Delaware Litigation Lawyer & Attorney : Francis G. X. Pileggi : Corporate, Business, Commercial, Delaware Chancery Court

In Young v. Klaassan, (Del. Ch., April 25, 2008), read opinion here, the Chancery Court granted a motion to compel discovery of the documents that a special litigation committee relied on, and because the defendant referred to the committee's finding in its motion to dismiss. The court did not accept the argument that the references to the committee's findings were "not relied on for the truth of the matter asserted".

 By referencing the committee's findings, the underlying Motion to Dismiss under Rule 12(b)(6) was converted to a Motion for Summary Judgment under Rule 56--for which limited discovery is often allowed prior to the opposing party being required to reply. The court noted the similarity between the facts and the law of this case and the recent Chancery Court decision in Fleischman v. Huang, 2007 WL 2410386 (Del. Ch., Aug. 22, 2007), that was summarized on this blog here.

The Delaware Business Litigation Report has a summary of Young v. Klassan here.

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In re Kent County Adequate Public Facilities Ordinances Litigation Consolidated, (Del. Ch., April 18, 2008),  read opinion here.

The purpose of this post is to provide excerpts on discovery issues listed in the title above that every  business litigator will encounter from time to time, and in those instances this decision will be a useful reference.

Here are a few practical quotes from this Chancery Court opinion:

An inadvertent disclosure of privileged communications will not necessarily
operate to waive the attorney-client privilege.28  In order to determine whether the
inadvertently disclosed documents have lost their privileged status, the Court must
consider the following factors: (1) the reasonableness of the precautions taken to
prevent inadvertent disclosure; (2) the time taken to rectify the error; (3) the scope
of discovery and extent of disclosure; and (4) the overall fairness, judged against
the care or negligence with which the privilege is guarded. 29
The Court is satisfied that Respondents have not waived the attorney-client
privilege with respect to the “inadvertently disclosed” documents.30  First, it
appears that Respondents instituted reasonable precautions to prevent the
disclosure of privileged materials—e.g., their outside litigation counsel reviewed
the documents prior to producing them to Petitioners. Given the volume of
discovery in this case, however, it is not inconceivable that Respondents’ counsel,
even with a diligent review of the documents, could inadvertently have produced
privileged materials to Petitioners.

-------------------------------------------------------
28.  WOLFE & PITTENGER, supra note 16, § 7-2[c][1], at 7-26.
29.  Id. at 7-27; Monsanto Co. v. Aetna Cas. & Sur. Co., 1994 WL 315238, at *6 (Del. Super.
May 31, 1994) (quoting Lois Sportswear, U.S.A., Inc. v. Levi Strauss & Co., 104 F.R.D. 103, 105 (S.D.N.Y. 1985))

-----------------

The following footnote provides excellent insight into why most courts abhor discovery disputes and why they should be avoided if possible. Although in some cases they are unavoidable, I tell younger associates in our firm that if the lawyer(s) on the other side are being childish and boorish, especially if they are out-of-town lawyers, "somebody needs to be the adult" and/or "somebody needs to be the Delaware lawyer" and if it is not a matter that will determine the outcome of the case or is a minor issue, it is more productive to focus on more substantive matters, and swallow one's pride, and pick a battle on a more outcome-determinative issue.

             FOOTNOTE 10:

The Court’s admonition to the parties in Amirsaleh v. Bd. of Trade of City of New York, Inc.,
2008 WL 241616 (Del. Ch. Jan. 17, 2008), regarding the conduct of discovery has considerable force in this case as well, particularly in light of the gratuitous barbed comments and pointed tone in the parties’ recent series of filings (and other communications between counsel submitted into evidence in connection with those filings):

The Rules of this Court are primarily based on the Federal Rules of Civil
Procedure, which were originally crafted in their modern form in 1938. The
framers of the federal rules intended the discovery process to be managed with
little judicial oversight by the parties, and intended that the process be cooperative
and self-regulating. Today, with far more complex cases and discovery processes
that are extraordinarily voluminous and complicated, cooperation and
communication among the parties and their counsel are even more important.
Such communication and cooperation were clearly absent in this case.
Defendants protest at length in their answering brief about [plaintiff’s counsel’s]
failure to discuss this discovery dispute. Such behavior is inappropriate. The
Court does not relish the opportunity to resolve discovery spats that likely could
have been resolved by the parties on their own. If defendants did not understand
[the Court’s prior discovery decision], they should have asked for clarification. If
plaintiff took issue with defendants’ response to discovery request, he should have
reached out to defense counsel to express his concerns. Plaintiff’s counsel should
certainly not refuse to articulate such concerns when explicitly asked to do so by
the other side. Both sides are reminded to treat one another with respect and
civility throughout the discovery process.
Id. at *3 (emphasis added) (citations omitted).

The Court, of course, does not intend to discourage the parties (or litigants generally) from
bringing to the Court’s attention legitimate discovery disputes, which, undoubtedly, will arise from time to time. Moreover, the Court acknowledges that counsel for both parties did, in fact, attempt to communicate regarding the present discovery issues, at least in the latter part of February and in early March. The lack of communication to resolve this dispute following the Court’s March 19 letter opinion, however, is inexplicable. The more acute problem in this case would seem to be the parties’ tendency to adopt intractable positions instead of seeking out pragmatic solutions to move the discovery process along.

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 On May 5th, Widener University School of Law in collaboration with Corporation Service Company (CSC) will be hosting a one day, interactive symposium which looks at The Delaware General Corporation Law (DGCL) in the 21st Century. The symposium aims to provide a forum to generate the best current thinking on how the DGCL needs to be modified to respond to or anticipate changes in markets and technology as the century unfolds. This event will take place on the Wilmington, Delaware campus of Widener Law and will be broadcast live via video webcast.

The symposium will include four panel discussions (The DGCL and Takeovers; Stockholder Litigation Under the DGCL; Stockholders in Corporate Governance; and What We Can Learn from Other Statutory Schemes) and a keynote address by Vice Chancellor Leo E. Strine, Jr.

(Note: keynote address will occur at lunch, which will not be video webcast) Each panel discussion will be followed by an open Q&A session where both in-person attendees and webcast participants will be able to share comments and pose questions. 

For those interested in more details, here is a link to registration and related information.

