Discussion of Key Delaware Corporate and Commercial Decisions from 2014

Delaware’s Key Corporate and Commercial Cases

January through June 2014

You are invited to a free audio conference for a discussion of the top ten decisions of 2014 to date from Delaware’s Supreme Court and Court of Chancery.

Thursday, July 24, 2014 at 3:00 p.m. EST

For the last nine years, Francis G.X. Pileggi and Kevin F. Brady have provided an annual review of key Delaware corporate and commercial decisions. In 2014, so far we have reviewed and summarized over 100 opinions from Delaware’s Supreme Court and Court of Chancery on the Delaware Corporate and Commercial Litigation Blog. Ten decisions with the most far-reaching application and importance during the first half of 2014 will be highlighted and discussed during an audio conference led by an Eckert Seamans’ team of corporate and commercial attorneys. Participants can dial-in on Thursday, July 24, 2014 at 3:00 p.m. EST.

Register and obtain a dial-in number by sending an email to: lbrinjac@eckertseamans.com

Speakers:

Francis G.X. Pileggi practices primarily in the areas of corporate and commercial litigation. He has extensive experience in matters involving fiduciary duties and corporate governance as well as summary proceedings under the Delaware General Corporation Law. Francis created and maintains the Delaware Corporate and Commercial Litigation Blog at www.delawarelitigation.com.

Kevin F. Brady represents clients in corporate and commercial litigation in the Delaware Court of Chancery, the Delaware Superior Court and the U.S. District Court for the District of Delaware. He counsels corporations, boards of directors, officers, individual directors, and individual shareholders in a wide range of issues involving corporate governance and interpretation of the Delaware General Corporation Law and federal securities matters.

Tara L. Lattomus represents clients in corporate and commercial litigation, bankruptcy and creditors’ rights and labor and employment matters. She has experience in representing both creditors and debtors in insolvency proceedings and has litigation experience in state and federal courts in commercial litigation matters on behalf of both national and local clients. She frequently publishes articles and makes presentations on recent Delaware decisions.

Jill K. Agro practices in the area of corporate and commercial litigation and represents a broad range of clients, including corporations, stockholders, directors, officers and members and managers of alternate entities. Jill has an extensive background representing clients in Delaware’s Court of Chancery.

SUPPLEMENT: Professor Bainbridge, one of the nation’s foremost corporate law scholars and often cited in Delaware opinions, graciously highlighted this event on his blog. It doesn’t get much better than that–to get such a positive mention by a luminary.

Corporate Benefit Doctrine Not Applicable to Volunteers

Raul v. Astoria Financial Corporation, C.A. No. 9169-VCG (Del. Ch. June 20, 2014).

Issue Addressed: Whether attorneys’ fees were appropriate under the corporate benefit doctrine when the court considered the benefit to be in the nature of volunteer help, and the claim presented could not survive a motion to dismiss.  Answer:  No.

Short Overview

This memorandum opinion provides a very useful overview of those situations where a benefit may be conferred on a corporation by a stockholder suggesting corporate action, but when those efforts do not rise to the level of the type of corporate benefit for which attorneys’ fees will be granted.

The key holding was summarized by the court as follows:  “. . . the stockholder has simply done the company a good turn by bringing to the attention of the board an action that it ultimately decides to take, [therefore,] she is not entitled to coerced payments of her attorneys’ fees by the stockholders at large.” See generally footnote 51 (explaining that the court does not typically issue injunctions requiring defendants to comply with the law, which they already have an obligation to honor).

The background of this case was a request by the stockholder that the company correct a failure to make proper disclosures pursuant to the Dodd-Frank Act.

The court explained that under the corporate benefit doctrine as it applies to moot claims, it is not necessary that a plaintiff actually file an action in order to recover fees.  See footnote 21.  However, the claim must have been meritorious when presented to the board.  The court observed that the corporate benefit doctrine promotes the private enforcement of fiduciary breaches, and through the fee-shifting mechanism, the legal system incentivizes private actors to police corporate misconduct.

The court also noted that the legal system is designed to adjudicate corporate wrongdoing and not the directors’ exercise of their discretion.

