Chancery Reviews Pre-Suit Demand Requirements

A recent Delaware Court of Chancery opinion provides practical instruction for corporate litigators regarding the difference between a direct v. derivative claim as well as an analysis of the requirements under Rule 23.1, and an application of the two-prong test in Aronson v. Lewis to satisfy the prerequisite of pre-suit demand futility.  Chester County Employees’ Retirement Fund v. New Residential Investment Corp., C.A. No. 11058-VCMR (Del. Ch. Oct. 7,2016). This case involves a challenge to a transaction involving affiliated entities.

Key Legal Principles Addressed

The Court conducts an educational description of a direct and a derivative claim, as well as recognition that some claims are both direct and derivative.

The Court also reviewed the standard under Rule 23.1 which embodies the pre-suit demand requirement that must be satisfied for a derivative claim.  The Court reviewed the two-pronged test to demonstrate demand futility with particularized facts that allege a “reasonable doubt” that: (1) the directors are disinterested and independent; and (2) the challenged transaction was otherwise the product of a valid exercise of business judgment.  In addition to providing a definition for determining if a director is “disinterested” as well as “independent”, the Court discusses the second prong which involves the rare case in which a transaction can be shown to be “so egregious on its face that board approval cannot meet the test of business judgment, and a substantial likelihood of director liability exists.”

The Court reviewed the alleged conflicts based on relationships involving interlocking directorships, but found that the plaintiff did not allege sufficient facts to excuse demand. The Court also reviewed the requirements for ripeness and the need for an actual controversy before the Court would hear a declaratory judgment action pursuant to 10 Del. C. § 6501.

Chancery Dismisses Claims Challenging Merger; Applies BJR

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

The Delaware Court of Chancery recently held that because a majority of the fully informed, uncoerced, disinterested stockholders voted to approve a merger, the directors were entitled to deferential review under the business judgment rule (“BJR”).  In re OM Group, Inc. Stockholder Litigation, C.A. No. 11216-VCS (Del. Ch. Oct. 12, 2016).

Background: Plaintiffs are former stockholders of non-party OM Group, Inc. (“OM” or the “Company”).  Plaintiffs filed this action against OM’s former board of directors for what Plaintiffs claimed was a rushed sale to avoid the embarrassment of a prolonged proxy battle.  Essentially, Plaintiffs claimed that Defendants, who were former directors of OM, shut out strategic acquirers in favor of a financial sponsor because the financial sponsor was more interested in acquiring OM as a whole and not its individual business units and this rush to judgment was fueled by a desire to avoid a proxy fight with a dissident shareholder.  Second, Plaintiffs contended that the board failed to manage conflicts with investment bankers who were compensated on a contingency basis.  And finally, Plaintiffs alleged that the board relied on manipulated projects designed to artificially drive down the merger price.

Defendants moved to dismiss under Rule 12(b)(6) on three grounds: First, Defendants claimed that the complaint failed to allege facts that lead to a reasonable inference that the board acted unreasonably under Revlon.  Second, since a majority of the fully informed, uncoerced, disinterested stockholders approved the merger, the board is entitled to the business judgment rule, and Plaintiffs failed to identify any material omissions or misleading disclosures relating to the merger.  Finally, Plaintiffs failed to plead facts that were sufficient to overcome OM’s exculpation clause in its certificate of incorporation.

Analysis: The court explained that when plaintiffs are attempting to hold directors individually liable for a merger that was approved by disinterested shareholders, they must show: (1) the transaction amounted to corporate waste; and/or (2) the stockholders were not truly informed or were actually coerced.  Plaintiffs in this case did not plead corporate waste.  Therefore, the court stated that Plaintiffs were left to show that a material fact was omitted­­––a fact that would have significantly altered the total mix of information––in order to show that the shareholders were approved the merger were not truly informed.