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In re Morgan Stanley Derivative Litigation, No. 05 Civ. 6515 (S.D.N.Y. Mar. 27, 2008). The U.S. District Court for the Southern District of New York applied Delaware law to dismiss a derivative suit in this case based on the failure to establish that pre-suit demand was excused. One of the claims was that disclosures to the SEC were not made quickly enough. The Wachtell Lipton firm highlights the opinion here on the Harvard Corporate Governance Blog, through which they also provide a link to the text of the decision and their own memorandum providing a fuller summary of the case.

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Here is a link via the Harvard Corporate Governance Law Blog to a memo by the Wachtell Lipton firm that provides wide-ranging suggestions to directors based on Delaware fiduciary duty case law, along with practical commentary that in some respects is akin to business advice on best practices for boards of directors to follow.

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Levitt Corp. v. Office Depot, Inc., 2008 WL 1724244 ( Del. Ch., April 14, 2008), read opinion here. The Delaware Chancery Court was presented in this case with differing interpretations of an "advance notice bylaw" and the argument by Office Depot that Levitt did not comply with the requirements of the bylaw related to Levitt's attempt to nominate new directors to the board in connection with a self-funded proxy contest.

 One of the issues addressed in the court's opinion was the interface between the concepts of "electing" directors as compared with "nominating" directors. The money quote follows:

The remaining question is whether the business of electing directors includes the nomination of directors. Of course, nominating candidates and voting for preferred candidates are separate steps. Levitt has recognized as much. Notwithstanding this difference, nomination is a critical part of the election process-in the absence of other nominations, the stockholder constituency has no electoral choice as between candidates; instead, the shareholders are left with only an “up or down” vote on the company sponsored candidates. Despite the role of nominations in giving substance to elections, i.e., providing shareholders with a selection of candidates, neither Subchapter VII of the Delaware General Corporation Law, FN41,  nor any provision of Office Depot's Bylaws discusses or imposes limitations on the nomination process.FN42  Perhaps the best explanation for this silence is that the concept of nominations is included within the broader category of elections. Typically, the election process is understood as spanning from nomination to voting to vote tabulation to announcement and certification of the results. Given that the Notice speaks generally of “elect[ing] ... Directors,” an item of business that contemplates putting forth individuals for stockholder consideration, the Court can discern no persuasive reason why the business of electing directors should not include the subsidiary business of nominating directors for election, especially where no guidance on the nomination process is found in Office Depot's Bylaws or in the Delaware General Corporation Law.FN43

FN41. Subchapter VII addresses shareholder meetings, elections, voting, and notice.
FN42. See 8 Del. C. §§ 211-233.

Although it was not necessary to the court's conclusion, the issue arose as to the interplay between the federal securities regulations and the disputed corporate bylaw provisions, a point that was addressed in a recent Chancery Court opinion in JANA Master Fund Ltd. v. CNET Networks, Inc., 2008 WL 660556 (Del. Ch. Mar. 13, 2008), expedited appeal granted, No. 141, 2008 (Del., Mar. 19, 2008) , summarized here on this blog.

Nor did the court need to address what impact the longstanding tradition in Delaware law of being solicitous about the sacrosanct shareholder franchise, would have on an interpretation of the bylaw in terms of the right to nominate directors. Nonetheless, in footnote 44 of the opinion, the Court made the following observation:

 Accordingly, the Court need not pass on Levitt's arguments that Section 14 [of the Bylaws at issue], does not apply to shareholder-funded proposals or that its advance notice period is unreasonably long.

Another way of viewing the outcome is to recognize that Office Depot's description of the business to come before the Annual Meeting (i.e., whether “election” subsumes nomination) was not clear and unambiguous. With that, the protection afforded the shareholder franchise, see, e.g., Openwave Sys., 924 A.2d at 239, [ Openwave Sys., Inc. v. Harbinger Capital P'ners Master Fund I, Ltd., 924 A.2d 228, 239 (Del.2007)], which includes the right to nominate competing board candidates, is properly implemented in this instance.

UPDATE: Steve Haas provides a summary here  via the Harvard Corporate Governance Blog.

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 Liberty Property Limited Partnership  v. 25 Massachusetts Avenue  Property LLC, (Del. Ch., April 7, 2008), read opinion here. Even though the focus of this blog is on business litigation cases that apply Delaware law, I include this recent decision that applies the law of the District of Columbia because this 50-page opinion provides insight into how the Chancery Court might approach a similar type of issue under Delaware law. The court's introductory summary of the issues addressed is much more pithy than I could provide, so I include it here verbatim:

This case presents an unusual question for the Delaware Court of Chancery to
answer: Does the contract law of the District of Columbia require the owner of a
building to accept a lease that no reasonable lessor would ever sign simply to facilitate
the lessee’s exercise of a contractual option to purchase the building?
This bizarre question arises because an option holder’s right to purchase a building
was subject to the prior condition that 85% of the building be under leases meeting
certain contractually specified conditions. When the option holder faced the expiration of
its option — an expiration that began a period when the owner could sell the building free
and clear of any option possessed by the option holder — the option holder tendered up a
last-minute “master lease” whereby it purported to lease the required space itself. As the
option holder has been forced to admit, no reasonable lessor would have ever accepted
the lease, because its terms would have been unpalatable to any actual lessor. The only
purpose of the so-called lease was to permit the option holder to exercise the purchase
option.
Indeed, the plain terms of the supposed lease permitted the option holder to
terminate the lease after a mere twelve days if a sale of the building to the option holder
was not closed for any reason, even if the reason for the failure in the closing was
conduct by the option holder. The lease also contained other commercially suspect
provisions, such as the absence of any security deposit, the requirement that a large
commission be paid to the option holder for securing the lease it itself was proposing, and
a holdback of nearly $10 million premised on the speculative costs that might be required
to improve parts of the building. This holdback would be used to meet the needs of
actual tenants who might someday arise to sublease and occupy (for purposes that would
not be known until then) the vast quantities of space the option holder was supposedly
promising to lease. For these and other reasons, even the option holder’s own testimonial
expert on commercial leases suggested that no reasonable landlord would enter into a
lease of this kind and that the only purpose of the lease was not to act as a lease, but as an
artificial fulfillment of the contractual condition to exercise the option.
District of Columbia contract law imposes no obligation on a party to a contract to
engage in an act of charity by waiving a condition precedent to enable an option holder to
obtain its wishes. In this case, the building owner had the freedom to sell the building to
the highest bidder if the condition to the option exercise was not fulfilled. To require the
building owner to excuse the failure of that condition by accepting a sham lease that no
reasonable landlord would accept would rewrite the parties’ agreement and undercut the
narrow reading given to option contracts. Therefore, I reject the option holder’s demand
that I grant it an order of specific performance permitting it to purchase the building at
the price it set in its purported exercise of the option.

