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

In Feldman v. Cutaia, (Del. Supr., May 30, 2008), read opinion here, the Delaware Supreme Court today affirmed the Chancery Court's ruling that, based on the facts before it, a stock option-related claim was a derivative cause of action and not a direct claim.  The Chancery Court's decision was summarized here on this blog.

Delaware's High Court summarized the appeal presented to it in this case as follows:

The plaintiff-appellant, Peter Feldman, appeals from a final judgment entered by the Court of Chancery following its issuance of a Memorandum Opinion and Order. The Court of Chancery dismissed all fourteen counts of Feldman’s Third Amended Complaint finding that the claims therein were solely derivative in nature. Applying this Court’s holding in Lewis v. Anderson, 1 the Court of Chancery held that Feldman lacked standing to pursue those derivative claims following a third-party merger (the “Merger”) in which all of his stock of the nominal defendant, The Telx Group, Inc. (“Telx” or the “Company”), was cashed out.
In this appeal, Feldman’s sole argument is that the Court of Chancery erred in dismissing Count XIII of the Third Amended Complaint. In that count, Feldman alleges that he received inadequate consideration from the Merger because of stock options previously issued to three of the defendants-appellees. According to Feldman, the allocation of the Merger
consideration to those stock options directly harmed him because he was paid less for his shares in the Merger than he would have been if the options had not existed. 

Relying upon this Court’s decision in Tooley v. Donaldson, Lufkin & Jenrette, Inc., 2 Feldman contends that his claim in Count XIII was an individual one and not derivative in nature. Feldman submits that Telx’s directors had an affirmative duty to reconsider the validity of the stock options at the time of the Merger and their failure to do so gave rise to a
separate and direct claim of harm. The appellees argue that, following this Court’s landmark decision in Tooley, except in the inapplicable limited circumstances involving controlling stockholders, described in Gentile v. Rossette 3 and Gatz v. Ponsoldt, 4 a claim that stock options have been wrongly issued to management states a claim for waste and is solely derivative in nature.

The Court of Chancery characterized Feldman’s contention that Count XIII states a direct claim as “a bootstrap argument.” The Court of Chancery concluded that the alleged diminution of Feldman’s share of the Merger proceeds in Count XIII are the same damages that flow from the alleged harm under the predicate derivative claims in those counts of the Third Amended Complaint that challenged the validity of the stock options. The Court of Chancery held that Count XIII was a creative but unsuccessful attempt to recast a derivative claim as a direct claim. We have determined that the judgment of the Court of Chancery must be affirmed.

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1. Lewis v. Anderson, 477 A.2d 1040, 1049 (Del. 1984).

2. Tooley v. Donaldson, Lufkin & Jenrette, Inc., 845 A.2d 1031, 1033 (Del. 2004).
3. Gentile v. Rossette, 906 A.2d 91, 99-101 (Del. 2006).
4. Gatz v. Ponsoldt, 925 A.2d 1265, 1277-81 (Del. 2007).

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In Zaman v. Amedeo Holdings, Inc., 2008 WL 2168397 (Del. Ch., May 23, 2008), read opinion here, the Delaware Chancery Court reviews corporate issues involving the ultra-rich Sultan of Brunei, and the London barristers of his brother, but more importantly for the readers of this blog, the court analyzes the barristers' claims for advancement and indemnification as well as "fees on fees". In the course of making its decision, it necessarily recites the background facts of royal family battles that could be part of movie script.

Among the details that compel a reading of the whole decision, is the following nugget: "... the Sultan preceded his 2004 legal campaign by amending Brunei's constitution to declare himself infallible and immune from any obligation to appear in court (or for his designees to appear), and to subject anyone who criticized him to criminal punishment."

The opinion in its original format almost 100 pages long and though it makes for very interesting reading, I only have time today to highlight the key issues decided by the court.

1. Are the plaintiffs entitled to indemnification for a federal lawsuit filed by the defendant entities against them, as well as a related proceeding in London?;

2. Are the plaintiffs entitled to advancement for an ongoing lawsuit in state court in New York? ; and

3. Are the plaintiffs entitled to fees for prosecuting the current case for advancement and indemnificiation?

However, in order to decide the foregoing issues, the court had to resolve a long list of subsidiary issues and to sort out a bewildering array of interlocking parent companies and affiliated companies formed in different countries around the world but which ultimately held assets in the U.S. owned by the Sultan and/or his brother.

Notably, the Chancery Court allowed advancement for certain counterclaims brought by the plaintiffs in the New York state court proceedings against them because the Chancery Court considered them compulsory counterclaims under the traditional test used in Delaware and federal civil procedure, and thus they are deemed to be part of a defense for purposes of DGCL Section 145.

The court also concluded that the plaintiffs were entitled to 80% of the costs of prosecuting their case for advancement and indemnification as they "substantially prevailed on their claims."

There is so much more factual background and legal analysis to this case that is both entertaining and educational, but I must return to paying clients -- though I hope to add to the summary of this fascinating case  at a later time. 

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Professor Bainbridge has a post here that reviews recent Delaware decisional law and statutes concerning bylaws. His post is more like a mini-law review article and it includes a scholarly analysis that addresses limitations on who can amend bylaws as well as how they may or may not restrict the board's powers.

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Westmeyer v. Flynn,  2008 WL 2152498 (Ill.App., 1st Dist., May 20, 2008). Courtesy of famed Chicago bankruptcy lawyer Steve Jakubowski, this decision  by the Appellate Court of Illinois, First District, Second Division, read opinion here, determined that Delaware law would recognize the concept of piercing the corporate veil in the context of an LLC. However, the 2 or 3 Delaware cases cited by the court are not directly on point in my view. Curiously, the court relies for its conclusion more heavily on opinions by the courts of other states applying Delaware law.  I think that a more nuanced approach is necessary  before one commences a wholesale application to the LLC context of piercing the corporate veil. As we have discussed on these pages frequently, not all the "conventional corporate analyses are automatically subject to being imposed onto the separate LLC framework."
See generally, Donald Wolfe and Michael Pittenger, Delaware Corporate and Commercial Practice in the Delaware Court of Chancery at Section 2.03[b][1][iii] (2008)(discussing  the concept of piercing the corporate veil generally as applied to corporations).

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In Monier, Inc. v. Boral Lifetile, Inc., (Del. Ch., May 13, 2008), read letter opinion here, the Chancery Court relied on prior precedent to hold that on a Motion to Dismiss under Rule 12(b)(6), it could not choose between two (or more) reasonable interpretations of an Operating Agreement. Thus, even if the plaintiff's interpretation did not ultimately prevail at trial, at the motion to dismiss stage it would be premature to favor one interpretation over the other.

