Interlocutory Appeal on Spoliation Issues Denied

A short ruling today by the Delaware Court of Chancery contains excellent quotes on two procedural topics, with which proficiency may not be needed every day–but this decision still deserves a place in the toolbox of those who labor in the vineyard of corporate and commercial litigation. In Chrome Systems, Inc. v. Autodata Solutions, Inc., et al., Civil Action No. 11808-VCG (Del. Ch. Sept. 21, 2016), the court addressed the public policy reasons that spoliation of evidence is contemptible and why interlocutory appeals are rarely permitted.

On spoliation, which was also addressed in another recent Chancery ruling highlighted on these pages, even though the court stayed its hand pending a decision by an arbitrator handling other issues in the case, the court explained that:

Because spoliation inhibits the search for truth and the administration of justice, it is anathema to our courts; accordingly, allegations of spoliation are taken seriously. There are, to my mind, two components involved in the appropriate resolution of claims of spoliation: minimizing its effect on the administration of justice, which may require shifting burdens of proof or excluding submissions of evidence by the spoliator to prevent prejudice to the non- spoliating party; and use of the contempt power to vindicate the integrity of the Court and the interest of the public in the preservation and presentation of evidence, in the interest of justice.

This topic has been in the news lately in connection with one of the candidates for president, but litigators recognize it as a serious issue.

Regarding the trial court’s review of a request for an interlocutory appeal, before the Delaware Supreme Court addresses it, the Vice Chancellor observed that:

As Supreme Court Rule 42 makes clear, interlocutory appeal is an extraordinary remedy, which “should be exceptional, not routine, because [such appeals] disrupt the normal procession of litigation, cause delay, and can threaten to exhaust scarce party and judicial resources.” Before certifying an appeal, I must determine that an interlocutory appeal would bring “substantial benefits that will outweigh the certain costs that accompany” such an appeal. (citing Supr. Ct. R. 42(b)(ii)).

The court declined the invitation to certify the interlocutory appeal. Notably, the Delaware Supreme Court recently amended the rule to emphasize that such an appeal should only be considered in truly rare circumstances.

$542,000 Awarded Based on Injunction Improvidently Granted

Justin M. Forcier, an associate in the Delaware office of Eckert Seamans, prepared this overview.
The Delaware Court of Chancery recently granted a motion to dismiss based on an application of the business judgment rule, and a motion to recover damages based on the earlier grant of an injunction later determined to have been improvidently granted. This case stems from a merger between C&J Energy Services, Inc. (“C&J”) and its subsidiary Nabors Industries Ltd. (“Nabors”). City of Miami General Employees’ & Sanitation Employees’ Retirement Trust v. Comstock, et al., C.A. No. 9980-CB (Del. Ch. Aug. 24, 2016)

Background: Plaintiffs originally sued to block the merger and were issued a preliminary injunction by the court, but that decision was reversed by the Delaware Supreme Court. That decision was highlighted on these pages.