First, Plaintiffs argued that the shareholders were not fully informed because the proxy failed to disclose that Advanced Technology & Materials Co. Ltd. made a competing proposal for $34.00­–35.00, a price slightly higher than the merger price, during the go-shop period.  The court rejected this argument because while the proxy statement did not mention Advanced Technology & Materials Co. Ltd. by name, it did state that OM had received competing bids, but OM was excluded from negotiating with them under the merger agreement.  Therefore, stockholders were informed of the competing bid when they cast their ballots for or against the merger.

Second, Plaintiffs alleged that OM failed to disclose that Steven J. Demetriou, a member of the OM board, was also Chairman and CEO of a company partially owned by Apollo (the acquiring company), and met with Apollo during the sales process, and that such omissions were material.  The court held that no facts in the complaint supported the view that Demetriou’s connection with Apollo was a material omission.  All the complaint stated was: (1) Demetriou was the CEO of Aleris; (2) Apollo owns 18.99% of Aleris; and (3) Demetriou had lunch with a key Apollo employee.  The court held that any alleged omission under these facts is conclusory and would not have been material to a reasonable investor.

Finally, Plaintiffs alleged that stockholders were uninformed about the amount of fees Apollo paid to Deutsche Bank, which served as a third-party advisor, until the day the OM board approved the merger and the proxy failed to disclose that OM initially contemplated hiring Deutsche Bank on a flat-fee basis.

Again, the court rejected that argument because, as it stated, “Plaintiffs have not well-pled facts that allow me to conclude it is reasonably conceivable that any of the omissions regarding Deutsche Bank would have significantly altered the total mix of information available to OM’s stockholders.”

Having decided that the majority of fully informed, disinterested, uncoerced stockholders voted to approve the merger, the business judgment rule applied.  And since Plaintiffs did not allege the merger amounted to corporate waste, they could not overcome the presumption of the business judgment rule.  Therefore, the court granted defendants’ motion to dismiss.


Annual Distinguished Lecture in Law

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

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

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

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

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

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

Prior Lectures have been highlighted on these pages.

Court Grants Motion to Dismiss Previously Released Claims

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

In Geier v. Mozido, LLC, C.A. No. 10931-VCS (Del. Ch., Sept. 29, 2016), the Court of Chancery granted Mozido, LLC (“LLC”) and Mozido, Inc.’s (“Inc.”) motion to dismiss claims by plaintiff Philip Geier (“Geier”) because Geier released his claims against the entities in a previous settlement agreement.

Background: In March 2012, after several courting attempts, Geier agreed to join the LLC board of directors. As an incentive, Geier acquired 1% of the outstanding membership units (the “Options”). After resigning from the board a year later, Geier loaned LLC $3 million through the Philip H. Geier Irrevocable Trust (the “Geier Trust”) and The Geier Group, LLC (the “Geier Group”). LLC defaulted on that loan and the Geier Trust and Geier Group filed a suit to recover. An LLC board member repaid the loan and filed an action in Florida against a member of the LLC (“Liberty”) for reimbursement. In the settlement agreement for that action, Liberty and LLC sought the release of any claims Geier, the Geier Trust, and the Geier Group could assert. In that agreement (the “General Release”), the Geier Group and the Geier Trust were named as releasers, but Geier was not.

In 2013, LLC assigned all of its rights and interests to Inc. However, Inc. did not assume LLC’s liability for the Options. Geier made a formal demand in 2014 to exercise his rights to the Options, but both LLC and Inc. have refused.

Analysis: The court reviewed this motion under the well-known Rule 12(b)(6) standard; however, the court noted that the release was governed under New York law. Geier made two separate arguments for why the release did not bind him: First, he argued that reading all of the documents surrounding the release together, the release was only meant to bind the Geier Trust and the Geier Group; and second, the terms of the release show that he was not a releaser.
The court rejected both of these theories. First, the court observed that the release was captioned “General Release” and did not contain any carve outs or limitations on who was bound by its terms. Furthermore, no parol evidence could have been considered since there was no ambiguity. Citing New York law, the court declined to consider the other documents because the General Release was executed separately from the other releases in the settlement documents. The court stated that the different agreements contained separate assents and there was no indication that the General Release was not meant to stand on its own.