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AT & T Corp. v. Lillis,  (Del. Supr., May 22, 2008), read opinion here. The Delaware Supreme Court in this 34-page opinion reiterates basic contract interpretation principles under Delaware law in the context of stock option rights, including in what instances extrinsic evidence will be considered by the court.  Delaware's High Court also addresses what weight, if any, should be given to prior admissions in pleadings that are later amended, as well as the difference between a stock for stock merger and a cash-out merger. Prior Chancery Court decisions in this case denying summary judgment, as well as the opinion appealed from after trial, have been summarized here and here.

  The Supreme Court provided its own introductory overview of the case in its opinion, which I quote here in part:

A Vice Chancellor denied cross motions for summary judgment, holding that Section XVIII.A of the 1994 plan controlled the plaintiffs-appellees’ options, (4) but that the term “economic position” in that section was ambiguous. The Vice Chancellor then held a trial to consider extrinsic evidence that could aid him in interpreting that term.

Interpreting Section XVIII.A., the Vice Chancellor noted AT&T’s initial position that Wireless could not cancel the stock options and accorded “great weight” to AT&T’s initial stance. The Vice Chancellor also found that the parties’  earlier transactions, where stock options were replaced with new stock options, demonstrated that the parties intended to preserve the time value of the options in each transaction. Because Wireless did not preserve the time value of the options in the 2004 merger, he found AT&T liable for a breach of the 1994 plan. The Vice Chancellor further found that AT&T had not transferred the 1994 MediaOne plan’s obligation to Wireless and, thus, did not hold Cingular liable.

On appeal, we uphold the Vice Chancellor’s conclusion that the term “economic position” is ambiguous because both plaintiffs-appellees and AT&T present reasonable interpretations of Section XVIII.A. On the one hand, the phrase “economic position” of a stock option is broad enough to encompass the prospect that its worth will increase over time, i.e. time value. On the other hand, in a cash out merger, option holders would expect to receive only a fixed cash sum when the merger becomes effective. In that context, the “economic position” of the options would not include any future value since the options will no longer exist. Instead that term would only incorporates the right to receive the options’ intrinsic value.

To resolve that ambiguity, we must consider what the extrinsic evidence shows the term “economic position” was intended to mean in the context of a cash out merger. The Vice Chancellor concluded that that term was intended to encompass the time value of the options in any merger, including a cash out merger. Having reviewed the Vice Chancellor’s opinion, we conclude: (1) that he declined to address the difference between a cash out merger and a stock for stock merger for purposes of interpreting “economic position;” and, (2) that he declined to consider the importance of the $85 cash election in the MediaOne-AT&T merger. Because we believe the cash election in the MediaOne-AT&T merger most closely resembles the cash out merger here, we REMAND the case for the Vice Chancellor to address fully the significance of (i) the distinction between a stock merger and a cash out merger; and, (ii) the $85 cash election in the AT&TMediaOne transaction, in deciding what the contracting parties intended by their use of the term “economic position.”

We also find that the Vice Chancellor should not have given any evidentiary weight to AT&T’s supposed admission because those supposed admissions did not relate to the interpretation of the 1994 plan. Thus, the Vice Chancellor should not afford AT&T’s supposed admissions any weight on remand.

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4.  There are three written opinions in this case. Lillis v. AT&T Corp., 896 A.2d 871 (Del. Ch. 2005); Lillis v. AT&T Corp., 904 A.2d 325 (Del. Ch. 2006); Lillis v. AT&T Corp., Del. Ch., C.A. No 717, Mem. Op. (July 20, 2007).

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In Sun Times v. Black,  oral argument  will be heard on Friday morning, May 23, 2008 in Delaware Chancery Court  at 10 a.m.  I am trying to determine if I can obtain a video clip to put on my blog if the Court will allow the argument to be broadcast live over the Internet via  www.courtroomlive.com.

UPDATE:   Here is a 5-minute video clip of the oral argument before Vice Chancellor Strine on the pending motions regarding whether Lord Black is entitled to advancement/indemnification pending the appeal of his convictions. Many thanks to www.courtroomlive.com for providing this clip.

Here is background on the argument.

Lord Conrad Black, the fallen media baron, will be back in the spotlight when oral arguments take place in the matter before Vice Chancellor Strine in the Delaware Court of Chancery. The case, Sun Times v. Black, has been closely watched because of  few definitive rulings on the question of whether companies have to continue paying the legal bills of ex-officers and directors even after they've been sent to jail but are still appealing their convictions. Black and his lieutenants say Sun-Times Media Group (STMG) jumped the gun by asking a Delaware court to force them to return more than $60 million in legal fees the newspaper company paid for their unsuccessful defense against fraud charges. Black and three of his former top officers seek a trial on their claim that Delaware law requires STMG to continue paying their legal bills while they appeal their convictions for allegedly siphoning off more than $100 million in revenue illegally from the publisher of the Chicago Sun-Times and other Chicago-area newspapers.

Here is a link to a short blog post about the Delaware Supreme Court's affirmance of the Chancery Court's decision regarding allegations against Lord Black previously filed in Delaware.

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Kevin O'Keefe, the nation's leading guru on blogs for lawyers, included a reference to me in a post today  about creating an "online presence" here that almost  made me blush. The excerpt graciously allowed that:

Francis Pileggi has made himself a brand name in the area of Delaware corporate litigation through his blog. Not only is Pileggi seen on his own blog, but his blog is routinely cited by well known practicing lawyers and law professors who write on corporate law issues. Now through syndication and social media, Francis' content is displayed at the Wall Street Journal, in the news at LinkedIn, at Harvard Law School [online] publications, and in Bloomberg news feeds.

Think in-house counsel and exec's selecting local counsel feel more comfortable calling Pileggi when they see him all over the place online?

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Smith v. Van Gorkom, a Delaware Supreme Court decision of seminal importance regarding corporate governance and fiduciary duties, issued in 1985, is the subject of an article with the same name from Prof. Stephen Bainbridge. Here is the good professor's overview of his article:

Smith v. Van Gorkom arguably was the most important corporate law decision of the 20th century. The supreme court of a state widely criticized for allegedly leading the race to the bottom held that directors who make an uninformed decision face substantial personal liability exposure. In so doing, the court breathed new life into the law of fiduciary duties.

For example, Van Gorkom presaged Unocal’s significant expansion of judicial review of corporate takeovers. Indeed, a Van Gorkom-based inquiry into whether the board was fully informed remains a key component of the Unocal methodology. Likewise, Van Gorkom laid the foundation for the subsequent Caremark decision and the resulting expansion of judicial inquiry into whether the board of directors exercised proper oversight of its subordinates. In fact, most of the modern edifice of corporate fiduciary duties rests in some degree on the Van Gorkom decision.