Following the Delaware Supreme Court’s decision, the transaction was approved by 97.66% of the stockholders who voted, or 81.73% of the outstanding shares.
With overwhelming stockholder approval, the transaction closed and the two entities merged. Seven months following the close, Plaintiffs filed an amended complaint alleging breaches of fiduciary duties against members of the C&J board and certain C&J officers for entering into the transaction with Nabors. The amended complaint also alleged, for the first time, various disclosures that were distributed to the C&J stockholders prior to the merger were deficient. Finally, Plaintiffs alleged that Morgan Stanley & Co., who served as the financial advisor for the special committee that ran the solicitation process, aided and abetted those breaches of fiduciary duties.
Defendants filed a motion to dismiss for Plaintiffs’ failure to state a case and a motion to recover damages in the amount of approximately $542,000. The court granted both motions.
Analysis: The court began its analysis with the seven theories alleged under the disclosure allegations. The court noted that material information must be disclosed to stockholders, but ultimately held that the alleged inadequacies in the disclosure documents would not have significantly impacted the “total mix” of available information. The court noted that despite having filed a pre-merger action, Plaintiffs waited until after the closing to challenge the disclosure—thus precluding any possible remedy through additional disclosures. However, instead of dismissing this claim under the doctrine of laches, the court evaluated the claim on the merits pursuant to Corwin v. KKR Financial Holdings, LLC.
The court rejected Plaintiffs’ claim that the proxy contained false information regarding the company’s post-merger EBITDA. The court found that the amended complaint failed to plead facts that the C&J CEO’s concession to pay a higher EBITDA multiple if the EBITDA forecast declined and that this concession resulted in the CEO’s willingness to stretch the EBITDA multiple in order to achieve a higher valuation.
Next, the court rejected Plaintiffs’ argument that the disclosures should have stated that the $445 million EBITDA estimate was management’s “upside case.” The court stated that such an assertion could not be squared with the Supreme Court’s review of the preliminary injunction. The “upside case” language was used as a negotiation tactic, not a projection by C&J management.
Plaintiffs also challenged the Nabors disclosures of the post-closing company’s EBITDA forecast. The court again rejected this claim because although the amended complaint alleged that Nabors numbers were incorrect, it did not state that C&J was aware of the inaccuracies or relied on numbers other than those provided by Nabors.
Next, Plaintiffs alleged that the disclosures should have included a synergy tax from a fictitious $1 billion intra-company loan. However, this was rejected because the Plaintiffs did not allege that the loan or tax benefits were would fail to produce the expected tax synergies.
Fourth, Plaintiffs claimed that the disclosures should have included information about a statement the C&J CEO made that he would refuse to sign the merger agreement if he and his team were not guaranteed future employment. This too was rejected because the proxy stated that C&J’s management team and Nabors would finalize the terms of the of their proposed employment arrangements.
Next, Plaintiffs claimed that Citi Group Global Markets Inc. breached its own conflicts policy by providing deal financing and advice and that information should have been disclosed. The court found that this information was indeed included in the proxy in a way that gave sufficient notice to a stockholder.
Sixth, Plaintiffs argued that other potential bidders should have been made known to stockholders. However, the disclosures did state that alternative bidders were not likely to produce a superior proposal than that received by Nabors. The court found that this was enough and the details of the other bidders were superfluous
Finally, Plaintiffs asserted that information concerning Morgan Stanley & Co.’s independence as the special committee’s financial advisor should have been included. However, the court again rejected this claim because the solicitation process became null upon the Supreme Court’s reversal of the injunction.
BJR and Fiduciary Duty Claims: Next, the court addressed the claims of breaches of fiduciary duties and ultimately applied the business judgment rule to review the transaction.
First, the court rejected Plaintiffs’ claim that a majority of the C&J board was conflicted. The board consisted of seven members, four of whom stood to be nominated to the surviving company’s board. However, this was not enough to hold that the members were interested in the transaction because, as the court noted, it would require the members to give up their current positions for the prospect of getting another.
The court also found that complaint failed to properly allege that C&J’s CEO deceived the board. Although the CEO stood to receive a lucrative employment contract, there was no evidence that this contract was a material increase from his existing ones or that his position was in danger. Furthermore, the CEO’s large equity stake helped to align his interests with those of the stockholders.
The court then held that the remainder of the fiduciary duties claims should be dismissed, which were centered on the level of reasonableness and care the board took in approving the merger. The court noted that the claims could have survived under a Revlon standard; however, that is not the standard for a post-closing action for damages that was approved by a majority of independent stockholders. Also any claim for aiding and abetting a breach of fiduciary duties cannot survive when the underlying claims of breach have not survived.
Finally, the court granted damages to Defendants in the amount of $542,087.89 as a result of a wrongful injunction because Plaintiffs were unable to state a claim for breach of fiduciary duties or to support a finding of bad faith.

Former CEO Entitled to Advancement and Fees on Fees under the Delaware LLC Act.

Justin M. Forcier, an associate in the Delaware office of Eckert Seamans, prepared this overview.
The Court of Chancery recently granted advancement of fees in Harrison v. Quivus Sys., Inc., C.A. No. 12084-VCMR (Del. Ch. Aug. 5, 2016) (TRANSCRIPT), based on the more flexible language of the Delaware LLC Act as compared with the more rigid structure of the Delaware General Corporation Law.