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Helaba Invest Kapitalanlagegesellschaft mbH v. Fialkow, 2008 WL 1128721 (Del. Ch., April 11, 2008), read opinion here. [Yes, that is a long and unusual case name. No, it is not a typo.] The Delaware Chancery Court decided an issue in this case that is usually of great interest to both lawyers and clients alike: attorneys' fees awarded by the court. As the court summarized it:

At a hearing held on March 13, 2008, this court approved the settlement of this action as fair and reasonable, but withheld decision on the award of attorneys' fees. This opinion considers the $1,500,000 fee application. The attorneys contend that they are entitled to this fee because they secured a $3,760,000 benefit to the stockholders and a substantial therapeutic benefit through several purportedly material disclosures. For the reasons set forth below, the application for attorneys' fees and expenses is granted in the amount of $500,000, plus expenses [of over $125,000.]

 Instead of the 26.4% of the monetary benefit that the plaintiff's counsel sought, the defendants only would agree to pay them 5% or less--roughly $244,000. In this case, there was no issue that the plaintiff's counsel were entitled to fees, the only issue was how much.

The court recited the familar 5 factors in the Delaware Supreme Court's Sugarland case, cited more recently in the Chancery Court's decision of In Re Plains Resources, 2005 WL 33281, at *3 (Del. Ch. 2005).

 In addition to emphasizing that the benefit to the corporation must be caused by the litigation and not merely  "post hoc ergo procter hoc" (the Latin phrase used by the court is a logical fallacy that means literally: "after this, therefore, because of this");  the court observed that as an alternative to the "common fund doctrine", attorneys'  fees can be awarded pursuant to the "corporate benefit doctrine" when a "tangible monetary benefit has not been conferred, but some other valuable benefit is realized by the corproate enterprise or the stockholders as a group." (footnote omitted.)

The court based its analysis partially on the common fund doctrine and partially on the corporate benefit theory, but notably, the court allowed in footnote 16 that the fee:

 "would not be paid from a common fund itself since the funds have already been paid to the class and the defendants agreed, in the stipulation of settlement, themselves to pay the fee and the expenses awarded by the court. Nevertheless, the court will determine this aspect of the fee petition by applying the same principles that guide the court where an actual common fund still exists."

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In Corporate Property Associates 14 Inc. v. CHR Holding Corp., 2008 WL 963048 (Del.Ch., April 10, 2008), read opinion here, the court denied a Motion to Dismiss fraud and negligent misrepresentation claims against a company for disclosing misleadingly incomplete information to warrantholders that discouraged them from exercising their warrants just prior to a transaction that devalued them--even though the court held that they were not owed fiduciary duties.

The purpose of this blog is to summarize key decision from Delaware courts on corporate and commercial topics. Not infrequently the use of the English language in the courts' opinions is so exemplary that it bears quoting verbatim instead of trying to summarize it, in order to get the full flavor. This is such opinion. It may be on the longer side as far as overviews go, but stick with it because it is worth the wait. The court introduces its opinion with a sketch of the factual and legal issues as well as its holding--with a memorable adage along the way.

The maxim silence is golden is not simply a goad to good manners at the local movie theater, it is good advice in many realms of life. For example, those are truly words of wisdom when you are not under a duty to speak and someone asks you a question that
potentially touches upon information that you would rather not divulge. Here, plaintiffs Corporate Property Associates 14 and Corporate Property Associates 15 (collectively “Corporate Property Associates”) held warrants in defendant CHR Holding Corporation, a wholly owned subsidiary of defendant “Platinum.” FN1  Those warrants did not require CHR to give Corporate Property Associates advance notice of cash dividends and did not protect the value of the warrants from being diluted through the payment of cash dividends. As such, CHR and Platinum had both the ability and the incentive to reduce the value of Corporate Property Associates' warrants by issuing large cash dividends from CHR to Platinum. In 2006 and 2007, CHR recapitalized by undertaking two large debt issuances and using the proceeds of those debt issuances to pay two large cash dividends.

The court summarized its holding on the various issues as follows:

Corporate Property Associates asserts that CHR, Platinum, Kotzubei, and Eva M. Kalawski, CHR's sole director, breached their fiduciary duties to Corporate Property Associates by not providing advance disclosure of the cash dividends. I dismiss those claims because warrantholders are not owed fiduciary duties. Likewise, I dismiss the claim that CHR breached its implied obligation of good faith and fair dealing in the warrants. It would be an error to imply an advance notice of cash dividends term in the warrant contracts because the sophisticated parties who negotiated those contracts included terms addressing similar issues and chose not to include a term addressing advance notice of cash dividends. On the other hand, I do not dismiss Corporate Property Associates' fraud and negligent misrepresentation claims against CHR and Platinum to the extent those claims relate to the second dividend. At the motion to dismiss stage, viewing the facts alleged in the complaint in the light most favorable to Corporate Property Associates, CHR's response to Corporate Property Associates' question about “any significant changes/developments” was misleadingly incomplete. I do, however, dismiss the fraud and negligent misrepresentation claims against Kotzubei because I have dismissed the fiduciary duty claim and therefore this court cannot exercise personal jurisdiction over Kotzubei under Delaware's director and officer consent statute, 10 Del. C. § 3114. (emphasis added).

For a helpful discussion of the implied duty of good faith and fair dealing, see page 6 of the Westlaw format of the opinion.

For a thorough analysis of the court's finding of  "fraud by silence in the face of a duty to speak", see page 8 of the Westlaw format and the related bountiful footnotes.

Negligent misrepresentation (also known as equitable fraud or innocent misprepresentation) was addressed in detail starting at page 9, including the necessary elements to establish a claim, such as the first requirement that  "defendant had a pecuniary duty to provide accurate information..." That requirement limits the reach of the cause of action to "situations where the defandant makes a 'representation in the course of a business or a transaction in which the defendant has a pecuniary interest.'" (copious citations in footnotes omitted, in which, inter alia,  recent Chancery Court opinions in H-M Wexford v. Encorp and Vague v. Bank One are distinguished to the extent they refer to the pecuniary interest requirement in dicta).