The perception that the decision had significantly increased director liability exposure drove dramatic changes in the D&O liability insurance market. In turn, important legislative initiatives soon followed, including the now nearly universal liability limiting charter provisions authorized by Delaware General Corporation Law § 102(b)(7).

Not surprisingly, the case generated great controversy and, in fact, continues to do so. Did the Trans Union board of directors actually deserve the criticism heaped upon it by the Delaware Supreme Court? Does the Court’s decision actually deserve the criticism heaped upon it by most commentators? This essay provides the back story to this remarkable decision and concludes that the gist of the decision is sound.

UPDATE: Here is a link to this post that appeared today on The Wall Street Journal's Law Blog as part of a compilation of "Most Popular Law Stories From Around the Web".

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NACCO Industries, Inc. and HB-PS Holding Co., Inc. v. Applica Inc., (Del. Ch., May 7, 2008), read opinion here.

The facts of this case involve a complaint that was initially amended once after a motion to dismiss was filed but prior to the opening brief. The motion to dismiss came after expedited discovery but also after a request for emergency injunctive relief was abandoned. A second motion to dismiss with an opening brief was filed after the first amended complaint was filed. This implicates both Chancery Court Rule 15(a) and Chancery Court Rule 15(aaa), the later specifically designed to address this situation. As the court explained:

Rule 15(aaa) contemplates amendments or motions for leave to amend after a dismissal motion is filed in only two situations: “(i) before the due date of a brief responding to the motion to dismiss, and (ii) after the court decides that dismissal is warranted.”

 “In the first case, the motion is governed by the liberal standards of Rule 15(a). In the second, the more stringent standard of Rule 15(aaa) applies . . . .” In this case, the plaintiffs have filed their motion for leave to amend instead of filing a responsive brief, thereby bringing this case under Rule 15(a)’s liberal standards. Rule 15(a) provides that motions for leave to amend “shall be freely given when justice so requires.” (citations omitted.)

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 896 ASSOCIATES, LLC v. GILLESPIE, (Del. Ch., April 22, 2008), read opinion here. This opinion would be of interest to landlords who have multiple tenants. The Chancery Court upheld the landlord's right to prevent distribution of pamphlets on the premises. Here is the court's summary:

 This is an action by 896 Associates, LLC (“896
Associates”) d/b/a Chelsea on the Square Apartments
(“Chelsea”) against a tenant, John W. Gillespie, for
distributing pamphlets in violation of Chelsea's
nonsolicitation policy. Gillespie distributed circulars
in the hallways of the apartment complex for the
purposes of establishing a tenants' association and to
inform other tenants of their rights under the
Delaware landlord/tenant code. At a hearing on
Plaintiff's motion for a preliminary injunction,
Gillespie maintained, among other things, that
Chelsea's nonsolicitation policy violated his free
speech rights under the First Amendment of the
United States Constitution and the Delaware
Constitution. The parties agreed Gillespie's
constitutional argument raises a legal issue suitable
for determination by way of a judgment on the
pleadings or summary judgment.

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Kevin LaCroix on his D & O Diary reports here on recent studies that he highlights as follows:

Excessive CEO pay remains a widely perceived marker for poor corporate governance and even for securities litigation risk. But recent scholarly analysis of senior corporate executive compensation suggests that outsized CEO pay may not only indicated weak governance, but may also be associated with company underperformance.

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Prof. Ribstein comments here  on a recent article by Professor Bainbridge entitled: Investor Activism: Reshaping the Playing Field?  Excerpts from Ribstein's overview of the article follow:

In this paper he announces that directors should have less power and that we should have more shareholder activism. Just kidding. Really, here's the abstract:

Shareholders of U.S. corporations historically tended towards rational apathy. Holding small blocks that were unable to affect the outcome of the vote and faced with the considerable costs associated with gathering sufficient information to make an informed decision, they adopted the so-called Wall Street Rule (it was easier to switch than fight). In the last 15 years or so, a growing number of commentators and investor activists have claimed that the rising importance of institutional investors has the potential to reshape the field by empowering shareholders to become active players in corporate governance. This paper situates investor activism in the so-called director primacy theory of corporate governance. In so doing, it demonstrates that the separation of ownership and control typical of U.S. public corporations has significant efficiency benefits. It then argues that shareholder activism threatens to undermine the advantages of director primacy without offering significant countervailing gains. Accordingly, the paper concludes that pending regulatory proposals to expand shareholder governance rights should be viewed with suspicion.

As Steve points out, "institutional investor activism does not solve the principal-agent problem but rather merely relocates its locus." He makes theoretical sense. Moreover, his theory his supported by the fact that we actually observe little effective shareholder activism. The exception is union and pension funds, which proves the rule. As Steve points out, "these are precisely the institutions most likely to use their position to self-deal—i.e., to take a non-pro rata share of the firms assets and earnings—or to otherwise reap private benefits not shared with other investors."

But if we can’t rely on the owners to keep managers honest, how can we make them accountable? Well, I have another idea – the “uncorporation,” including private equity and publicly held partnerships. See my Rise of the Uncorporation. These firms go Steve one better by effectively eliminating outside shareholders.

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Most corporate lawyers recognize the name Shannon Pratt as the author of several seminal and widely cited treatises on the valuation of businesses. He is in the process of publishing a new edition of The Lawyer's Business Valuation Handbook, which should be available by the summer.  I am flattered to have been requested to write the foreword to the upcoming edition. I am sure that many of my readers have relied on the book and have cited it in their briefs (as I know it has been cited in many court decisions including those of the Delaware Chancery Court).

If you want to share any views of the book that would be appropriate for me to refer to in the foreword, please let me know. Thank you.

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Professor Stephen Bainbridge has just published yet another book on corporate law. His most recent publication is entitled: The New Corporate Governance in Theory and Practice

The summary on Amazon.com here  (where it can be pre-ordered for delivery in about 6 weeks), describes the book as follows:

Forty years ago, managerialism dominated corporate governance. In both theory and practice, a team of senior managers ran the corporation with little or no interference from other stakeholders. Shareholders were essentially powerless and typically quiescent. Boards of directors were little more than rubber stamps. Today, the corporate governance landscape looks vastly different. The fall-out from the post-Enron scandal and implementation of the Sarbanes-Oxley Act have resulted in shareholder activism becoming more widespread, while many observers call for even greater empowerment. The notion that the board of directors is a mere pawn of top management is increasingly invalid, and as a result, modern boards of directors typically are smaller than their antecedents, meet more often, are more independent from management, own more stock, and have better access to information.