Key Excerpts

The Court reasoned that: “Where a volunteer stockholder . . . notifies directors, not that they are in breach of their duties, but simply that they have missed a corporate opportunity or should avoid a corporate loss, the consideration of such a notification is a board, not a Court, affair.”

Moreover, the court held that:  “It is only where a benefit results from a demand to address corporate wrongdoing under Rule 23.1, however, that it is appropriate for the Court to intervene in the equitable distribution of the costs among all stockholders . . .”

Moreover, the court emphasized that a claim is considered meritorious for purposes of the corporate benefit doctrine “if it can withstand a motion to dismiss on the pleadings, and if, at the same time, the plaintiff possesses knowledge of provable facts which hold out some reasonable likelihood of ultimate success.”  See footnotes 27 and 29.

ABA Journal Picks Top Law Blogs

To quote Professor Bainbridge:

The ABA Journal is again accepting nominations for their Blawg 100. I’m not allowed to nominate myself, but I am allowed to tell you that you can nominate me here.

ABA’s Business Lawyer Publication Seeking Authors

At the request of the ABA, I am publishing the following notice:

The Editorial Board of The Business Lawyer is soliciting submission of articles and essays for Volume 70. TBL is the flagship scholarly journal of the American Bar Association  Section of Business Law. It reaches 40,000 readers on a quarterly basis. Authors must submit exclusively to the journal and submissions are peer-reviewed. TBL provides a good forum to reframe scholarly articles published elsewhere for an audience of judges and practitioners.

Articles should be submitted to Diane Babal, Production Manager, at diane.babal@americanbar.org. Questions about submissions can be addressed to Associate Editor-in-Chief, Professor Gregory Duhl, at gregory.duhl@wmitchell.edu

Nuances on Advancement of Fees for Counterclaims Against Directors and Officers

Pontone v. Milso Industries Corp., C.A. No. 7615-VCP (Del. Ch. May 29, 2014).

Issue Addressed: The appropriate standard to apply to determine whether counterclaims are covered for purposes of a former director’s entitlement to advancement of attorneys’ fees.

Short Background

The Delaware Court of Chancery previously determined in a motion for partial summary judgment in this case that the former officer and director was entitled to advancement for certain counterclaims.  The court directed the parties to follow the procedures set forth in Fuhlendorf v. Isilon Systems, Inc., 2010 WL 4570225 (Del. Ch. Nov. 9, 2010), to process the request for advancement.  The court also previously appointed a Special Master to resolve any disputes between the parties regarding the amount of fees subject to advancement.  This memorandum opinion is a ruling on exceptions to the second report of the Special Master.

Key Rulings

The court observed some inconsistency between decisions of the Delaware Supreme Court and the Delaware Court of Chancery regarding the types of counterclaims eligible for advancement.

The court in this decision determined that the governing standard is the one established in Roven, under which compulsory counterclaims “advanced to defeat, or offset affirmative claims may be subject to advancement” (citing 603 A.2d at 824 (emphasis in original)).

The Court of Chancery concluded that the following two-part test would control:

A counterclaim will be considered to be ‘defending’ and thus advanceable, if it is: (1) ‘necessarily part of the same dispute,’ in the sense that it qualifies as a compulsory counterclaim under the prevailing Delaware and federal procedural standard; and (2) ‘advanced to defeat, or offset’ the affirmative claims.

Procedure to Determine Which Particular Fees from Among Multiple Claims Are Subject to Advancement (When Bills Are Not Clear On the Point)

The court also determined that when not all claims are subject to advancement, the procedure to follow in order to determine which time charges apply to only those claims that are subject to advancement, should be the procedure utilized by the Court of Chancery in Fasciana v. Electronic Data Systems Corp., 829 A.2d 160 (Del. Ch. 2003).

That methodology will determine what portion of the fees and expenses incurred by the parties seeking advancement relate to matters that were subject to advancement.  In that decision, the court directed the plaintiff to:  “Submit a good faith estimate of expenses incurred to date” that relate to the precise allegations that triggered advancement.  Id. at 177.