Finally, an essential insight into Section 3114 of Title 10 of the Delaware Code, regarding the imposition of Delaware jurisdiction over officers and directors of Delaware corporations, is discussed at page 14.  Section 3114 has been interpreted over the last 25 years by Delaware courts, to be limited to imposing jurisdiction only for claims involving violations of the DGCL; corporate charter or bylaws; and breaches of fiduciary duties owed to the company or to stockholders  (regardless of whether the statute potentially can be read to mean something else.) Thus,  because the only remaining claims were for fraud and negligent misrepresentation, Section 3114 could not be used to impose personal jurisdiction over the officer.

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Smartmatic Corp. v. SVS Holdings, Inc. and Sequoia Voting Systems, Inc.,(Del. Ch., April 4, 2008), read opinion here. This letter opinion involved the application of New York law to multiple disputes surrounding a stock purchase agreement. Because this blog focuses on Delaware law, the only point I want to highlight in this 24-page decision is a footnote that reiterates basic Delaware law to the effect that forum clauses are generally upheld, but even as here where the law of another state is applied to the substantive dispute, Delaware procedural and remedial law will still govern. That was key here because there were cross-motions for summary judgment filed along with motions for expedited proceedings and injunctive relief--and summary judgment was granted less than 3 weeks after the complaint was filed. Here is the money quote from footnote 21:

“As a general proposition, Delaware courts will recognize and enforce contractual choice-of law provisions if the selected jurisdiction has a material connection with the transaction.”
Trilogy Dev. Group, Inc. v. Teknowledge Corp., 1996 WL 527325, at *3 (Del. Super. 1996)
(citing Falcon Tankers, Inc. v. Litton Systems, Inc., 300 A.2d 231, 235 (Del. Super. 1972)). The current dispute involves interpretation of several agreements providing that New York law governs disputes resulting therefrom. The parties conduct business in New York. New York law thus governs interpretation of this contract. Procedural matters, however, are determined by Delaware law. See, e.g., Taylor v. LSI Logic Corp., 1998 WL 51742, at *4 n.19 (Del. Ch. Feb. 3, 1998); Lutz v. Boas, 176 A.2d 853, 857 (Del. Ch. 1961) (“It is well established that the law of  the forum governs questions of remedial or procedural law.”).

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In Miller v. McDonald, et al., ( D. Del., Bankr., April 9, 2008), read opinion here, the Bankruptcy Court for the District of Delaware decided an issue of great importance to those who follow corporate governance issues related to the fiduciary duties of officers and directors. In this opinion on a motion to dismiss claims against an officer of a company,  the Bankruptcy Court relied on decisions of the Delaware Chancery Court and the Delaware Supreme Court to deny a motion to dismiss in the course of ruling that Caremark duties would be imposed on an officer (who was not a director), that was on the management team when the President of the company committed fraud and other actions and omissions that ultimately led to the bankruptcy filing of the company.  This is notable in part because there are not as many decisions that address the fiduciary duties of officers, as opposed to directors of a corporation.

 Here is a summary  on this blog of a Delaware Chancery Court decision of a few weeks ago that also imposed fiduciary duties on a corporate officer, (with a link to other similar cases and to a recent article on the topic by Professor Lyman Johnson).

No, this is not a "deepening insolvency case". This case involves a fiduciary duty claim that alleged that even if the defendant did not commit any of the fraud and other abuses that led to the downfall of the company, he breached his fiduciary duty to make an effort to put monitoring systems in place that would have increased the likelihood that the fraud perpetrated by the company President could have been detected sooner and/or could have been prevented sooner. (see page 29 of opinion linked above). Here is a key quote from the opinion:

To date, the fiduciary duties of officers have been assumed to be identical to those of directors. With respect to directors, those duties include the duty of
care and the duty of loyalty. There has also been much discussion regarding a duty of good faith, which may or may not be subsumed under the duty of loyalty. Ovitz became an officer of Disney on October 1, 1995 when he
became President of the corporation, and he became a director on January 22, 1996. Therefore, upon becoming an officer on October 1, 1995, Ovitz owed fiduciary duties to Disney and its shareholders. 
In re Walt Disney Co. Derivative Litigation, No.15452, 2004 WL 2050138, at *3 (Del. Ch. Sept. 10, 2004),  (internal citation omitted).

Other courts have also applied the Delaware law and recognized that officers owe fiduciary duties to the corporation. In Stanziale v. Nachtomi (In re Tower Air, Inc.), the Third Circuit Court of Appeals upheld the bankruptcy trustee’s claims against
Tower Air’s directors and officers. Count two alleged that Tower Air’s officers breached their fiduciary duty to act in good faith, inter alia, by failing to tell the directors about maintenance problems, and by failing to address the maintenance problems. 416 F.3d 229, 234 (3d Cir. 2005). The Third Circuit held that “[t]he
officers’ passivity in the face of negative maintenance reports seems so far beyond the bounds of reasonable business judgement that its only explanation is bad faith.” See id. at 234, 239.

The same part of the above 2004 Disney decision was relied on for a similar reason in a 2007 Chancery Court decision. See Ryan v. Gifford, 935 A.2d 258, 269 [n.27] (Del. Ch.2007).

Also notable about this case is that the Bankruptcy Court relied on Section 307 of the Sarbanes Oxley Act because this was a publicly-held company--and because that section applies to lawyers such as the officer in this case. The background (at pages 24 to 26) in the opinion, to the above quote from the 2004 Disney case, is important enough to provide below verbatim:

The basis for the Trustee’s claim is that [defendant officer] breached his duty of care by failing to implement an adequate monitoring system and/or the failure to utilize such system to safeguard against corporate wrongdoing. See In re Caremark Int’l Inc. Derivative Litig., 698 A.2d 959, 967-71 (Del. Ch. 1996); Stone v. Ritter, 911 A.2d 362, 370 (Del. 2006). Even though Florida law governs this claim, Delaware law is still relevant because “[t]he Florida courts have relied upon Delaware corporate law to establish their own corporate doctrines.” Connolly v. Agostino’s Ristorante, Inc., 775 So.2d 387, 388 n.1 (Fla. Dist. Ct. App. 2000) (citing Int’l Ins. Co. v. Johns, 874 F.2d 1447, 1459 n.22 (11th Cir. 1989)). 