The New Corporate Governance in Theory and Practice offers an interdisciplinary analysis of the emerging board-centered system of corporate governance. It draws on doctrinal legal analysis, behavioral economic insights into how individuals and groups make decisions, the work of new institutional economics on organizational structure, and management studies of corporate governance. Using those tools, Stephen Bainbridge traces the process by which this new corporate governance system emerged, and explores whether such changes are desirable or effective.

We know from citations to his publications in their opinions that members of both the Delaware Supreme Court and the Delaware Chancery Court read the corporate law writings of Professor Bainbridge, and he has appeared at seminars on the same panel as members of the Delaware bench. Anyone interested in the latest developments in corporate law should read this most recent magnum opus by one of the nation's leading authorities on corporate governance.

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 The Delaware Superior Court has adopted a new rule regarding mandatory ADR. One may read a copy of new rule here.

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Fisk Ventures, LLC v. Segal, 2008 WL 1961156 (Del. Ch., May 7, 2008), read opinion here. This Chancery Court opinion, I predict, will be cited often by scholars and practitioners alike as part of the ongoing discussion about the difference between applying fiduciary duty concepts to LLCs--or not--as compared with the conventional application of those duties in the corporate context.

This case began as an action to dissolve an LLC pursuant to 6 Del. C. Sections 18-801 and 802 but this decision does not address those issues. Rather, the court grants motions to dismiss filed by the Third-party Respondents based on a personal jurisdiction argument and failure to state a claim. (Thus, the court was not called upon yet to address the dissolution issues.)

The third-party claims that the court addressed alleged that  the third-party defendants: (i) breached the LLC Agreement; (ii) breached the implied covenant of good faith and fair dealing; and (iii) breached fiduciary duties, among other allegations. 

[Although the court granted a motion to dismiss based on lack of personal jurisdiction pursuant to 10 Del. C. Section 3104 and 6 Del C. Section 18-109, because the other issues decided have much more far-reaching importance, I won't spend any time on the personal jurisdiction discussion, which otherwise is noteworthy in its own right.]

Though clearly separated in the structure of the opinion, the court's discussion of the breach of contract claim and the breach of fiduciary duty and implied duty claims was somewhat, of necessity, interwoven. The court began its analysis with basic contract principles and the truism that LLCs are creatures of contract, and that a prerequisite to any breach of contract analysis, is to determine if there is a duty  in the document that has been breached.

In this regard, the court cites in footnote 34 to Delaware Supreme Court Chief Justice Myron Steele's article entitled: Judicial Scrutiny of Fiduciary Duties in Delaware Limited Partnerships and Limited Liability Companies, 32 Del. J. Corp. L. 1, 4 (2007)("Courts should recognize the parties' freedom of choice exercised by contract and should not superimpose an overlay of common law fiduciary duties...")  See here  for overview of  that article on this blog and a link to it.

Prof. Larry Ribstein, one of the country's leading experts on LLCs, was cited twice in footnote 35 of the court's opinion, on the topics addressed in this case that he has written about extensively, such as the "freedom of contract" principles underlying LLC Agreements.

Importantly, the court found no provision in the LLC Agreement at issue that:  "create[d] a code of conduct for all members; on the contrary, most of those sections expressly claim to limit or waive liability."

Here is the money quote:

"There is no basis in the language of the LLC Agreement for Segal's contention that all members were bound by a code of conduct, but, even if there were, this Court could not enforce such a code because there is no limit whatsoever to its applicability".

The "implied covenant of good faith and fair dealing" claim was carefully examined and dispatched with one of the more lucid and cogent treatments I can recall of this amorphous cause of action.

Finally, the breach of fiduciary duty claim was confronted by first reciting the provisions of the Delaware LLC Act  at Section 18-1101(c) that allow for complete elimination of all fiduciary duties as part of an LLC Agreement. The court read the parties' LLC Agreement in this case to eliminate fiduciary duties because it flatly stated that:

"...members have no duties other than those expressly articulated in the Agreement. Because the Agreement does not expressly articulate fiduciary obligations, they are eliminated."

Query: If the parties' LLC Agreement was completely silent on the issue of whether any fiduciary duties were eliminated, would the court have reached the same result? Comments are welcome.

UPDATE: Here is the analysis of the case by Prof. Ribstein, who answers my above query thusly:

So what result here without an express elimination of duties?

As discussed in my article linked above [The Uncorporation and Corporate Indeterminacy] and in other writings, the Delaware cases have made it clear that the parties must contract carefully to waive fiduciary duties, as the parties did in Fisk. In other words, courts will add fiduciary duties to the express contract if the parties don't negate them. This can be reconciled with CJ Steele's admonition in this way: in the absence of contrary agreement, the fiduciary duties are part of the Delaware standard form contract, consisting of statutory and common law default rules. This seems sensibly consistent with the parties' usual expectations.

UPDATE II: Here is my post about the case on The Harvard Law School Corporate Governance Blog.

FURTHER UPDATE: Here is the Court's decision of July 3, 2008 denying a motion for reargument and emphatically explaining its interpretation of the Operating Agreement, finding no fiduciary duty.

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Nelson v. Emerson, 2008 WL 1961150 (Del. Ch., May 6, 2008), read opinion here. This Chancery Court decision provides a cornucopia of useful  and important statements of Delaware law for those lawyers whose practice overlaps corporate governance and creditors' rights, including bankruptcy proceedings. Although one could appropriately write a lengthy article about this case, the constraints of time and paying-clients compel me to highlight just a few key points from the opinion, with copious quotations from the court's decision.

The essential claims made were that the directors and majority stockholders of a company breached their fiduciary duties to the only secured creditor by causing the company to file for bankruptcy and by paying themselves "excessive compensation" during the time that the creditor was insolvent, both before and after the bankruptcy.

In sum, the court determined that Nelson, the creditor/plaintiff,  had made the same arguments before, and they were rejected in the bankruptcy court. Or, as the court expressed it: "The problem with Nelson's claims is that he is seeking a second chance to win the same game." The court nonetheless explained its reasoning in great detail. Along the way, there are several statements of Delaware law that are eminently quotable and worth "having handy for future reference", such as the following quote:

Nelson also argues that the bad faith standard used
in bankruptcy law is not the same as the standards
used to determine breaches of fiduciary duty under
Delaware law. In making that argument, Nelson
misunderstands the applicable Delaware law. It is
settled Delaware law that an insolvent company is
not required to turn off the lights and liquidate when
that company's directors believe that continuing
operations will maximize the value of the company.
Federal bankruptcy law shares this belief and
provides procedures that enable an insolvent
company to continue its operations while at the same
time balancing the interests of the affected corporate
constituencies.

