letter from NASDAQ in April 2010 warning Fuqi that it would face delisting if it did not bring its reporting requirements up to date with the SEC.
When faced with these and other signs that the company controls were inadequate, the directors were required to take steps to prevent further wrongdoing from occurring. After noting that “[a] conscious failure to act, in the face of a known duty, is a breach of the duty of loyalty,” the Court found that the plaintiff had alleged facts sufficient to state a claim for breach of the duty of good faith under Caremark.
No Stay of Delaware Action in Favor of New York Actions
Fuqi argued that the Court of Chancery should stay or dismiss the Delaware action in favor of several securities actions and two derivative actions pending in New York. The Court denied the request to stay the case until audited financial statements were released or the SEC investigation was completed expressing concern that, among other things, the New York courts did not have personal jurisdiction over the individual defendants (many of whom are residents of China) while Delaware did have jurisdiction over each of the individual defendants because they are directors of a Delaware corporation.
Delaware Fiduciary Duty of Disclosure Explained by Chancery
In re Wayport, Inc. Litigation, Cons., C.A. No. 4167-VCL (Del. Ch. May 1, 2013).
Issues Addressed: Among the several issues addressed in this case, the most noteworthy is a fulsome discussion and restatement of the fiduciary duty of disclosure that directors and majority shareholders owe to other existing shareholders from whom they are purchasing or selling shares.
Introductory Overview
The procedural posture of this case was a post-trial opinion in connection with claims for breach of fiduciary duty and resulting damages arising out of the sales of stock in Wayport, Inc. involving insiders (insider trading). A prior Chancery decision dismissed in part many of the original claims. See Latesco, L.P. v. Wayport, Inc. (highlighted on these pages here), 2009 WL 2246793 (Del. Ch. July 24, 2009).
Highlights of Key Legal Principles Discussed
The plaintiffs alleged that the defendants owed them fiduciary duties that included a duty to disclose material information when they purchased the shares of the plaintiffs. The court explained that directors of a Delaware corporation owe two fiduciary duties: care and loyalty.
The court added that “the duty of disclosure is not an independent duty, but derives from the duty of care and loyalty…. The duty of disclosure arises because of the application in the specific context of the board’s fiduciary duties . . . Its scope and requirements depend on context; the duty does not exist in a vacuum.” Slip op. at 26 (citations omitted).
The court described the need to engage in a context specific analysis to determine the scope and requirements of a disclosure obligation. The court referred to several recurring scenarios in which these issues arise, and provided a discussion of four scenarios that it labeled as prominent in an analysis of the duty of disclosure. In other words, the duty of disclosure most often arises in four common contexts described below as scenarios.
The First Recurring Scenario
The court described the first recurring scenario as a classic, common law ratification in which directors seek approval for a transaction that does not otherwise require a stockholder vote under the DGCL. See Gantler v. Stephens, 965 A.2d 695, 713 (Del. 2009). See id. at n.54 (“The only species of claim that shareholder ratification can extinguish is a claim that the directors lack the authority to take action that was later ratified. Nothing herein should be read as altering the well established principle that void acts such as fraud, gift, waste and ultra vires acts cannot be ratified by a less than unanimous shareholder vote.”)
Second Scenario
The second scenario involves a request for stockholder action when directors submit to the stockholders a transaction that requires stockholder approval, such as a merger or charter amendment. In such a transaction that is not otherwise interested, the directors have a duty to “exercise reasonable care to disclose all facts that are material to the stockholders’ consideration of a transaction or a matter, and that they can reasonably obtain from their position as directors.” See Stroud, 606 A.2d at 84. Failure to disclose material information in this context “may warrant an injunction against, or rescission of, the transaction, but will not provide a basis for damages from defendant directors absent proof of: (i) a culpable state of mind or non-exculpated gross negligence, (ii) reliance by the stockholders on the information that was not disclosed, and (iii) damages proximately caused by that failure. See Loudon v. Archer-Daniels-Midland Co., 700 A.2d 135, 146-47 (Del. 1997).