The Trustee relies on ATR-Kim Eng Fin. Corp. v. Araneta, No. 489-N, 2006 WL 3783520 (Del. Ch., Dec. 21, 2006) for his position. In Araneta, the court found two defendants who were directors and officers of the company liable for not stopping the company’s majority shareholders and fellow director from transferring the company’s assets to members of his family, a violation of his fiduciary duties. See id. at *1, 19, 23-25. The court cited the Delaware Supreme Court’s Stone decision for directors’ liability:

Caremark articulates the necessary conditions predicated for director oversight liability: (a) the directors utterly failed to implement any reporting or information system or controls; or (b) having implemented such a system or control, consciously failed monitor or oversee its operation thus disabling themselves from being informed of risks or problems requiring their attention.
Id. at *24 (citing Stone, 911 A.2d at 370).

The court reasoned that:

One of the most important duties of a corporate director is to monitor the potential that others within the organization will violate their duties. Thus, a “director’s obligation includes a duty to attempt in good faith to assure that a corporate information and reporting system, which the board considers to be adequate, exists.” Obviously, such a reporting system will not remove the possibility of illegal or improper acts, but it is the directors’ charge to “exercise a good faith judgement that the corporation’s information and reporting system is in concept and design adequate to assure the board that appropriate information will come
to its attention in a timely manner as a matter of ordinary questions, so that it may satisfy its responsibility.”
Id. at * 23-24 (quoting Caremark, 698 A.2d at 970).

The Trustee alleges that as the vice president of operation and in-house general counsel to World Health, [defendant officer] was responsible for failing to implement any internal monitoring system and/or failing to utilize such system as is required by Caremark and Araneta. The material misrepresentations contained in World Health’s SEC filings are examples of such failure. Since the SEC adopted a final rule pursuant to § 307 of the Sarbanes-Oxley Act, effective August 5, 2003, a general counsel has an affirmative duty to inspect the truthfulness of the SEC filings. 17 C.F.R. Part 205 (Jan. 29, 2007).

Section 307 addresses the professional responsibilities of attorneys. It directs the SEC to issue rules that “set[] forth minimum standards of professional conduct for
attorneys appearing and practicing before the Commission in any way in the representation of issuers.” Sarbanes-Oxley Act § 307, 15 U.S.C. § 7245 (2005). The standards must contain a rule requiring “an attorney to report evidence of a material violation of securities law or breach of fiduciary duty or similar violation by the issuer up-the-ladder within the company.” Id. Therefore, the Trustee appropriately asserts that [defendant officer] as the in-house general counsel and the only lawyer in top management of World Health during the relevant period, had a duty to know or should have known of these corporate wrong doings and reported such
breaches of fiduciary duties by the management.

UPDATE:  Here is a discussion of the case (and more) from Steve Jakubowski,  Chicago's preeminent bankruptcy lawyer, the Justice Cardozo of the blogosphere, and a paradigm of a good man, on his Bankruptcy Litigation Blog. He also amazingly catalogued, with links, the last 27 or so cases that I have summarized on this blog with bankruptcy related issues. I am humbled by the kind words in his post.

UPDATE II : Here is another discussion of the case from Sean McAffity on his Property Of The Estate blog, and here is further reference to the case by Scott Riddle on his Georgia Bankruptcy Law Blog.

UPDATE III: Here is a post by Professor Bainbridge, who also adds relevant commentary from his book on the Sarbanes Oxley Act.

UPDATE IV:  Here on The Harvard Corporate Governance Blog is another version of my post  on this case.

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Nicastro v. Rudegeair, 2008 WL 979677 (Del. Ch., April 1, 2008), read opinion here. This is a one-page letter decision (with several footnote citations to cases law), which includes a helpful reference to the procedure necessary to remove a Notice of lis pendens  filed pursuant to Section 1608 of Title 25 of the Delaware Code. Namely, once a motion is filed, the "court must  determine that there is not a probability that final judgment will be entered in favor of the party recording the notice of pendency."

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In Re The Bear Stearns Companies, Inc. Shareholder Litigation, (Del. Ch., April 9, 2008), read opinion here, (Hat Tip to Prof. Steve Davidoff). Yesterday the Delaware Chancery Court stayed the litigation in Delaware over the Bear Stearns imbroglio in favor of pending litigation in New York involving substantially the same issues and parties. The quote from the opinion highlighted by Prof. Davidoff follows:

 In this case, considering that the New York court has scheduled an expedited preliminary injunction hearing, the issues presented involve application of established precedents of Delaware corporate law to an unusual set of facts, which is unlikely to recur, and the persuasive practical reasons against embarking unnecessarily on a collision course with our sister court in New York in these extraordinary circumstances, I find Defendants have shown that failing to stay this action would result in overwhelming hardship.

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This case summary is provided courtesy of Carl Neff, a distinguished lawyer in the Wilmington, Delaware, office of our firm.

 In Asphalt Paving Systems, Inc. v. Department of Transportation, 2008 WL 852817 (Del. Ch., Mar. 20, 2008), read opinion here, the Delaware Chancery Court granted summary judgment in favor of the Delaware Department of Transportation (“DelDOT”). DelDOT solicited bids for the microsurfacing of certain roads in Sussex County, Delaware (the “Project”). Plaintiff Asphalt Paving Systems (“APS”) submitted the lowest bid of $524,444.44. DelDOT, after reviewing the bids, determined that APS’s bid was not on the bid bond form issued by DelDOT with the bid package, but instead was on a bid bond form issued by the American Institute of Architects. DelDOT interpreted its contract documents and the applicable provision of Delaware’s public works law, 29 Del. C. § 6962(d)(8)(a) to require rejection of APS’s bid given that it failed to use the precise, identical DelDOT form required (even though it was substantially similar in all material parts).

APS initially sought an order compelling DelDOT to award the contract to APS, along with interim injunctive relief against an award of the contract to the second lowest bidder, Dosch-King Company, Inc. (“D-K”), and an injunction against an award to D-K. Alternatively, APS sought an order requiring DelDot to rebid the Project. APS’s support for the latter argument was that DelDOT’s instructions relating to the delivery of a bid bond were misleading. Given that there were no material facts were in dispute, the Court was able to treat this matter as if submitted for summary judgment by all parties.