Here is another money quote:

The directors of an insolvent company who, in good faith, undertake a strategy to benefit the company's equity holders cannot be held liable just because the strategy failed. The Bankruptcy Court has already determined that Repository's bankruptcy filing was a non-frivolous strategy and that it was partially successful. That precludes any finding that the Emersons breached their fiduciary duties by causing the Company to undertake that strategy.

Even if Nelson was not precluded from bringing his claims due to the prior rulings of the bankrupcty court, the Chancery Court explained why he still had an uphill battle ahead of him in order to prevail on his claims:

Alternatively, I note that even if Nelson were not precluded from making his fiduciary duty claim, his pleadings fail to state a claim that the Emersons breached their fiduciary duties. Repository's charter contains a § 102(b)(7) clause that exculpates its directors from liability for breaches of their duty of care. Nelson must, therefore, plead facts supporting a viable claim for a breach of the duty of loyalty to survive the Emersons' motion to dismiss. Nelson's assertion that the Emersons caused Repository to pay them excessive compensation while the Company was insolvent does not support a duty of loyalty
claim because the complaint neither quantifies the amount of the allegedly excessive compensation nor describes which directors approved that compensation or suggests that those unknown directors were not independent. Likewise, Nelson's contention that the Emersons caused Repository to file for bankruptcy in bad faith for the purpose of
frustrating Nelson's efforts to collect the debt owed to him by Repository does not support a duty of loyalty claim.

At footnote 13 and accompanying text, the Chancery Court discusses two causes of action that may be familiar to bankruptcy lawyers, but are not commonly seen in Chancery Court opinions. Namely, "recharacterization of loans from debt to equity" and "equitable subordination". These were claims that the company pursued against the creditor in response to the creditor's efforts to have the bankruptcy dismissed--which he was successful in doing, but not  because of the mismanagement basis and the bad faith reasons he wanted the court to rely on.

The Chancery Court extensively discusses each of the elements of the doctrine of collateral estoppel and applies them to the facts to explain why that doctrine bars the claims presented in this case.

Here are a few other instructive quotes that reiterate important statements of Delaware law and that, I suggest, are of great interest to business litigators:

It is settled Delaware law that “[e]ven when the company is insolvent, the board may pursue, in good faith, strategies to maximize the value of the firm.”FN54  Filing a Chapter 11 bankruptcy petition is a federally-sanctioned strategy for maximizing the value of an insolvent company.FN55  Here, after a full trial, the Bankruptcy Court determined that
Repository used that strategy in good faith.FN56 Directors of a Delaware corporation do not commit a breach of fiduciary duty against the corporation if they, in good faith, seek to benefit the equity holders by bringing a bankruptcy, in order to recharacterize certain debt as equity.FN57  So long as that action is not frivolous, such an exercise of business judgment to advance the interests of the equity holders is not a breach of fiduciary duty simply because the directors do not achieve ultimate success.FN58

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FN54.Trenwick Am. Litig. Trust v. Ernst & Young, L.L.P., 906 A.2d 168, 204 (Del. Ch.2006), aff'd, 931 A.2d 438 (Del.2007).

FN55. See, e.g., Trenwick, 906 A.2d at 204 (“Chapter 11 of the Bankruptcy Code expresses a societal recognition that an insolvent corporation's creditors (and society as a whole) may benefit if the corporation continues to conduct operations in the hope of turning things around.”); Production Resources Group, L.L.C. v. NCT Group, Inc., 863 A.2d 772, 793 n. 66 (Del. Ch.2004) (“[I]n most instances when a firm is insolvent but believes itself to have a
prospect for viability, the firm will seek out the protections of the Bankruptcy Code and
attempt to restructure its affairs through the well-articulated body of federal law specifically designed for that purpose.”); see also Trenwick, 906 A.2d at 204 n. 103 (citing numerous federal decisions explaining the purpose of federal bankruptcy protection and the discretion afforded to directors in deciding whether to take advantage of the bankruptcy process).

FN56. Nelson's argument that good faith in bankruptcy law only considers objective
factors whereas good faith in Delaware fiduciary duty law considers subjective
intent is misguided. The very decision that Nelson cites to support that proposition
explains that in determining whether the debtor filed for bankruptcy in bad faith a court “may consider any factors which evidence an intent to abuse the judicial process and the purposes of the reorganization provisions.”In re McCormick Road Associates, 127 B.R. at 413 (quoting In re Phoenix Piccadilly Ltd., 849 F.2d 1393, 1394 (11th Cir.1988) (emphasis
added); see also id. at 415 (“[O]nce a court has properly found that the debtor has failed
to satisfy the court's objective good faith inquiry-i.e., whether reorganization is the
proper course of action in a particular debtor's case-it may properly dismiss the debtor's petition without considering the debtor's subjective good faith. In other words, a finding of subjective bad faith-i.e., intentional abuse of the bankruptcy laws-is not a necessary prerequisite to dismissal for bad faith filing.”) (internal quotation and citations omitted). Moreover, the use of objective factors as a proxy for subjective intent makes sense. See Production Resources, 863 A.2d at 793 n. 85 (“Because it is impossible for non-divine judges to peer into the hearts and souls of directors, this court has recognized the importance of considering relevant circumstantial facts that bear on scienter, which include the substance and effects of the defendants' conduct.”). The reality is that Nelson
received a trial on, among other issues, whether Repository's bankruptcy filing was
made in subjective bad faith. That he failed to prevail on that contention does not mean
his argument was not fairly considered.

FN57.See Gheewalla, 930 A.2d at 103 (explaining that its rationale for not recognizing direct fiduciary duty claims by creditors was that “[d]irectors of insolvent corporations must retain the freedom to engage in vigorous, good faith negotiations with individual creditors for the benefit of the corporation”) (citing Production Resources, 863 A.2d. at 797).

FN58 See id.(“Recognizing that directors of an insolvent corporation owe direct fiduciary duties to creditors, would create uncertainty for directors who have a fiduciary duty to exercise their business judgment in the best interest of the insolvent corporation.”).

Regarding the claim that the defendant directors paid themselves "excessive compensation", the court's opinion provides a tutorial about the necessary elements of that claim:

To state a claim for excessive compensation, a plaintiff “must either plead facts from which it may reasonably be inferred that the board or the relevant committee that awarded the compensation lacked independence (e.g., was dominated or controlled by the individual receiving the compensation), in which event proof of such allegations would cast upon the
officer the burden to prove that the compensation paid was objectively reasonable in the circumstances or plead facts from which it may reasonably be inferred that the board, while independent, nevertheless lacked good faith (i.e., lacked an actual intention to advance corporate welfare) in making the award.”FN60

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FN60.Gagliardi v. TriFoods Intern., Inc., 683 A.2d 1049, 1051 (Del. Ch.1996).