Third Scenario
The third scenario involves a corporate fiduciary that speaks outside of the context of soliciting or recommending stockholder action such as: “public statements made to the market, statements informing shareholders about the affairs of the corporation, or public filings required by the federal securities laws. “ Malone v. Brincat, 722 A.2d 5, 11 (Del. 1998). In that context, directors owe a duty to stockholders not to speak falsely. Such a breach may result in a derivative claim or a cause of action for damages or equitable relief. Id. at 14.
Fourth Scenario
The fourth scenario is when a corporate fiduciary buys shares directly from or sells shares directly to an existing outside stockholder. The Delaware Supreme Court adopted the “special facts doctrine” to address this scenario, in the case of Lank v. Steiner, 224 A.2d 242 (Del. 1966). Under that doctrine, a director has a fiduciary duty to disclose information in the context of a private stock sale “only when a director is possessed of special knowledge of future plans from secret resources and deliberately misleads a stockholder who is ignorant of them.” Id. at 244. If this standard is met, a duty to speak exists. If the standard is not met, then the director does not have a duty to speak and is liable only to the same degree as a non-fiduciary would be.
Importantly, this duty does not exist to purchases or sales in impersonal secondary markets. Transactions in the public markets are distinctly different.
The current case originally raised the second, third and fourth scenarios but only the fourth scenario remained at trial.
Three Rules (Majority View, Minority View and Delaware View)
The court discusses the three rules developed to address the duty of disclosure of a fiduciary in a direct purchase by a fiduciary. Among the scholarship cited by the court was an article by Professor Stephen M. Bainbridge entitled: Incorporating State Law Fiduciary Duties into the Federal Insider Trading Prohibition, 52 Wash. & Lee L. Rev. 1189, 1219 (1995). The court also quotes extensively from an article by Professor Lawrence A. Hamermesh entitled: Calling Off the Lynch Mob: The Corporate Director’s Fiduciary Disclosure Duty, 49 Vand. L. Rev. 1087, 1099 (1996). Both professors are friends of this blog and among the most cited corporate scholars in Delaware opinions.
The court discussed the majority rule, the minority rule, and the compromise position known as the “special facts doctrine,” that the Delaware Supreme Court, in the words of this Chancery opinion, “appears to have adopted” based on the analysis of decisions of Delaware’s High Court discussed in this opinion. The conflict of viewpoints on this issue present different standards to determine the contours of the duty that a director owes to disclose to the selling stockholder material facts which are not known or available to the selling stockholder but are known or available to the director by virtue of his position as a director. See Slip op. at 31.
Special Facts Doctrine (the Delaware View)
In order to satisfy the special facts doctrine requirement, a plaintiff must “generally point to knowledge of a substantial transaction, such as an offer for the whole company. This may also include a third party offer to purchase a corporation’s stock at a multiple value.”
The court emphasized that the standard for finding “special facts” is lower than the standard of materiality.
The court explained that officers have the same fiduciary duties of disclosure. In footnote 3, the court noted that it is possible for a non-fiduciary to be liable for aiding and abetting a breach even if the board members are exculpated from a breach of their duty of care, and a non-fiduciary would not enjoy that same exculpation under DGCL Sections 102(b)(7) or 141(e).
Duty of the Corporate Entity
The court observed a nuance of corporate law not often addressed, and that is that the corporate entity itself does not owe fiduciary duties to its stockholders. See Slip op. at 44.
Duty to Speak
The court explained that in this context, a director would only have a duty to speak if he possessed special knowledge of future plans and deliberately misled a stockholder who is ignorant of those plans. In addition, a duty to speak can arise because of statements a party previously made, and then subsequently acquired information makes the previous statement untrue, or if the speaker knows that subsequently acquired information would make untrue a previous representation that when made was true. See Slip op. at 45.