The Court held that under 29 Del. C. § 6962(d)(8)(a), DelDOT was required to reject APS’s bid, given that the bid bond form used by APS was not pre-approved by DelDOT. While there was a dispute over the fact that the Office of Management and Budget (“OMB”) never formally “issued” a bid bond form for DelDOT to use (as is required by the statute), the Court held that because the bid bond used by DelDOT was pre-approved by DelDOT (as is also required by the statute), and that it would be unreasonable to conclude that the legislative intent would be to interfere with DelDOT’s ongoing bidding procedures because of the absence of the OMB standard bid bond form, the Court agreed with DelDOT’s assertion that DelDOT approved bid bonds must be submitted with all potential bids. Further, the Court declined to require DelDOT to rebid the Project, given that APS’s Amended Complaint or its brief failed to argue that it was, in fact, misled by the instructions. For these reasons, the Court granted summary judgment in favor of DelDOT.

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In TravelCenters of America, LLC. v. Brog,  the Delaware Chancery Court, on April 4, 2008,  issued a ruling from the bench, available here (HT  Prof. Davidoff), after a short trial, that a notice of intent to nominate new members of the board of managers of the LLC did not comply with a provision of the LLC agreement, and was in violation of several U.S. securities laws applicable to proxy contests.

On April 3, 2008, the Court also issued a pre-trial letter decision here, that allowed Professor Randall Thomas to provide expert testimony at trial on the issues of materiality and U.S. securities laws, but the good professor was prohibited from opining on matters of Delaware law (as prior decisions by Chancellor Chandler have made clear.) Here is a prior summary of a decision of about a week ago in the same case by the Chancery Court involving a books and records counterclaim.

Professor Steven Davidoff here, (who also writes on The New York Times DealBook blog), and Professor Larry Ribstein here, have today already provided thoughtful commentary on the case. Professor Ribstein cites to articles he has written on the topic of LLCs not being subject to the same corporate governance structure as corporations--including materials he presented at an symposium at which the author of the instant Chancery Court decision was also participating.

Here is a money quote from the  letter decision of April 3:

Delaware does not impose a legal requirement on LLCs to draft their bylaws to be consistent with some abstract notion of “good corporate governance.” On the contrary, limited liability companies are creatures of contract, “designed to afford the maximum amount of freedom of contract, private ordering and flexibility to the parties involved.”

I predict that this decision will be cited often to distinguish between the governance of an LLC compared to a corporation. However, curiously, in the opinion of about 10 days ago in this case that was summarized here, involving a demand for books and records, the court said that it might refer by analogy to the corporate statute to analyze such a demand. Of course, a demand for books and records  is a type of issue does not directly impact corporate governance and is perhaps simply a practical approach to deciding a books and records demand in the LLC context.

Having recently returned from a two-day seminar on corporate governance, and cognizant of the many trees that have been killed over the last few decades alone in connection with publishing bookshelves full of treatises and articles and opinions written about corporate governance (and now the terabytes of space on computers taken up by writings about corporate governance), it is notable and worth repeating the truism that in the LLC context, all those high-falutin'  corporate governance ruminations and ideals can be "contracted away".

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Professor Timothy Glynn of Seton Hall University highlights here on the Race to the Bottom blog, a new article he has written that examines the internal affairs doctrine, and in particular the 2005 decision of the Delaware Supreme Court  called Vantage Point Venture Partners 1996 v. Examen, Inc., 871 A.2d 1108 (Del. 2005). (Here is a link to summaries on this blog of both the Chancery Court's decision in the foregoing case as well as a link to the Delaware Supreme Court's opinion affirming, as cited above.)

He discusses the broader implications of the doctrine in the context of the "tug of war" between and among Delaware and the federal government--and other states--for preeminence in the governance of corporate law issues. This is a topic that has been the subject of many posts on this blog, including links to the writings of several other professors who have written on the topic.  See, e.g., here.

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A veritable treasure trove arrived in today's mail inside the current issue of the Delaware Lawyer magazine. The issue is devoted to a re-examination of the Delaware General Corporation Law (DGCL) by assorted luminaries from Delaware as well as those from New York and elsewhere who spend more time in Delaware Chancery Court fighting about the nuances and meaning of the DGCL than many Delaware lawyers do.

Here is the Table of Contents that lists the articles. Several argue for proposed changes to the DGCL  and other articles assert that the status quo is just fine. They are short articles that are easy, quick reading, but nevertheless this publication is "must reading" for anyone interested in:  where the DGCL has been, where it is now, and where it is heading.

Although it was not easy to pick one, if I had to choose my favorite among the articles, it would be the one by legal legend R. Franklin Balotti, and co-authored by Donald A. Bussard and Thomas A. Uebler. The concluding paragraph indicates the important and far-reaching theme of this short piece, as follows:

"Unless a court must determine the validity of a self-dealing transaction before it considers a director's equitable conduct and potential liability, [DGCL Section] 144 should not be considered when determining director liability. Until the General Assembly instructs otherwise, Section 144 should be limited to the purpose expressed by Professor Folk 40 years ago--validation of self-dealing transactions."

The current issue was edited by Vice Chancellor Leo Strine, Jr. of the Delaware Chancery Court. Among the articles is a transcript of a recent conversation among those who worked with Professor Folk on the 1967 revisions of the DGCL, and who provide insights into the reasons behind the revisions. The articles in the current issue of the magazine, in one sense, serve a purpose similar to what occurred in Delaware during the "Summer of Love", to the extent that  many of the leading lights of the corporate bar have explained how they think the DGCL should be updated and revised to keep up with the current developments--in a major way, as opposed to the updates that are made each and every year to the DGCL in a manner that is not considered akin to a complete overhaul.

Here is a recent, related post that describes background materials in connection with the 1967 revision of the DGCL that is made available by Prof. Larry Hamermesh at the Widener University Law School.

Here is a link to the Delaware Bar Foundation's website. The Foundation publishes the Delaware Lawyer and at least in the past has eventually made the articles available online on their site, but they have not allowed me to post the articles here. I have been told--but have not verified myself--that  the articles will eventually be available via Westlaw and Lexis.

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In Concord Steel, Inc. v. Wilmington Steel Processing Co., Inc., 2008 WL 902406 (Del. Ch., April 3, 2008), read opinion here, the Chancery Court upheld the portion of an Asset Purchase Agreement (ASA) that prevented the seller from competing against the business it sold for 4 years. In the context of a preliminary injunction motion, the court found:  (i) a probability of success on the merits of the claim that the covenant of noncompetition was violated. The court also found that (ii) an imminent threat of irreparable injury was shown, and that (iii) the balance of equities tipped slightly in favor of the plaintiff.