The court went on to example why Nelson woefully fell short of these prerequisites. For example, the court observed that:

Second and even more fatally to Nelson's claim, his complaint provides no information about the amount or specific instances of the alleged excessive compensation.FN64  By no facts, I mean none that quantify what compensation the Emersons received and when, much less any that support an inference that the non-pled amounts exceeded what was
rational and proper. As explained above, Nelson has no excuse for the lack information about the alleged excessive compensation. Therefore, “[i]n the absence of [pled] facts casting a legitimate shadow over the exercise of business judgment reflected in
compensation decisions,” this claim must be dismissed.” FN65

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FN64.See id. ¶ 2 (alleging that the Emersons enriched “themselves and members of their
family through the payment of exorbitant salaries, benefits and expenses); id. ¶ 13
(alleging that “Mrs. Emerson received excessive commissions in that commissions
were paid for customer service, rather than sales activities); id. ¶ 14 (alleging that the
Emersons “both dined frequently at [Repository's] expense, charging meals to
the company American Express Card”); id. ¶ 20 (alleging that the “continued payment of
excessive salaries and commissions further diminished [Repository's] cash reserves”).
Nelson's contention that amounts and specifics are not necessary because the
payment of “any compensation during insolvency was exorbitant” is absurd and
illustrates why conclusory pleading that compensation is “excessive” has been held
to be not sufficient to state a claim. Nelson Ans. Br. at 18 n. 9 (emphasis in original).

FN65.Gagliardi, 683 A.2d at 1051.

UPDATE: Here is an insightul analysis of the case from a bankruptcy expert's perspective by Steve Jakubowski on his Bankruptcy Litigation Blog.

Supplement: Although it is not directly on point, a somewhat related recent decision I came across in the current issue of the ABA/BNA Lawyers' Manual on Professional Conduct, might be worth a "see generally" type of closing footnote. The Virginia Supreme Court on April 18 ruled in the case of McNally v. Rae , (VA, No. 070522), that an attorney has no duty to warn an adversary that the attorney's client is considering a filing for bankruptcy. The Virginia Supreme Court in this case reversed a trial court's imposition of attorneys' fees on an attorney for the costs of trial preparation due to the attorney not announcing to his opponent until the day that trial started that his client, the defendant, had filed bankruptcy the night before, though the client had been contemplating it for some time. Part of the reasoning would be that the client had a right to file bankruptcy, and requiring an attorney to disclose his client's deliberations prior to making the decision would have a chilling impact on the attorney/client relationship.

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Sutherland v. Sutherland, 2008 WL 1932374 (Del. Ch., May 5, 2008), read opinion here.

[This is one of four opinions issued on May 5 by the Chancery Court, two of which were written by the same vice-chancellor. I hope to post on the other 3 opinions issued on May 5 by tomorrow.]

Factual background details can be obtained from the three prior decisions by the Chancery Court involving these parties, and summarized on this blog here, here and here. This latest opinion in this ongoing internecine Sutherland family squabble denied a motion to dismiss, despite the great weight often given to the recommendation of the Special Litigation Committee (SLC), on which the defendant companies relied for their motion to dismiss. The reason for rejecting the SLC's conclusions: After having considered the briefs, affidavits, limited discovery and arguments of the parties, the Chancery Court reasoned that:

"the special litigation committee [consisting of one man] has not satisfied the court that it acted in good faith and conducted a reasonable investigation."

The opinion also discusses the issue of independence, the third requirement that the SLC needs to satisfy pursuant to the decision in Zapata Corp. v. Maldonado, 430 A.2d 779 (Del. 1981), as well as closely scrutinizing whether the SLC satisfied the other requirements of good faith and reasonable investigation.

One lesson from this opinion that can be learned by "negative example" is how "not to constitute"" an SLC (if one wants to have maximum "protection") , and how "not to conduct an SLC investigation" (if one wants to increase the odds of not  having the court disregard the SLC's conclusions.)

The court noted that the SLC has the burden of establishing its good faith, reasonable investigation and independence, based on Rule 56 standards, although the review has some aspects of a Rule 12(b)(6) motion. The court also referred to the decision in Kaplan v. Wyatt , 484 A.2d 501, (Del. Ch. 1984), that requires the SLC's conclusions to be supported by a "thorough record". The court may also apply its own business judgement to the conclusion of the SLC even if the SLC satisfied all other prerequisites.

A central theme in the complaint was that the directors were allegedly using the company's assets for their own personal benefit via such things as personal use of the corporate jet, lavish personal expenses charged to the company for chartered private railroad cars, private parties, club memberships, expensive hotels, rental cars, and other examples of opulence not required by their position at the company.

The court provided reasoning and examples of why the one-man committee's investigation was not adequate. He only spent  less than one full-day at the company's office reviewing records. He arrived at 8:30 and then met with various accounting and management personnel before reviewing records. He took a one-hour lunch and then left at 3:30. The following quote from the opinion provides more details:

Perhaps more notable than what Jeffrey did is what Jeffrey [the one-man committee] did not do. Jeffrey testified at his deposition that, although he is a certified public accountant, he did not arrive at the companies' offices with a plan for how he was going to conduct the review. He did not take any notes. Thus, there is no written record of what he did. Jeffrey testified that he did not review a statistically significant number of invoices when testing whether the accounting records were accurate. He did not verify that the vendor number he asked the accounting department to run was Perry's only vendor number. And he conducted no search for payments the companies may have made to third parties on Perry's behalf. For instance, if Perry used Maysville and Maysville then invoiced the companies rather than Perry, Jeffrey's investigation would not have found the check sent to Maysville on Perry's behalf.FN33  Nor, as Jeffrey testified, would he have found checks the companies made to credit card issuers on Perry's behalf. Indeed, Jeffrey testified that his review of the ledgers would have failed to capture the two large payments made to King on Perry's behalf.

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Personnel Decisions, Inc. v. Business Planning Systems, Inc., 2008 WL 1932404 (Del. Ch., May 5, 2008), read opinion here. This Chancery Court decision is 15 pages long in the Westlaw format which usually is the equivalent of over 40 pages in the original slip opinion format. This opinion contains precious iterations of Delaware law on contract principles, and  explains civil procedure rulings that deserve thorough review, but  in this post I will only highlight 5 key points that I have extracted:

1) Parties may consent to be governed by the Delaware Uniform Arbitration Act (DUAA) even if the Federal Arbitration Act (FAA) would otherwise apply absent specific provision in the agreement of the parties. (See, e.g., footnote 29),

2) The DUAA differs from the FAA and most other state arbitration acts in several respects. For example, a distinction is made in the DUAA between "notice" of the arbitration given to the opposing party--separate from the "demand" for  arbitration. After a thorough analysis, the court determined that this distinction could not be inequitably  leveraged to defeat the legislative intent of DUAA sections 5702 and 5703 which was to give the defending party an opportunity to seek an injunction in Chancery Court  to have the arbitration enjoined. (See, e.g., footnote 63).