The court in that case also required the attorneys to provide a sworn affidavit certifying their good faith belief that the identified litigation expenses relate solely to “defense activity” undertaken in response to allegations for which advancement was owed.

Noting that “some level of imprecision will be involved in the retrospective accomplishment of this task,” the court nevertheless found that the procedure put in place provided adequate protection so that the defendant can reserve any ultimate fight about the precise amounts until a later notification proceeding.

The Fasciana decision provides a methodology, and accounts for different work required for various counterclaims.

The court addressed the concern that time entries that were redacted to avoid the revelation of work product or mental impressions created a problem to the extent that redacted time entries lacked meaningful indication of, for example, what general legal issues the billing individuals were researching or working on as a result of the heavy redactions.

The court emphasized that the company making the advancement payments was entitled to information “sufficient to indicate that the claimed expenses do not relate to counterclaims for which advancement has been disallowed, to the extent such information can be provided without revealing attorneys’ work product or mental impressions.”

The court resolved this concern by requiring counsel for the plaintiff to “indicate, under oath, whether any of those time entries [which were inadequately described] relate to those counterclaims [that were non-advanceable], and Milso’s advancement obligations shall be offset accordingly.” See generally, Paolino v. Mace Security International, No. 4462-VCL (Del. Ch., revised December 14, 2009), read opinion here. (In Paolino, the court bound the company by its attorney’s representation that the former director should not be entitled to advancement because the work on his complaint could not be distinguished from the counterclaim as the issues were so interwined. Based on that representation in that case, the court held that the former director was entitled to all the fees incurred and not just those for defending a counterclaim.)

The court also observed that the person seeking advancement needs to present a specific bill for a specific amount demanded in order to trigger the clock for pre-judgment interest, but in this case the court found that a blanket denial made that requirement futile.

Delaware Securities Act Not Applicable to Actions Outside of Delaware

Eurofins Panlads, Inc. v. Ricerca Biosciences, LLC, C.A. No. 8431-VCN (Del. Ch. May 30, 2014).

This Delaware Court of Chancery opinion provides an analysis of the Delaware Securities Act and concludes that it does not apply to the alleged fraud that occurred outside the State of Delaware.  The court explained that status as a Delaware corporation alone does not provide a sufficient nexus for application of the Delaware Securities Act to activities that occur outside the state.

The court also explained the general rule that a corporate officer who signs a contract on behalf of a corporation does not thereby become a party to that contract.  However, there is an exception to that general rule and officers can be personally liable when they personally participate in a tort, for example, if they fraudulently induce a party to enter into the contract.  See footnotes 148 and 149.

Justice Jacobs’ Top 20 Delaware Decisions

The Hon. Jack Jacobs recently completed 29 years as a member of the Delaware Judiciary, first as a vice chancellor on the Court of Chancery and then as a Justice on the Delaware Supreme Court. He had all the best qualities that make for an exemplary jurist and his contributions to Delaware corporate law and other areas of Delaware law leave a legacy that will benefit many generations to come.

Professor Bainbridge, one of the favorite corporate law experts among the Delaware Judiciary, has selected the top 20 decisions of Justice Jacobs, and the good professor explains the method he used to select them in his post.

“Close Corporation” Defined for Purposes of Hobby Lobby Decision

Chancery Awards Fees For First Time Based on Delaware Computer Misuse Act

Wayman Fire Protection, Inc. v. Premium Fire & Security, LLC, C.A. No. 7866-VCP (Del. Ch. June 27, 2014). 

This Delaware Court of Chancery ruling is noteworthy for at least two reasons: (I) it applies a powerful tool that businesses can use against competitors who hire executives or other employees who leave to work for competitors and take with them electronically-stored data from their former company; and (II) because, for the first time, the amount of attorneys’ fees awarded is quantified in a civil case pursuant to Delaware’s Misuse of Computer System Information Act, 11 Del. C. Section 941. The underlying claims relate to a former employee taking data from the computer of his former employer and using it for the benefit of his competing new employer.

One of the factors the court considered is that this statutory breach was only one of several claims made, and this award of fees was virtually the only recovery in the case. The $200,000 award was about 20% of the total fees incurred, net of expert fees which were also awarded.