Background: Plaintiff John E. Harrison formed a joint venture with Prince Bander Bin Adbulla Bin Mohammed Al-Saud of Saudi Arabia in 2007. The name of the entity was Quivus Systems, Inc. (“Quivus”). Quivus was formed under the Delaware LLC Act and included advancement rights to members or managers of the company (and their heirs, estate, personal representative, or administrators) to the fullest extent allowed under Delaware law.
After the business relationship between Harrison and Prince Bander broke down, Harrison was removed from his position as CEO in 2014. One year later, Prince Bander filed a lawsuit against Harrison in Washington, D.C., alleging claims of mismanagement, incompetence, and corporate malfeasance while Harrison was serving as the CEO. Harrison sent a letter to Quivus demanding advancement of fees to defend the charges against him and Quivus refused. Harrison then filed this action in the Delaware Court of Chancery.
Analysis: The court began its analysis by observing that this case was not a normal, run-of-the-mill advancement action because it was being brought under the more flexible Delaware LLC Act and not under § 145 of the Delaware General Corporation Law. The significant difference between the two statutes is that advancement under the DGCL normally hinges on whether the defendant is being sued “by reason of the fact” that he took action in his official corporate capacity. Under the Delaware LLC Act, however, advancement and indemnification is available for “any and all claims and demands whatsoever.”
Defendants asserted that notwithstanding this broad language, Harrison did not have advancement rights because he was sued a year after being removed as the CEO. The court rejected that argument because it stated, “If nothing else, Harrison was a present manager when he was CEO of the company and when the events underlying the . . . action occurred.”
The court also found that the defendants’ interpretation improperly ignored the advancement clause’s language that future managers are owed rights. The court found that this rejected logic of the company was reminiscent of the movie Spaceballs, in that the company argued Harrison “could be a present manager in the past, but not in the present,” for the purpose of advancement. The court also reiterated Delaware’s public policy of respecting advancement rights to encourage qualified persons to serve as corporate directors without the ever-present threat of having to fund a lawsuit to defend themselves.
Finally, the court held that in light of Harrison’s success, he was entitled to attorneys’ fees on top of his advancement fees, more commonly known as fees on fees.

Court Rejects Section 220 Demand for Corporate Records

This Delaware Court of Chancery opinion is notable for denying, after trial, a demand for books and records of a publicly held company for purposes of valuation and to seek documents under Section 220 to investigate alleged mismanagement based on Caremark claims.  Beatrice Corwin Living Irrevocable Trust v. Pfizer, Inc., C.A. No. 10425-JL (Del. Ch. Sept. 1, 2016). This opinion provides an excellent explanation and example of a successful defense to a demand by a stockholder for corporate records.

This is the second Section 220 opinion within the span of a few days by former Master in Chancery LeGrow, who is now a Delaware Superior Court Judge, but was appointed to decide these cases as a Vice Chancellor-by-Designation under Del. Const. art. IV § 13(2). The prior case was also highlighted on these pages.

Background:

The stockholder seeking books and records under Section 220 in this matter is a trust. The two stated purposes for the demand were both proper purposes but they still did not satisfy the nuanced requirements established by case law which must be satisfied in order for the proper purpose requirement to be met. The purposes for demanding books and records in this case were to investigate mismanagement of alleged Caremark claims for failure to disclose the amount of tax liability for the billions of dollars in revenue that was “located” outside the United States–if the funds were repatriated into the U.S. But the company had no plans to repatriate those funds in the United States, at which time they would be subject to taxation. The company maintained that it had no foreseeable plans to repatriate the funds and therefore there was no need to determine the tax liability. Moreover, they were not required to do so under the applicable accounting standards based in part on their position that to do so was not practicable.

The plaintiff maintained that nonetheless it was a violation of the board’s fiduciary duty of oversight not to determine the amount of potential tax if the funds were repatriated, and they claimed that would have an impact on the valuation. The Court disagreed based on a careful and thoughtful analysis.