 Procedurally, it is notable that, while not done at the lightening speed of a TRO motion, this PI motion was still decided quite expeditiously. Argument was heard in March 2008 after suit was filed in November 2007 and extensive discovery was taken and pre-trial briefs were submitted over the end of year holiday season.

 The standard for granting a preliminary judgment motion was carefully recited a pages 3 and 4 of the Westlaw version of  the 15 page opinion (that would be about 45 pages in the slip op. format.) The court reviewed the extensive factual background including what it referred to as:  "The ASA ... a complicated, 53 page agreement, and the nonsolicitation and noncompetition covenants are particularly convoluted."

 The court also reiterated basic contract interpretation principles. Although these principles are well-known and often summarized on these pages, a few gems are worth repeating:

 " A contract is not rendered ambiguous solely because parties do not agree as to its construction." Also, "extrinsic, parol evidence cannot be used to manufacture an ambiguity in a contract that facially has only one reasonable meaning." However, under the parol evidence rule, "where the language of a written integration is susceptible to more than one reasonable interpretation, the court will consider profferred admissible evidence bearing upon the objective circumstances relating to the background of the contract".

 The opinion also includes at page 5 the essential elements of an enforeceable contract. Basic stuff but I find it helpful to periodically review fundamental principles.

At page 6 and footnotes 42 and 43, the court lists the prerequisites for enforceability of a covenant not to compete, and cites to several Delaware decisions upholding such agreements, the elements for which must be  proven by "clear and convincing evidence." See also footnote 52.

Several cases are cited at footnote 86 in which the Delaware courts have found the irreparabale harm necessary for a PI where a covenant not to compete is breached, in light of the "loss (or foreseeable loss) of client goodwill..." At footnote 89, the court collects cases that recognized, as here, a stipulation of the parties that irreparable harm would be suffered in the event of  a breach.

Finally, on an issue of apparent first impression in Delaware, the court observed that even  though Chancery Court Rule 65 requires that a bond be posted when an injunction is granted, in the agreement involved in this case, the parties agreed that the bond requirement would be waived, and the court enforced that provision--especially as the agreement was the result of protracted negotiations between sophisticated, well-represented parties.

However, the court cautioned in footnote 92 that: " I do not intend the absence of a bond requirement ... to diminish in any way Concord's potential liability for any damages Defendants incur, if the preliminary injunction proves to have been granted improvidently."

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In TravelCenters of America, LLC  v. Brog,  2008 WL 868107 (Del.Ch., March 31, 2008) , read opinion here, the  Delaware Chancery Court addressed  issues relating to a demand for books and records of an LLC. The books and records claim was presented as a counterclaim in a suit that involved the issue of an advance bylaw notice. In dismissing the counterclaim without prejudice, the court emphasized the long line of Delaware cases that stand for the position that a books and records claim is a summary proceeding that should be handled distinct from other ancillary issues. Thus, the court determined that in light of the first, main complaint that was already filed and given expedited treatment, the books and records counterclaim could not be addressed distinct and apart from other issues in the primary action.

 Notable also was the court's observation that due to the fewer number of reported decisions involving books and records demands in the LLC context, compared to the corporate context,  the court looks to the plethora of opinions concerning demands for books and records in the corporate context under Section 220. Note, however, that the provisions of the Delaware LLC Act regarding a books and records demand are far different than the analogous provisions in Section 220 of the DGCL. Here is the money quote on the general point from footnote 2 in the instant decision:

 "Because of a lack of reported decisions in the LLC context, the Court may look to cases interpreting similar Delaware statutes concerning corporations and partnerships.” (citing Somerville S Trust v. USV Partners, LLC., No. 19446-NC, 2002 WL1832830, at *5 n. 4 (Del. Ch. Aug. 2, 2002)).

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Prof. Larry Ribstein has literally "written the book" on LLCs and other "alternative forms of entities" and has also written many articles on the topic, in his role as one the nation's leading authorities on LLCs and other non-corporate forms of entities. He comments on his Ideoblog  here  about proposed revisions to the uniform laws relating to LLCs. The introduction to his post provides that:

I have already written on the incredibly misguided Revised Uniform Limited Liability Company Act. In my analysis of the law, I note that the Act "threaten[s] to impose substantial risks and costs on limited liability companies. . .that there is little reason for states to adopt the Act, and that practitioners should be wary about advising clients to form under it."

...

As misguided and as harmful as the "uniform" law is, many state legislatures do need some sort of model because they lack the resources to draft state-of-the-art statutes. They can use the more sophisticated statutes, including those of Delaware, Colorado, Georgia, and Virginia. But they may need guidance picking particular provisions from these statutes.

Anyone serious about keeping up to date on the latest developments in the law of LLCs, needs to read the whole post above and the links provided therein to other original sources and writings on the topic.

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This post is only of practical value for those of us who file complaints in Chancery Court and need to have them served. The current practice is for the Court to grant a Motion to Appoint a Special Process Server, which often is one of the local messenger companies, which allows for quicker timing for the formal process of hand delivering a complaint to someone who has not agreed to accept "service of the complaint" without the formal procedure.

Now, in a move towards greater efficiency, the court has issued an Order, available here, and effective as of May 1,  that dispenses with the process of filing a Motion for Special Process Servers in place of a system that allows for Special Process Servers to be registered with the court on an annual basis. (Perhaps this is akin to having a stable of pre-approved horses in one's stable, although I know the messengers to be much more valuable and much smarter than any horse could ever be.)

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In GMAC Bank v. HTFC, Corp., (E.D., Pa., 2008), read opinion here, a federal judge in neighboring Philadelphia imposed financial penalties on both the deponent and his lawyer for abusive conduct during a deposition. The blog called Above the Law highlights key factual aspects of the case here, such as the deponent "using the "F-bomb" and its variants 73 times". It makes the deposition abuses outlawed by the Delaware Supreme Court in Paramount Communications, Inc. v. QVC Network, Inc., 637 A.2d 34 (1994), mentioned here, seem like child's play.