Equitable Fraud and Common Law Fraud
The court described the difference between equitable fraud and common law fraud, the former sometimes referred to as “constructive fraud”. Equitable fraud differs from actual fraud based on the existence of a special relationship such as where the defendant is a fiduciary for the plaintiff.
Equitable fraud has also been described as a form of fraud having all the elements of common law fraud except the requirement of scienter. Equitable fraud has also been referred to as providing a remedy for negligent or innocent misrepresentations.
Postscript: Prof. Brian J.M. Quinn has a helpful review of the case at this link. Professor Stephen Bainbridge also highlights the case at this link.
Post-Mediation Statement by Mediator Not Admissible to Enforce Settlement
United Health Alliance, LLC v. United Medical, LLC, C.A. No. 7710-VCP (Del. Ch. May 6, 2013).
Issue Addressed: Whether a post-mediation e-mail by a mediator is admissible for purposes of enforcing the terms of a settlement reportedly reached during mediation. Short Answer: No.
Brief Overview
This short but useful decision describes a situation involving a mediation during which the parties appeared to reach an oral settlement agreement. Following the mediation, however, during their attempts to formalize their agreement into a written document, the parties disputed the scope of the release. One of the parties received, in response to a post-mediation request, an e-mail from the mediator, and in that e-mail the mediator agreed with one party’s version of the release and settlement terms. The party who received the e-mail from the mediator attached it as an exhibit to the motion to enforce the settlement.
This decision rules on the motion to strike the e-mail from the mediator based on several theories. The court granted the motion to strike the post-mediation e-mail from the mediator based on the hearsay rule of evidence.
Highlights of Ruling
The basis of the court’s ruling was that the post-mediation e-mail from the mediator was hearsay and that none of the applicable exceptions applied, in part, because the mediation agreement prohibited any of the parties from forcing the mediator to testify, and therefore, the mediator was “not available” to be questioned about his e-mail. See Delaware Rules of Evidence 801 and 802.
The court also recognized the following public policy in Delaware: “There is a general policy that prohibits the introduction into evidence of communications made in connection with mediation.” (emphasis added). The court emphasized that the policy favoring confidentiality is not limited to communications made at the mediation, but extends to all communications made “in connection with the mediation,” which of course can include statements made after the mediation, to the extent that there is continuing mediation-related discussion or communication.
The court discusses Court of Chancery Rule 174 but that rule did not apply to this case because that rule only applies when the Chancellor or the Vice Chancellor presiding in the case, with the consent of the parties, refers the case to another member of the court for mediation purposes. Nonetheless, the court referred to the policy expressed by that rule regarding the important confidentiality aspect of mediation proceedings.
However, the confidentiality policy for mediation does not apply if the parties waive that confidentiality. In this case, the court determined that the parties waived that confidentiality by revealing in their court filings detailed information about the communications during the mediation.
The court refers to several decisions regarding the public policy in Delaware favoring confidentiality in connection with mediation, and the court also refers for support to the Uniform Mediation Act.
Settlement Agreement Enforced Without All Signatures
Whittington v. Dragon Group LLC, C.A. No. 2291-VCP (Del. Ch. May 1, 2013). Multiple prior decisions in this case have been highlighted on these pages and they provide more background details for the interested reader.
Issue Addressed: Whether a settlement agreement needs to be fully executed by all parties in order to be enforceable. Short Answer: No.
Brief Overview
Multiple prior decisions in this decades-long feud regarding the ownership of a family-owned business are available on these pages at the above referenced link. The most noteworthy aspect of the latest installment on this final aspect of the parties’ litigation is whether or not a settlement agreement needs to be fully executed by all parties in order to be enforceable.
On page 7 of the opinion, the court refers to the particular perspective that the court applies in connection with a motion to enforce a settlement agreement. See footnotes 18 through 21. Most notable is the following statement of contract law: “Nothing in the law of contracts requires that a contract be signed to be enforceable.” See footnote 22.