Analysis:

The court provided the public policy reasons why it must balance the interests of a stockholder in obtaining books and records with the duties of the board of directors to manage the affairs of the corporation under DGCL § 141. This opinion provides excellent recitations of important principles of corporate litigation and corporate governance involved in Section 220 demands. The many nuances of this common claim as established by case law over the years are explained in lucid fashion.

The sole issue in this case was whether the plaintiff satisfied the prerequisites for establishing a proper purpose for the inspection. The court found that the trust failed to satisfy the necessary elements of a proper purpose which in this case meant that the plaintiffs neither: (i) established that they have a credible basis to investigate mismanagement or wrongdoing based on their Caremark allegations, (ii) nor have they shown that the tax issues for which they sought information would have any material impact on the valuation of the company.

Importantly, the court explained that in order to satisfy a proper purpose for investigation of mismanagement, “mere suspicion” or “subjective belief of wrongdoing, without more, is not sufficient to stay a proper purpose.”

The court provides a very useful explanation of the details that would satisfy the credible basis standard when a Section 220 demand alleges the failure of the board to fulfill its duties under Caremark.

Compare the case cited at footnote 39 in which a successful 220 case based on a Caremark claim was recognized by the Court of Chancery. See Oklahoma Firefighters Pension and Retirement System v. Citi Group, Inc., 2015 WL 1884453, at *5-6 (Del. Ch. Apr. 24, 2015).

This opinion is also helpful to explain those situations in which a publicly held company can successfully defend against a demand for books and records when the purpose stated is valuation and there has not been a satisfactory justification for explaining why the documents requested are necessary for purposes of valuation – – or not otherwise publicly available.

Commentary:

This opinion should be read together with the opinion by Vice Chancellor-by-Designation LeGrow which was published within a few days of this decision in the matter of Bizzari v. Suburban Waste, highlighted on these pages here, in which the demand for corporate records by a director was denied based on somewhat unusual facts involved in that case.

Both of these cases involve post-trial denials of Section 220 demands. Readers of these pages over the years will be forgiven for perceiving a constant refrain in the commentary on many of the Section 220 cases highlighted on these pages in which one might detect a theme that Section 220 cases can be quite expensive and time-consuming and, after trial, do not always result in any substantial document production for the plaintiff.

Delaware Primer on BJR Applicability and Stockholder Ratification

Why Notable: This Delaware Chancery decision is essential reading for those involved in corporate litigation who need to know under what circumstances uncoerced and informed stockholder approval will cleanse the vote of a conflicted board and entitle it to the defense of the business judgment rule (BJR) – – when no controlling stockholder is involved either on one-side or on both sides. Larkin v. Shah, C.A. No. 10918-VCS (Del. Ch. Aug. 25, 2016).

Highlights: The background facts of this case feature the increasingly prevalent situation of either a venture capital affiliated stockholder or a private equity affiliated stockholder whose appointed directors are accused of selling the company for less than might have otherwise been negotiated, based on the alleged goal of liquidating their investment early, instead of waiting for a later, perhaps more speculative but potentially more lucrative deal. This opinion provides one of the more pithy restatements of basic corporate governance principles such as the:

1) articulation of the fiduciary duties of directors;

2) presumption of the BJR as a standard of review;

3) when the BJR applies;

4) how the BJR is rebutted.

This opinion also provides an eminently clear articulation and application of the various permutations of one-sided or both-sided controlling stockholder transactions, and what standard of review applies, as well as the standard that applies in this case, where there is no controlling stockholder – – but there is stockholder approval.

An application of the recent Chancery opinion in the Volcano case, and the Supreme Court’s Corwin decision, is also worth the time required to read this 55-page jewel.

Many other important restatements and clarifications of Delaware M&A law are found in this ruling but are not covered in this short overview. This opinion is a likely candidate for one of the most useful opinions of 2016.

Chancery Applies 3-Year Contract Statute of Limitations

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

The latest Delaware opinion in long-running litigation in this case granted partial summary judgment as a result of the claims for breach of contract being subject to the three-year statute of limitations for contracts. AM General Holdings LLC v. The Renco Grp, Inc. & The Renco Grp., Inc. v. MacAndrews AMG Holdings LLC, C.A. No. 7668-VCS (Del. Ch. Aug. 22, 2016). Even a casual reader of this blog will recognize the parties in this case because several of the many prior decisions in this case have been covered on these pages.