3) Filing a complaint alone to initiate a lawsuit in a particular forum, without service of the complaint, in the nature of a placeholder, will not carry the customary weight of a "first-filed" suit for purposes of the familiar McWane analysis. (See footnote 58).

4) "Quasi-Estoppel" is a rarely applied doctrine that can be a useful arrow in a litigator's quiver. It can be used to prevent a party from changing its position "in mid-stream" during litigation--to another party's disadvantage, e.g., by asserting a right inconsistent with a previous position taken. (See footnotes 38 and 39).

5) "Course of Performance" is the second best means to employ in the interpretation of a contract, after first trying to determine the "plain meaning". Course of  performance may also be evidence of a party's intent to modify or waive certain terms of  the agreement. (See footnotes 21 and 22).

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In the Matter of Burnbrae Maintenance Association, 2008 WL 1952166 (Del. Ch., May 5, 2008), read opinion here. This is an example of the broad variety of cases that the Chancery Court handles on occasion. This case involves a custodian that was appointed to oversee a condominium association and who now seeks to be discharged and have his fees paid, relying on Section 226 of Title 8 of the Delaware Code.

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Del-Chapel Associates v. Conectiv, 2008 WL 1934503 (Del. Ch., May 5, 2008), read opinion here.

The Chancery Court decided issues of adverse possession and those instances where trespass occurs when the scope of a license is exceeded by one's actions. 

This is one of 4 cases promulgated by Chancery Court on May 5, and one of about 10 published this week, many of which were over 40 pages long in original format. That's my excuse for not making this a long summary, in addition to the fact that the topic not being one that most readers would expect extensive treatment of on these pages.

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Prof. Bill Sjostrom on Truth on the Market Blog posts about an article on SSRN that provides an empirical study which concludes that among those LLCs  formed outside the state of their principal place of business, more LLCs choose Delaware to form their LLC in, with suggested reasons why. Good stuff for those interested in why certain jurisdictions are chosen over others for the formation of entities.

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Prof. Bainbridge analyzes here the applicable standard under Delaware corporate law that would apply to the defensive measures taken by Yahoo to spurn the advances of Microsoft. He explains why the case of Blasius v. Atlas Corp. would not apply. Blasius imposes a heightened standard of review when the shareholder franchise is interfered with by the board. Yahoo amended its bylaws in reply to Microsoft's bid so that the date by which nominations for board members had to be submitted was delayed until 10 days after the announcement of the annual meeting (which has not been announced yet.)  Professor B. explains that the Delaware Supreme Court's decision in Stroud v. Grace supports the argument that the standard announced in Delaware Supreme Court opinion in Unocal, and not  the Blasius standard, should apply in the "Microhoo" situation where the primary purpose in any changes that impacted the shareholder franchise was related to a defense to a takeover attempt.

Prof. Ribstein has also provided several insightful posts on the situation, e.g., here.

Although not nearly as scholarly as the good professors, I was quoted here by the San Francisco Chronicle in an article in today's edition that addressed the same issues about the standards that would apply to Yahoo's actions (or inactions).

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The Delaware Chancery Court issued a clarification yesterday to lawyers in order to clarify that passwords for eFilings of pleadings and other submissions with the Court are only to be used by Delaware lawyers and shall not be "lent to" (my words) or shared with non-Delaware lawyers, nor shall non-Delaware lawyers be added to the "electronic service list" through which those who eFile documents with the court are sent notice of eFilings by other lawyers in the case.

Here is  the text of the short admonition that was emailed to Delaware lawyers yesterday. This, of course, is of great practical importance to any lawyer who serves as local counsel for the large number of out-of-state lawyers from around the country who practice in Chancery Court.

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An all-day seminar yesterday at Widener University Law School featured leading members of the judiciary as well as practitioners and academics who proposed changes to Delaware corporate  law on (or about)  the 40th anniversary of the last major overhaul of the Delaware General Corporation Law in 1967 (although minor updates have been made each year since then.)  Unlike most other jurisdictions, Delaware recognizes practitioners and academics from other states as  being well-versed enough about Delaware law that their opinions are respected in terms of their suggestions for changes in our law. Indeed, the last major revision in 1967 of the DGCL was done under the scholarly direction of University of Virginia Law Professor Ernest Folk.

Here is a post I did recently on the current issue of the Delaware Lawyer magazine which contains articles with many suggested changes by several of the panel members at yesterday's seminar.

Here is a list of the topics covered at yesterday's seminar along with the panel members' names and an overview of the purpose of the seminar.

I am attempting to provide a link to the materials because the volume of topics addressed is too much to cover in a blog post, but among the suggestions I though most notable were those made by Ted Mirvis of the Wachtell Lipton firm in New York, who proposed 2 changes to the DGCL as follows (and I am only paraphrasing):

1. All claims related to the DGCL or regarding fiduciary duties, shall be brought in the Delaware Chancery Court; and

2. Rulings regarding the exercise by directors of their fiduciary duties in change of control cases should be contextual only and should not be the subject of a per se rule.

Professor Faith Stevelman Kahn of New York Law School suggested that for policy reasons, a mandatory forum selection clause would not be advisable--even if permissible by applicable law to do so.  Professor Elizabeth Nowicki of Tulane University Law School argued that Section 102(b)(7) should be "gutted" (my word) in order to give directors a negative incentive (or in her words, "fear of punishment") that would scare them into better observance of their duties.

During a luncheon speech, Vice Chancellor Leo Strine, Jr. provided insights during a 40-minute presentation that I cannot do justice to in the short space appropriate to this forum, but one nugget I wrote down in my notes (and this is only a paraphrase that runs the risk of being taken out of context), is his suggestion that even though Congress has the authority to increase their regulation of corporate governance, they should not engage in "selective intervention" into the corporate governance arena while still leaving the hard work to the states of enforcing fiduciary duties on a case-by-case basis.

Many other luminaries offered suggestions about how to change the DGCL to keep up with the global competition in the 21st Century, and I hope to add more details about the symposium later.