Therefore, it had to be interpreted within its own four corners and no extrinsic documents could be considered.
Second, the court observed that the General Release expressly named the Geier Trust and the Geier Group as releasers, but it also stated that it applied to any claims the releasors’ “affiliates, subsidiaries, and parents . . . ever had, now have or hereafter can have” against the releasees. The court found that Gieir is an affiliate of the Geier Group and the Geier Trust because the complaint shows that he is in control of both entities—Geier is a co-trustee of the Geier Trust and Chairman of the Geier Group.

Finally, the court found that Geier also released his claims against Inc., even though it was not explicitly named in the General Release. Simply stated, the General Release contained broad language defining a “releasee” to mean those entities that were named as well as any subsidiaries of the LLC. Since Inc. is a subsidiary of LLC, Geier had no recourse against either entity.

Chancery Awards Injunctions and Damages for Breach of Non-Compete and Non-Solicitation Agreements

Alexandra D. Rogin, an associate at Eckert Seamans, prepared this overview.

The Delaware Court of Chancery recently granted injunctive and monetary relief based on the parties’ contractual agreements and obligations. This case involves two Delaware entities that own school meal management software: inTEAM Associates, LLC (“inTEAM”), and Heartland Payment Systems, Inc. (“Heartland”). The action stems from a transaction in which Heartland bought substantially all of the assets of inTEAM’s predecessor, School Link Technologies, Inc. (“SL-Tech”). inTEAM Associates, LLC v. Heartland Payment Systems, Inc., C.A. No. 11523-VCMR (Del. Ch. Sept. 30, 2016).

Background: In the sale, Heartland acquired WebSMARTT, a program categorized by the USDA as Nutrient Analysis Software. Heartland did not acquire inTEAM’s Decision Support Toolkit (“DST”) program. Three agreements, the Asset Purchase Agreement, the Co-Marketing Agreement, and the Consulting agreement, govern the transaction. The collective agreements contain non-competition, non-solicitation, and cross-marketing provisions.

The Asset Purchase Agreement prohibited the parties from providing competitive products or soliciting customers in competition with Heartland’s business. However, inTEAM’s consulting, eLearning, and DST portions of the business were explicitly excluded from the scope of the provision (the “inTEAM carve-out”). Thus, inTEAM could still competitively pursue those aspects of its business.

The Co-Marketing Agreement also contained reciprocal non-competition provisions. Additionally, it contained a provision obligating Heartland to provide inTEAM with marketing support with respect to particular products. Heartland was allowed to terminate the Co-Marketing Agreement if inTEAM did not meet specified sales targets.

The Consulting Agreement provided that Goodman was to act as an advisor to Heartland. It also contained non-competition and non-solicitation provisions.

The parties later agreed that inTEAM could develop a new program based on DST technology: KidsChoose. Heartland was to share beneficial information in exchange for a portion of the resulting revenue. After KidsChoose failed to meet expectations, inTEAM was allowed to develop a new version of the product. Thereafter, Heartland terminated its support obligations under the Co-Marketing Agreement.

In 2014, inTEAM employees emailed a potential customer about providing an inTEAM alternative to Heartland’s WebSMARTT program. Although WebSMARTT contained POS features, inTEAM was interested in adding a POS feature to its current software. inTEAM later sent two additional emails to a school district to obtain information about their current POS software.

In 2015, Heartland and an inTEAM competitor, Colyar Technology Solutions, Inc. (“Colyar”) submitted a joint proposal to Texas for the development of meal management software. After Texas declined Heartland’s proposal, Heartland promised to “ramp up efforts with Colyar[ ]” to bid in other states.

inTEAM then revealed a new program, CN Central, which combined prior DST technology. The USDA classified CN Central as Menu Planning Tool software, as opposed to Nutrient Analysis Software, such as WebSMARTT.

Parties’ Allegations: inTEAM alleges that Heartland breached its non-competition, cross-marketing, and support obligations by partnering with Colyar and failing to support inTEAM’s software development with respect to KidsChoose. Heartland asserts that inTEAM and Goodman breached their non-competition obligations by developing CN Central in competition with WebSMARTT. Additionally, Goodman breached his non-solicitation obligations by participating in inTEAM’s efforts to solicit business from schools.