Background: This long-lasting litigation stems from a joint-venture transaction between Renco and MacAndrews. Renco alleged that the merger agreement was breached when MacAndrews: (1) made unauthorized royalties and management payments to MacAndrews AMG; (2) made unauthorized ER&D payments; and (3) made unauthorized transfer pricing transaction for the engines involved in the deal. MacAndrews defended by claiming Delaware’s 3-year statute of limitations bars all of these claims because the alleged breach occurred over a decade ago.

Analysis: First, Renco argued that the statute of limitations did not begin to run for the unauthorized royalties and management payments because it claimed that the payments were made out of a mutual, running account. For this Renco relied on 10 Del. C. Section 8108, which provides that the statute of limitations does not begin to run on a mutual, running account until the account closes.

The court rejected this argument because it noted that the parties’ accounts were separate and were irreducible to a single balance. Moreover, any periodic distributions from the two accounts were calculated based on proportional values of each separate account. Therefore, the statute of limitations applied.

Second, Renco alleged that the misconduct that had occurred since 2004 was a continuing breach, which starts the clock for the purposes of statute of limitations only when full damages can be calculated. Renco contended that the alleged breaches were inexorably intertwined because each breach was part of a broader scheme to enrich MacAndrews’ account at Renco’s expense.

Again, this argument was rejected. The court found that each time MacAndrews made an unauthorized management fee and royalty payment, misallocated ER&D, or manipulated transfer pricing, it constituted a separate breach with a separate effect on Renco’s account. Therefore, these alleged breaches were not inexorably intertwined and the statute of limitations barred any recovery.

Finally, Renco attempted to invoke the time of discovery doctrine and toll the statute of limitations for the ER&D claims and the transfer pricing claims because it was unable to discover the predicate facts for those breaches.

The court also rejected this argument. During the negotiations between the entities, Renco exerted great effort to protect itself from any mismanagement of the venture by MacAndrews. Renco secured broad books and records rights and MacAndrews agreed to make regular disclosures concerning the accounts. The court also held that equitable tolling did not apply because a prior court ruling determined that the parties disclaimed any fiduciary duties that would otherwise apply in the joint-venture agreement. Lastly, the court held that the relation back doctrine did not apply because the original complaint does not infer the facts that the current claims were based upon.

Holding: Therefore, the court granted summary judgment for MacAndrews because the claims were barred by the statute of limitations applicable to contracts.

New Chair of ABA Business Law Section

Congratulations to Delaware attorney Bill Johnston on becoming the new chair of the American Bar Association’s Business Law Section. Bill is a partner at Young Conaway Stargatt & Taylor in Wilmington where he concentrates on corporate and other business counseling and litigation, with an emphasis on Delaware Chancery Court practice and Delaware Superior Court Complex Commercial Litigation Division practice. Bill is widely-respected around the country as the consummate gentleman. In my view and the view of many others, by his example Bill sets the standard by which others should be measured.

Bill is married to The Honorable Mary Miller Johnston, a Judge of the Delaware Superior Court. The ABA is fortunate to have someone of Bill’s high caliber and integrity to lead the Business Law Section.

Director Barred from Receiving Corporate Records

Why This Decision is Noteworthy: A recent Delaware Court of Chancery decision should be read by all corporate litigators who need to know when a director can be prevented from receiving books and records of a corporation on whose board he serves. Bizzari v. Suburban Waste Services Inc., C.A. No. 10709-JL (Del. Ch. Aug. 30, 2016).

Background: This case involves a closely held company in which the founder was later fired when a new stockholder who acquired a 1/3rd interest joined forces with an original stockholder who owned another 1/3rd interest in the company. This opinion provides a rare instance in which the court denies a director unfettered access to the books and records of a corporation on whose board he serves, but this case also involves somewhat extreme facts which are not often replicated.