The court explained that in this analysis the key is whether or not the parties specified expressly that the settlement would not be binding unless and until it was reduced to a writing that was formally and fully executed. Absent such a condition, a fully executed written contract is not required. See footnotes 22 through 24 and accompanying text.
Also, in awarding fees based on a provision in the agreement that shifted fees to the prevailing party, the opinion references Court of Chancery Rule 88 in connection with an affidavit submitted with an application for fees.
Attorney/Client Privilege and Work Product Doctrine Again Addressed by Chancery
AM General Holdings LLC v. The Renco Group, Inc., C.A. No. 7639-VCN (Del. Ch. April 18, 2013). A prior Chancery decision in this case was highlighted on these pages at this link.
Issue Addressed: Whether the attorney/client privilege and the work product doctrine are defenses to a motion to compel.
Short Answer: They can be.
Brief Overview
This is one of four Chancery decisions during the month of April, in separate cases, that addressed in a careful and balanced manner both the attorney/client privilege and the work product doctrine as defenses to a motion to compel. Each case of course presented different factual and procedural situations. The other three cases were highlighted on these pages at the following links: see Comverge, JPMorgan and Kalisman.
I selected below some of the most noteworthy aspects of this decision that has widespread practical utility.
● Simply because an attorney created a document does not make it privileged and especially when a lawyer is performing a business function. See footnote 2 and accompanying text.
● An overly-broad designation of documents as privileged may result in the loss of privilege even for those documents within the set that should otherwise have been protected. See footnote 7.
● The court discusses the type of detail that should be in a privilege log and that it should provide a specific description and designation of the basis of the privilege in order to give the court a basis upon which to weigh the application of the privilege. See footnotes 11 and 12, as well as accompanying text.
● “If e-mails are privileged, but the attachments to the e-mails do not independently earn that protection, then the attachments may not be withheld on the ground of privilege emanating from the e-mail which they accompany.” See Slip op. at 10.
Chancery Addresses Attorney/Client Privilege and Work Product Doctrine
JPMorgan Chase & Co. v. American Century Companies, Inc., C.A. No. 6875-VCN (Del. Ch. April 18, 2013).
Issue Addressed: Whether the attorney/client privilege and work product doctrine were defenses to a motion to compel?
Short Answer: Yes in part and no in part.
Brief Overview
This letter decision provides a useful application of both the attorney/client privilege and the work product doctrine, as well as the “at-issue exception” to those protections from discovery. This ruling is both practical and even-handed. Although a 24-page decision is relatively short by comparison to most decisions from the Court of Chancery, I would venture to say that very few courts devote as much time and space to a careful and thorough discussion of what may appear to be a routine discovery dispute.
The following bullet points highlight some of the more noteworthy aspects of this utilitarian and scholarly decision.
● Court of Chancery Rule 26 is the starting point for a discussion of the general principle that a party may “obtain discovery regarding any matter, not privileged, which is relevant to the subject matter involved in the pending action. The standard of relevance is whether the discovery sought is reasonably calculated to lead to admissible evidence.”
● An application of the work product doctrine turns in part on why the document was produced. Unlike other courts that use the primary purpose test, that test was rejected in Delaware, which instead asks whether the document was created “because of litigation.” See footnote 16.
● The amount of a “litigation reserve” that was prepared in anticipation of litigation would generally be protected from discovery as “opinion work product,” and the protection is not precluded merely because the document may also serve a business function.
● “Opinion work product” is only discoverable in Delaware under a more stringent standard than otherwise applies to other types of work product. See footnote 39 and accompanying text.
● Court of Chancery Rule 33(d) refers to the well-settled standard that when replying to an interrogatory, a party may specify the records from which an answer may be derived if the burden of deriving the answer is substantially the same for the parties serving the interrogatory as for the party served, when the answer may be derived from the business records or the party upon whom the interrogatory has been served.
● The court also discusses the “at-issue” exception to the protection afforded by the attorney/client privilege and the work product doctrine.
● The court distinguishes the recent Comverge decision, highlighted on these pages here, that also dealt with the attorney/client privilege and work product doctrine.