Court’s Analysis: The court found that inTEAM did not breach its non-competition obligations, as CN Central was based on DST technology covered by the inTEAM carve-out. The carve-out contemplated future versions of DST software, like CN Central, with greater functionality. The Court did not consider Heartland’s extrinsic evidence on this matter because the agreement unambiguously described the carve-out. The agreement documents plainly discussed the “future release” of DST technology, and anticipated the development of a product with functionality that did not exist at closing.

Heartland also argued that CN Central competed with WebSMARTT because both programs had the ability to analyze nutrients. However, CN Central, a Menu Planning Tool, could only perform a subset of the abilities of Nutrient Analysis Software, such as WebSMARTT. Heartland argued that the USDA’s software classifications were not dispositive, as the programs had overlapping functionality. However, the Court explained that the USDA classifies the various software according to their functionality. Thus, CN Central did not compete with WebSMARTT.

With respect to Heartland, the Court found that it breached its non-competition obligations when it collaborated with inTEAM’s competitor, Colyar, to produce software covered by the scope of inTEAM’s business. It did not matter that the anticipated technology never came to fruition. However, Heartland did not breach its support obligations relative to KidsChoose. KidsChoose was a brand of Heartland’s software, and Heartland validly terminated those obligations in 2013. Regardless, inTEAM did not point to any evidence that Heartland failed to provide adequate cross-marketing aid. Moreover, there was no evidence Heartland caused any problems with the unsuccessful version of the program.

Finally, with respect to Goodman, the Court found that he did not breach his non-competition obligations as a result of the inTEAM carve-out. As discussed, CN Central did not compete with WebSMARTT, despite similar functionality. Additionally, an email evidencing inTEAM’s interest in developing POS features was not proof that inTEAM was actively engaging in selling POS software. However, the Court found that Goodman did breach his non-solicitation obligations when he encouraged a school district to adversely modify its existing relationship with Heartland by proposing an alternative tool to WebSMARTT.

Conclusion: In finding that no equitable defenses applied, the Court granted inTEAM an injunction because: (1) it showed actual success on the merits; (2) breaching a covenant not to compete is an irreparable injury; and (3) the balance of equities favored inTEAM because Heartland agreed to the non-compete covenant, and inTEAM would continue to suffer harm contemplated by the agreements if the behavior continued. However, inTEAM was not entitled to costs and fees pursuant to the language of the agreements.

Similarly, Heartland was entitled to an injunction regarding Goodman. The parties contractually agreed that an injunction was the appropriate remedy for the specified violations. In balancing the equities, the court limited the injunction to six months from the execution date. Unlike inTEAM, Heartland was entitled to damages pursuant to the agreement language.

Pre-Close v. Post-Close Disclosure Claims

A recent Chancery opinion addressed several key legal principles with broad application to corporate and commercial litigation in Delaware. In Nguyen v. Barrett, C.A. No. 11511-VCG (Del. Ch. Sept. 28, 2016), the court addressed several notable topics in connection with claims challenging a merger agreement.

For example, the court explained what was needed to successfully defend a Rule 12(b)(6) motion when trying to rebut the business judgment rule and trying to overcome the exculpatory provisions of DGCL Section 102(b)(7). See Slip op. at 12-14.

In addition, the court discussed the standards of review that apply to disclosure claims made prior to, and after, closing–as well as related nuances and consequences regarding the timing of those claims.

Does BJR Apply to Corporate Officers?

A recent opinion noted an issue that deserves further analysis; namely: are corporate officers protected by the business judgment rule (BJR)? In Palmer v. Reali, Civ. No. 15-994-SLR (D.Del. Sept. 29, 2016), the U.S. District Court for the District of Delaware observed in the context of denying a Rule 12(b)(6) motion that no cases were cited by the defendants to support the position that the BJR applied to officers (as compared to corporate directors). Id. at n.8.