Analysis: This blog is replete with summaries of many decisions involving stockholders and directors who demand books and records of a corporation or an LLC under DGCL § 220 and the analogous section of the Delaware LLC Act at 6 Del.C. § 18-305. A common theme in the multitude of such cases highlighted on these pages is that what appears to be a relatively simple statute that allows few successful defenses, nonetheless–on a practical level, is often met with expensive and protracted litigation (which is, by court guideline, supposed to be a summary proceeding). To the extent this case lasted for more than a year (through no fault of the court, in light of a stay to allow for settlement discussions), and involved discovery; pre-trial briefing; a trial; and post-trial briefing which gave the stockholder and director who demanded books and records very little of what was sought, this case is consistent with the referenced common theme observed by this writer in the many Section 220 cases reviewed on these pages over many years.

Still, this opinion provides an excellent recitation of the multi-faceted, nuanced prerequisites for demanding books and records, including the recognized proper purposes and the limited defenses available.

Court’s Reasoning: The primary basis for the court’s reasoning in this case was centered on the somewhat unusual facts. The court found during trial that the director and stockholder, who was also a member and manager of an affiliated LLC, engaged in efforts to compete with and inflict reputational harm on the entities. The plaintiff’s actions in that regard were “driven by his intense hatred of the entities’ other two owners and principles.” Together with the familial relationship of the plaintiff with one of the entities’ main competitors, it makes the “prospect of the plaintiff misusing the books and records both real and troubling.”

In sum, the court concluded that “the entities have carried their rather substantial burden of proving that the plaintiff’s demand to inspect books and records in his capacity as a director and manager is not motivated by a proper purpose.”

Key Defenses for Entities Opposing Demands for Corporate Books and Records:

The defense of the corporation and LLC in this matter that was largely successful. The entities demonstrated to the satisfaction of the court that the plaintiff did not have a credible basis from which the court could infer possible mismanagement or wrongdoing–based on the allegations in the complaint. Equally important was the court’s finding that notwithstanding the stated purpose for the demand which was proper, the “true purpose” for the plaintiff’s demand of books and records was “to compete with, and inflict reputation harm on, Suburban Waste because of his personal animus toward” the other two principals  and managers of the entities.

Importantly, the general rule is that a director should be entitled to unfettered access to the books and records based on the need of a director to fulfill his duty to oversee a company. That presumption, however, was rebutted in this instance because of the evidence shown at trial that the director in the past not only competed with the companies but attempted to damage their reputation–even if it may have been contrary to his economic interests. The court determined that his primary purpose in demanding inspection of the documents was to gain access to confidential information with the aim of harming the company.

Although one of the stated purposes was valuation, and the court explained why that was a proper purpose, and why he would be given limited “high level” financial information for purposes of valuing his stocks, the additional information he requested would not be provided based on the following improper purposes that the court found were the primary reason the stockholder wanted to obtain the books and records: (1) The purpose was adverse to the company; (2) The purpose was not related to a legitimate interest of the stockholder; and (3) It was intended to harass the corporation. See footnote 36.

The foregoing was true notwithstanding the general principle that as long as the primary purpose of the stockholder to obtain books and records is legitimate, “any secondary purpose is considered irrelevant.” See footnote 35. Although the threshold to establish that the stated purpose is not the primary purpose can be challenging, the facts of this case made that defense more easily available for the corporation.

There are many other gems in this opinion regarding the many nuances of the prerequisites of, and defenses to, demands for books and records which makes this opinion essential reading for those interested in knowing the latest iteration of Delaware law on this topic.

Procedural Notes:

An important procedural note in this case that is important for corporate litigators is the court’s commentary on the impact on this Section 220 case of a subsequently filed plenary action. By subsequently filing a plenary action, the court concluded that the plaintiff had sufficient information under Rule 11 to file the plenary complaint without first inspecting the books and records sought in this action. The court reasoned that by filing the subsequent plenary action, the plaintiff in this case effectively “conceded that the books and records he seeks are not necessary or essential to his stated purpose of investigating mismanagement or wrongdoing.” Moreover, the court reasoned that the plaintiff “can complete any additional investigation under the much broader discovery that will be available to him” in the plenary action.