Chancery Rules on Rights of Director to Corporate Information
Kalisman v. Friedman, C.A. No. 8477-VCL (Del. Ch. April 17, 2013).
Issue Addressed: Can a corporation deny access to confidential data to a member of the board of directors based on the attorney/client privilege or work product doctrine? Short Answer: Not based on the facts of this case.
Short Overview
This gem of a decision is both succinct and replete with useful information for the corporate litigator regarding what information a director of a corporation is entitled to receive and under what circumstances a director’s access to such data may be restricted, such as based on the attorney/client privilege. There is much more to it than that, and at only 10-pages, it’s one of the shorter Court of Chancery decisions one will find, so read the whole thing. Compare: Recent Chancery decision in Comverge case highlighted on these pages at this link, that addressed an attorney/client privilege issue in a different context.
Thomson Reuters provides a helpful article by Frank Reynolds about the case, available at this link. As a courtesy to Frank for allowing me to link to his article, I refer the reader to: “Westlaw Journals blog, part of the Thomson Reuters The Knowledge Effect site, features content from all 32 Westlaw Journals titles, including Delaware Corporate, edited by Frank Reynolds.”
New Scholarship on Revlon Duties of Directors
Professor Stephen Bainbridge, a favorite corporate scholar of the Delaware Courts (based in part on the number of times his corporate scholarship is cited in their opinions), has penned an article entitled the The Geography of Revlon-Land, that includes a discussion of the duties of directors under the seminal Delaware decision in Revlon and its progeny, as well as related matters. The good professor’s abstract of the article follows:
In Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986), the Delaware Supreme Court explained that when a target board of directors enters Revlon-land, the board’s role changes from that of “defenders of the corporate bastion to auctioneers charged with getting the best price for the stockholders at a sale of the company.”
Unfortunately, the Court’s colorful metaphor obfuscated some serious doctrinal problems. What standards of judicial review applied to director conduct outside the borders of Revlon-land? What standard applied to director conduct falling inside Revlon-land’s borders? And when did one enter that mysterious country?
By the mid-1990s, the Delaware Supreme Court had worked out a credible set of answers to those questions. The seemingly settled rules made doctrinal sense and were sound from a policy perspective.
Indeed, my thesis herein is that Revlon and its progeny should be praised for having grappled — mostly successfully — with the core problem of corporation law: the tension between authority and accountability. A fully specified account of corporate law must incorporate both values. On the one hand, corporate law must implement the value of authority in developing a set of rules and procedures providing efficient decision making. U.S. corporate law does so by adopting a system of director primacy.
In the director primacy (a.k.a. board-centric) form of corporate governance, control is vested not in the hands of the firm’s so-called owners, the shareholders, who exercise virtually no control over either day-to-day operations or long-term policy, but in the hands of the board of directors and their subordinate professional managers. On the other hand, the separation of ownership and control in modern public corporations obviously implicates important accountability concerns, which corporate law must also address.
Academic critics of Delaware’s jurisprudence typically err because they are preoccupied with accountability at the expense of authority. In contrast, or so I will argue, Delaware’s takeover jurisprudence correctly recognizes that both authority and accountability have value. Achieving the proper mix between these competing values is a daunting – but necessary — task. Ultimately, authority and accountability cannot be reconciled. At some point, greater accountability necessarily makes the decision-making process less efficient. Making corporate law therefore requires a careful balancing of these competing values. Striking such a balance is the peculiar genius of Unocal and its progeny.
In recent years, however, the Delaware Chancery Court has gotten lost in Revlon-land. A number of Chancery decisions have drifted away from the doctrinal parameters laid down by the Supreme Court. In this article, I argue that they have done so because the Chancellors have misidentified the policy basis on which Revlon rests. Accordingly, I argue that Chancery should adopt a conflict of interest-based approach to invoking Revlon, which focuses on where control of the resulting corporate entity rests when the transaction is complete.
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