The post-trial opinion in this case was previously highlighted on these pages. 

Delaware Court of Chancery Examines Nuances of Implied Covenant of Good Faith

In re: El Paso Pipeline Partners, L.P. Derivative Litigation, C.A. No. 7141-VCL (Del. Ch. June 12, 2014).

Key Issue Addressed:  This Delaware Court of Chancery opinion examines in 51-pages the nuances of the implied covenant of good faith in the context of claims made in connection with a challenged transaction involving limited partnerships, as well as related principles.

Although the copious factual background in the opinion is integral to a complete understanding of the reasoning of the court in this case, for present purposes, and for the most likely usefulness to the reader, I will highlight the legal principles, shorn of their factual adornments, that would have the most widespread applicability.

Highlights of Principles Recited in Opinion

● The court examined the subjective good faith contractual standard used in the Limited Partnership Agreement.  This opinion refers to prior Delaware decisions applying similar contractual standards of good faith – - as distinct from the implied covenant of good faith.

● The court explained that when analyzing the subjective belief of directors in connection with a subjective good faith contractual standard, the Delaware Supreme Court has stated that trial judges should not replace actual directors with hypothetical reasonable people.

● In this opinion, the Court of Chancery reasoned that “because science has not yet developed a reliable method of reading minds, objective facts are logically and legally relevant to the extent they permit inferences that the defendants lack the necessary subjective belief.” Slip op. at page 25.

● Citing to the Supreme Court decision in Encore Energy, 72 A.3d at 107, the Court of Chancery explained that some actions are so unreasonable they are inexplicable on grounds other than subjective bad faith.

● The court emphasized that contractually defined good faith standards are not the same as the standard of good faith in the implied covenant of good faith and fair dealing.  See footnotes 3 and 4.

● The court underscored that the implied covenant is a doctrine by which Delaware law “cautiously supplies implied terms to fill gaps in the expressed provisions of an agreement.  Contractual gaps always exist because human negotiators and drafters lack perfect foresight, operate with limited resources and practice their craft using the imprecise tool of language.”

● The court explained that “it would be impractical to raise, negotiate and address every conceivable situation in the express terms of even the most prolix agreement.”  See footnote 5.

● Gaps in agreements exist for several reasons.  For example, some aspects of a deal are so obvious, the parties do not feel a need to address them.  Other understandings or expectations between the parties are so fundamental that they did not need to be negotiated.

● Moreover:  “Precisely because gaps always exist, the implied covenant is a mandatory, non-waivable aspect of every contract governed by Delaware law.”  See footnotes 4 and 5.

Implied Covenant Analysis

● The first step in the analysis of the implied covenant is: “the process of contract construction, which is distinct from the process of contract interpretation.  Interpretation is the process by which a court resolves ambiguity in the express terms of a contract . . ..  By contrast, construction is the process by which a court determines the scope and legal effect of those terms.”

● The second step is:  “If a contractual gap exists, then the court must determine whether the implied covenant should be used to supply a term to fill the gap.  Not all gaps should be filled.”  See Slip op. at page 38.

● The court must determine whether the language of the contract expressly covers a particular issue, in which case the implied covenant will not apply, or whether the contract is silent on the subject, revealing a gap that the implied covenant might fill.  Id. at page 38.

● Examples of gaps that need to be filled and which may exist in a contract include the following:  (1) where the parties simply fail to perceive a need for the term and never considered to include it; (2) when the parties felt the issue was too unimportant or too remote to warrant negotiations or inclusion; and (3) the term was too obvious to articulate.

● The court explained that:  “Terms are to be implied in a contract not because they are reasonable but because they are necessarily involved in a contractual relationship so that the parties must have intended them and have only failed to express them because they are too obvious to need expression.”  Id. at page 40.

Comparison Between Implied Covenant and Fiduciary Duty

● The court emphasized that the implied covenant is not a substitute for fiduciary duty analysis.

● The limited partnership agreement in this case eliminated all fiduciary obligations.

● The court found that the implied covenant alone “cannot support a generalized duty to disclose all material information reasonably available.”