This reasoning should be compared with another very recent Chancery opinion that made similar observations about the interface between a Section 220 action and a subsequently filed plenary action while both cases were pending at the same time. See In Re Investors Bancorp, Inc. Stockholder Litigation, highlighted on these pages.

Another useful practice tip is contained within this opinion to the extent that it describes the types of documents that are necessary for purposes of valuing an interest in a closely-held company. This should be compared with a Chancery decision in Lim v. The PowerWise Group, Inc., highlighted on these pages, in which the Court of Chancery required an extensive list of data to be provided in order for a valuation to be completed. That list of data was based on one of the leading treatises on valuation, authored by Shannon Pratt. 

The point here is that even if valuation is the stated proper purpose, vigorous litigation can result regarding what specific documents are necessary in order to satisfy the proper purpose of valuation. The court observed in the instant case that some of the documents sought for valuation purposes were in reality sought primarily to obtain information about clients and vendors and creditors in order to allow the plaintiff “to further his vendetta” against the other two stockholders, one of whom was the plaintiff’s wife and the other was a former friend of the plaintiff, who was sleeping with the plaintiff’s wife during the plaintiff’s marriage.

Although there are others, the last practice tip that I will note in this overview is that, unlike for a stockholder demand, in a demand for a stockholder list, and/or when a director is demanding books and records, the corporation has the burden of proof to establish that the purpose for the inspection is improper. In this case, the evidence at trial demonstrated that the plaintiff’s motives were “inconsistent with his fiduciary obligations and with the interests of Suburban Waste and its stockholders.” Thus, the corporation met its burden of proof.

Postscript: This decision should be compared to an opinion authored by the same jurist and issued one day later in the Pfizer case, also highlighted on these pages. That ruling also featured a successful defense by a corporation that opposed a stockholder demand for corporate records for the stated purposes of valuation and also to investigate alleged mismanagement based on Caremark claims.

Non-Signatory Still Bound by Contract

The Delaware Court of Chancery recently addressed important contract principles, including when a non-signatory will be bound by a contract, as well as burden of proof standards and requirements to establish damages, that have wide application for corporate and commercial litigation, in Medicalgorithmics S.A. v. AMI Monitoring, Inc., C.A. No. 10948-CB (Del. Ch. Aug. 18, 2016).

443718-Royalty-Free-RF-Clip-Art-Illustration-Of-A-Cartoon-Black-And-White-Outline-Design-Of-A-Dysfunctional-Family-Fighting-150x150 Background

The first 48-pages of this 86-page opinion are mostly factual details that are important for understanding the case, but for purposes of a short overview and to provide minimum context of the more widely applicable legal principles, this case can be described pithily as involving a manufacturer of medical devices that sent a notice of termination to its exclusive U.S. distributor after learning that the distributor was violating the agreement by developing a competing product, and based on related troubles with the contractual relationship. In return, the distributor counterclaimed that the manufacturer was in breach. After a careful analysis, the court found that the distributor was in material breach and the manufacturer’s notice of termination was justified.

Legal Principles

The court provided an unusual analysis to support its finding that a non-signatory was bound to a contract because it was an affiliate of the signatory, and was controlled by the signatory, and the contract applied to affiliates. Moreover the affiliate accepted the benefits of the contract. See footnote 219.

The court describes the factors that must be considered in order to conclude that a breach is material such that it relieves the other party to the contract of its performance obligations. See page 66.

The analysis of when a party has materially breached such that the other contractual party need not perform is a high-stakes determination because if a court later finds that there was no material breach, then of course the contractual obligation to perform will be turned against the party claiming a breach.

A useful definition of the burden of proof based on a preponderance of the evidence standard, is something that all litigators should keep in mind at the outset of a lawsuit. See page 50.

The court observed that damages need not be proven with mathematical certainty but that speculative damages will not suffice. See pages 73 and 79.

Postscript: A useful practice tip for litigators is found at footnote 214 in which the court observed that a motion that is filed but not sufficiently “called to the attention of the court” later in the litigation may be deemed waived or abandoned.