 I have no interest in embarrassing anyone, so I will not use any individual names in connection with this post on the above GMAC case, but for those of us who are required to work in the trenches of depositions, it is helpful to have a court opinion that can be cited to as guidance and which can be used in response to those who abuse the deposition process but often are not called to task by busy judges who (understandably) do not enjoy "playing schoolyard monitor" when lawyers cannot "play nice". Of course, even if only one party is at fault, much like the schoolyard monitor, the court does not always have time to determine "who started the fight" and gets disgusted with all counsel. This 44-page opinion is a good example of a judge who took the time to spell out the infractions to carefully excoriate those responsible. ( I understand that the penalty imposed on the lawyer is on appeal.)  

 Let me also be clear that there are many opinions in Delaware that have drawn a clear line in the sand to define and condemn violations of the rules applicable to depositions, and many have been highlighted on this blog, but by necessity not every discovery abuse can be the subject of a formal written opinion, so when those opinions surface, as here, they need to be highlighted.

 For prior posts on this blog on the topic of Delaware deposition practice, (in addition to the above link to the Paramount decision), including cites to court decisions condemning violations, see, e.g., here and here and here.

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 In Reinhard & Kreinberg v. The Dow Chemical Co., 2008 WL 868108 (Del. Ch., Mar. 28, 2008), read opinion here, the Chancery Court addressed the issue of advancement in the context of a counterclaim. The court determined that only compulsory counterclaims and not permissive counterclaims would be subject to advancement. The court left for another day the determination about whether the counterclaim involved was permissive or compulsory.

 Here is a money quote from the court's opinion, that may be applicable to many cases:

Advancement agreements require a hefty dose of
good faith on the part of both sides in order to work.
Given the context in which advancement often arises
(i.e., a dispute between the company and its former
directors/officers), good faith cooperation is
undoubtedly difficult to muster. Nevertheless, this
Court does not relish and will not perform the task of
playground monitor, refereeing needless and
inefficient skirmishes in the sandbox. FN31.   As this
Court has stated before, “a balance of fairness and
efficiency concerns would seem to counsel deferring
fights about details until a final indemnification
proceeding.” FN32

FN31. Cf.  Fasciana v. Electronic Data Sys.
Corp., 829 A.2d 160, 177 (Del. Ch.2003)
(“[T]he function of a § 145(k) advancement
case is not to inject this court as a monthly
monitor of the precision and integrity of
advancement requests.”).
FN32.  Id.

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As a follow-up to my posts from yesterday, this is my last post from the two-day seminar at the Tulane Corporate Law Institute. One of the benefits for the 250 attendees at this New Orleans venue, is the further clarification and direction for corporate practitioners provided by members of the Delaware Chancery Court and Delaware Supreme Court who are on the panels at this seminar along with other leading lawyers from around the country who labor in the vineyards of Delaware corporate governance. Remember that these comments by members of the judiciary are "off the record" and do not represent the official position of the courts on which they sit, but nevertheless for those who need to understand the formal opinions of these courts, such commentary is akin to manna from heaven.

One other "added value" of the seminar is the intangible positive impact from the interaction "on a personal level, without discussing cases" of the members of the judiciary who attend, with the lawyers from around the country who often appear before the Delaware courts. Some of the "Delaware-bashing" commentators who criticize judges who participate in scholarly colloquia or write and participate in the development of the law outside of their judicial opinions, miss at least one point. There is a demonstrable increase in professionalism and efficiency when lawyers and judges gather outside the courtroom on a personal level and get to know each other on a collegial basis. This interaction, on a human level, makes it easier and more enjoyable to work with people, even if they are lawyers on opposite sides of a case.

Former Chancellor William Allen, who is now a professor at New York University Law School and also on the faculty of their Stern School of Business, was on a panel this morning and gave his perspective of Delaware corporate law about 20 years ago, prior to 1985. At that time, former Chancellor Allen explained, things were much simpler and there were two basic principles that governed the analysis of director conduct, for example, in the context of mergers and acquisitions. The two basic governing principles were: (i) the fiduciary duty concept that any self dealing by directors or controlling shareholders would be subject to a much higher level of scrutiny and a shifting of the burden of proof; and (ii) the Business Judgment Rule that provides that the court will not second-guess a board's decision if the circumstances justify the presumption that their decision was made on an informed basis, in good faith and in the best interests of the company. Then, if 1985, came the decisions in Van Gorkom, Unocal and Revlon, which heralded a much more nuanced and multi-layered range of standards to review directors' actions.

Chief Justice Myron Steele of the Delaware Supreme Court was also on a panel this morning and his  "off the record" remarks were also illuminating. He reminded those gathered that for purposes of corporate governance (as compared with LLCs, for example), there are three bedrock principles that are fundamental: (i) the Delaware General Corporation Law which provides at Section 141(e) that the directors manage the corporation; (ii) the shareholder franchise is sacrosanct (my word) and will be vigorously protected; and (iii) all cases are factually-based, and the facts cannot be separated from the decision of the courts. He also remarked that practitioners found it helpful when the members of the judiciary present at seminars and shed light on less clear areas of the law--for the benefit of lawyers--and other judges-- who need to know what that law is so that they can advise their clients on what the law is and what standards judges will use to decide issues presented to them. Another panel discussed MAC clauses, and one of the members of the Chancery Court suggested that in the current environment it was likely that there would be more "deal certainty" which of course will impact the price of the particular deal.

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As a follow-up to the prior post earlier today from the Tulane corporate law seminar, Vice Chancellor Leo Strine, Jr., from Delaware's Chancery Court, is on the panel this afternoon along with other leading practitioners, discussing recent Delaware cases that address the duty of the board under Delaware law in the context of the sale process for a company.

Here are a few comments from His Honor to help one in applying recent Chancery Court cases on the topic. For example, he said that one key is for the board to demonstrate that the sale process is fair to the highest bidder because, in part, the analysis regarding whether one's fiduciary duty has been fulfilled is "inherently contextual" and necessarily factually based, as opposed to lending itself to per se, bright line rules, which are the purposes of statutes, as opposed to the role of a court of equity. See, e.g., a law review article by Professor Rock, in which he describes the role of Delaware courts in formulating corporate law as, in part, writing heavily fact-based decisions as "morality tales" or parables if you will, as opposed to bright line rules: Saints and Sinners: How Does Delaware Corporate Law Work?, 44 UCLA L. Rev. 1009.

His Honor also commented that the minutes of board meetings should have attached the reports of financial advisors that are making presentations to the board to clarify