A bankruptcy trustee alleged various breaches of fiduciary duties that the corporate officers engaged in preceding the filing of bankruptcy. Of course, it remains settled Delaware law that fiduciary duties apply to corporate officers as much as they do to corporate directors. But just as officers do not enjoy the exculpatory provisions of DGCL Section 102(b)(7), at least one court in Delaware was not aware of authority for, or was not provided with citations to support, the position that officers are entitled to the presumptions of the BJR. This aspect of corporate litigation scholarship would be a good topic for a law review article.

Hat tip to The Chancery Daily for bringing this recent decision to our attention.

Supplement: This post was only intended as a short observation of how one court treated the issue in footnote 8 of the opinion, but we are grateful to Professor Megan Shaner, a former Delaware corporate litigator, who brought to our attention her scholarship on the titular topic. For example, the good professor wrote an article in 2010 in the Business Lawyer, entitled “Restoring the Balance of Power in Corporate Management: Enforcing an Officer’s Duty of Obedience” in which she cites to the scholarship of Lyman Johnson (whose articles have been noted on these pages over the years) and friend-of-the-blog Larry Hamermesh (same), all of which discuss the application of the BJR to officers.

Scholarship on Limited Liability

Professor Stephen Bainbridge, a nationally-recognized corporate law scholar whose scholarship has been cited in the opinions of Delaware courts, has added another book to the list of his prolific publications. He has co-authored with Professor Todd Henderson, a book entitled “Limited Liability: A Legal and Economic Analysis“. It has been favorably reviewed in The Economist magazine, and the publisher’s flyer has additional details.

For those interested in the latest cutting-edge analysis of LLC law by leading experts, this book should be on your shelf. One of the gems found in this book is a discussion of how the concept of piercing the corporate veil is applied in the context of an LLC for purposes of imposing personal liability on an LLC member.

Delaware Firearms Law Seminar

The Delaware Association of Second Amendment Lawyers will present its Third Annual Delaware Firearms Law Seminar on October 6, 2016 at 8:30 a.m. in Wilmington, Delaware, at the Doubletree Hotel. The foregoing hyperlink has more details, but in addition to nationally-recognized constitutional law scholars, two members of the Delaware judiciary will be making a presentation that qualifies for legal ethics CLE.

Extra-Contractual Claims Barred

This Court of Chancery decision provides a useful example of those circumstances in which the express terms of a contract serve as a barrier for claims of fraud, misrepresentation and related claims that are dependent on statements or other facts outside the four corners of an agreement. Flores, et al. v. Strauss Water Ltd., C.A. No. 11141-VCS (Del. Ch. Sept. 22, 2016).

Background: This case involves a claim by a bankruptcy trustee that a creditor masterminded a fraudulent scheme to obtain valuable technology and business opportunities from a company to whom it loaned money – – with the expectation that the company would not be able to repay the loan and then the lender would obtain valuable assets upon default.


Among other reasons why this decision is of practical value to commercial litigators is the excellent statement of important legal principles of Delaware law and the elements of a cause of action for common claims in commercial litigation.

First, the court provides an exemplary recitation of the standard under Court of Chancery Rule 12(b)(6) for failure to state a claim upon which relief can be granted.

The court recited the elements of the cause of action for the following claims, and with one limited exception found that the express terms of the contract barred such claims: (1) fraud; (2) fraudulent inducement; (3) negligent misrepresentation; (4) breach of the implied covenant of good faith and fair dealing; (5) breach of contract; (6) promissory estoppel; (7) estoppel; (8) tortious interference with contract; and (9) tortious interference with prospective business relationship. The court also highlighted some elements of the foregoing claims that are common or shared.

The court found that the claims contradicted clear and unambiguous terms of the written contract between the parties which was negotiated through sophisticated counsel.  Among other reasons described in this 40-page decision, the court explained that the claims for negligent misrepresentation are limited by the economic loss doctrine.  [Compare: equitable fraud v. negligent misrepresentation.] In addition, the claims for tortious interference with contract failed because the allegedly improper acts were expressly permitted by the parties’ contracts.

The court found, however, that there was a reasonably conceivable inference that Strauss tortiously interfered with prospective business relationships.