The Transitive Property of Entity Litigation

In a recent ruling destined to be referred to often, the Delaware Court of Chancery provided the analysis used, in the context of a closely-held company, to determine an award of attorneys’ fees in representative corporate litigation. It is most notable for its discussion of the infrequently discussed concept of the “transitive property of entity litigation.” In the end, in Baker v. Sadiq, C.A. No. 9464-VCL (Del. Ch. Aug. 16, 2016), the court awarded typical fees based on the payment of settlement proceeds directly to the minority stockholder. Also included is a useful recitation of the typical range of fees awarded by the court based on a sliding scale percentage of settlement funds created.

BackgroundMoneyth-150x150

The court explained that the transitive property of entity litigation recognizes that a derivative action that asserts claims for breaches of fiduciary duty and an investor class action that asserts similar theories may be conceptually distinct and doctrinally separate, but can be functionally equivalent and, therefore, substitutes.

The court described the concept of transitive property in mathematics as providing that if A = B, and B = C, then A = C. In the world of entity litigation, the transitive property recognizes that an entity-level recovery can be the equivalent of an investor-level recovery and vice versa. This concept calls to mind a comparison with the syllogistic logic or Aristotelian logic exemplified by the following syllogism: 

Major premise: All humans are mortal.
Minor premise: All Greeks are humans.
Conclusion: All Greeks are mortal.

The court gave the following example of the transitive property concept: Consider a minority investor suing derivatively on behalf of the entity. If the plaintiff prevails entirely the typical remedy would provide a monetary recovery payable to the entity. The entity-level of monetary recovery benefits all the investors indirectly, including the controller who was found liable for breaches of fiduciary duty. The indirect benefit to the minority investor is equal to her percentage interest in the entity multiplied by the amount of the entity-level recovery.

In light of this reality, the controller could make the minority investors whole through a direct cash payment equal to their proportionate share of the entity-level recovery. This, of course, would typically apply in the context of a closely-held company with a small number of stockholders.

Legal Analysis

The court provided several examples of transcript rulings in which the Delaware Court of Chancery employed the transitive property concept to settle derivative actions using investor-level relief.

The court also discussed the legal principles and the public policy basis involved. The benefits of using the transitive property to settle derivative litigation with an investor-level recovery provides an advantage to the plaintiff who gets actual cash rather an indirect benefit. It also benefits the defendant who pays a much lower net settlement amount.

The court referred to the endowment effect in which humans value items that they own or control more highly than items of equal value that they do not own or control.

Direct recovery also incentivizes investors who are not enthusiastic about providing an entity-level recovery to fiduciaries who have a history of defalcation and who present the risk of repeated bad behavior.

Basis for Attorneys’ Fees

The downside for plaintiffs’ lawyers in this situation is that the award of attorneys’ fees for representative litigation is usually based on the total fund created for the settlement. In this context, a direct payment to a minority investor is of course much lower than would be the case in the typical entity-level settlement.

Although counsel for plaintiffs in this case sought a recovery based on a hypothetical entity-level recovery of $25 million on which they based their request for $6 million in attorneys’ fees, the court could find no legal basis for applying a percentage to anything other than the $3.2 million direct benefit to the minority stockholder.

Percentage of Fees Based on Settlement Amount and Stage of Case

The court observed that the customary percentages for fee awards are 10% to 15% of the monetary benefit conferred if a “case settles early.” If a case settles after the plaintiffs have “engaged in meaningful litigation efforts, typically including multiple depositions and some level of motion practice,” fees awards in the Court of Chancery range from 15% to 20% of the monetary benefits conferred. Higher percentages up to 33% at the top range are warranted when cases progress to a post-trial adjudication.

In this case, the court awarded 20% of $3.25 million or $650,000. The court found that this was not excessive based on the amount of $390,000 which the plaintiffs would have billed if this were done on an hourly basis. Especially when compared to the billings by defense counsel of over $2 million, the court found the fee award to be on the low end of the scale, but the most appropriate amount based on the facts of this case.

There are many other gems of legal analysis and public policy reasoning to commend the reader to carefully examine the entire court decision in this matter, which should be required reading for anyone interested in the latest iteration of Delaware law on this topic.

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