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Madison Real Estate Immobilien-Anlagegesellschaft Beschrankt Haftende Kg v. Kanam USA XIX Ltd. Partnership, 2008 WL 1913237 (Del.Ch., May 01, 2008), read opinion here. (Yes, that is the correct spelling of the unusual and long case name.) Before I address the substantive parts of the opinion, allow me three brief introductory comments about this recent Chancery Court decision involving the denial, after trial, of a demand by a limited partner for books and records of a limited partnership. ( This opinion may not have the type of sexy issues that makes headlines like the recent Yahoo and Microsoft dance, but this case provides answers to the type of quotidian issues that most business litigators need to have in their toolbox.)

First, unlike most cases under DGCL Section 220, an added dimension of "books and records demands" involving alternative entities, as in this case, is the separate governing agreement that often provides a separate basis to demand documents--separate from any statutory right. Delaware cases have established that those agreements may appropriately either expand or expressly limit statutory rights to books and records, but here is the burning question for inquiring minds:

If the claim is based entirely on an agreement, and not the statute, must the requesting party still have a "proper purpose" which is a requirement of the statute, even if it is not stated as a prerequisite in the agreement? In this case, the court presented both sides of the argument thusly:

 Here, the Partnership Agreement does not impose a proper purpose requirement on a limited partner's inspection right. Therefore, Madison generally need not state a proper purpose to enforce its contractual inspection right.

However, the Chancery Court in this case goes on to allow that:

Under the “improper purpose defense,” however, a court may deny a partner's request for access to a partnership's records when:

(i) neither the explicit contractual provision in a partnership agreement nor statutory language negate the notion that a partner must have a proper purpose, and (ii) the partner denying another partner access to partnership business records can show that the partner seeking access is doing so for a purpose personal to that partner and adverse to the interests of the partnership considered jointly. FN96
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FN96. Bond Purchase, L.L.C. v. Patriot Tax Credit Props., L.P., 746 A.2d 842, 857 (Del. Ch.1992).

See also footnote 36 and related text in this opinion for the court's reliance on Section 220 cases by analogy in order to determine proper purpose. Accord,  Donald Wolfe and Michael Pittenger, Corporate and Commercial Practice in the Delaware Court of Chancery, at 8-107, Section 8-6[a][2] (2007).

Second, as was mentioned in a recent Chancery opinion here, there are not as many Delaware decisions regarding "books and records demands" involving alternative entities, as compared with those under Section 220 for corporations. Thus, this opinion should be noted for its membership among a relatively sparse population. Professor Larry Ribstein, one of the nation's leading scholars on alternative entities, has written extensively on the topic of "uncorporations" in general and comparisons with the corporate form in particular. See, e.g., here.

Third, it is notable that after a trial and extensive briefing (read: considerable expense), the request for books and records in this case was denied. As has been mentioned on these pages frequently, one should not assume that a request for books and records will be either inexpensive or easy. See generally, Professor Bainbridge's comments here about recent proposed legislation in the U.S. Congress that would require states to make more information publicly available about the ownership of all entities.

 Now, onward to more specifics of this case with apologies if my introductory remarks dwarf my discussion of the details of the opinion. This demand for books and records in this case was based on both Section 17-305 of the Delaware Revised Uniform Limited Partnership Act as well as the terms of the Partnership Agreement itself.

The court relied extensively on two prior cases to address the issue of whether the plaintiff in this case had a "proper purpose" for requesting the documents. Madison Ave. Inv. Partners, LLC v. Am. First Real Estate Inv. Partners, L. P. (Madison I ), 806 A.2d 165 (Del. Ch.2002) and BBC Acquisition Corp. v. Durr-Fillauer Medical, Inc., 623 A.2d 85 (Del. Ch.1992).

One of the issues in this case was whether the primary purpose for the records was to prepare for a tender offer. The court found the BBC case, supra, to be closer to the facts of this case and determinative of the outcome. The plaintiff in this case was an investment vehicle comprised mostly of German nationals who invested in retail real estate, often for the purpose of making tender offers. The prior Chancery Court decision in Madison I, supra, ruled that the simple fact that a limited partner is in the business of making tenders offers, does not , ipso facto, disqualify that party from establishing a proper purpose.

Contrariwise, however, the prior Chancery Court decision in BBC, supra, held that where the primary purpose was not to value one's own current interest, but rather to determine whether to increase an offering price to buy the whole company, and if so, by how much--that primary purpose was not reasonably related to one's interest as a shareholder, and thus, was not a "proper purpose" as is required in order to successfully pursue a books and records claim.

So too, in this case, the court concluded that the evidence demonstrated that the primary purpose for seeking books and records was for the purpose of making a tender offer, which was not a proper purpose, based on the BBC case, supra.

The court also relied on the defenses available at Section 17-305(b) which allows documents to be withheld if they are trade secrets and/or if they are the subject of confidentiality agreements with third-parties (even if, as here, they are oral agreements).

As for the strictly contract claim discussed above, the court determined that the language relied upon was not ambiguous enough to resolve doubts against the drafter, but that the language in the document  providing for "books and accounts" did not include the documents sought by the plaintiff--even if a "proper purpose" requirement was not superimposed on the contract claim.

 In any event, some classic contract interpretation principles were reiterated and warrant quotation:

Limited partnership agreements are contracts the courts construe like any other contract.FN80 Under Delaware law, contract construction is a question of law.FN81 When interpreting a contact, the court strives to determine the parties' shared intent, “looking first at the relevant document, read as a whole, in order to divine that intent.”FN82 As part of that review, the court interprets the words “using their common or ordinary meaning, unless the contract clearly shows that the parties' intent was otherwise.”FN83 If the contractual language is “clear and unambiguous,” the ordinary meaning of the language generally will establish the parties' intent.FN84 A contract is ambiguous, however, when the language “in controversy [is] reasonably or fairly susceptible of different interpretations or may have two or more different meanings.”FN85 Under the doctrine of contra proferentem, ambiguities in a contract will be resolved against the drafter. FN86
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FN80.See Arbor Place, 2002 WL 205681, at *3. The court in Arbor Place cited Elf Atochem N. Am., Inc. v. Jaffari, 727 A .2d 286, 290-91 (Del.1999), for the proposition that: “ ‘The policy of freedom to contract underlies both the [LLC] Act and the LP Act.... The basic approach of the [LLC] Act is to provide members with broad discretion in drafting the Agreement and to furnish default provisions when the members' agreement is silent.’ “ Id.

FN81.Rhone-Poulenc Basic Chems. Co. v. Amer. Motorists Ins. Co., 616 A.2d 1192, 1195 (Del.1992).

FN82.Matulich v. Aegis Comm'ns Group, Inc., 2007 WL 1662667, at *4 (Del. Ch. May 31, 2007) (citing Kaiser Aluminum Corp. v. Matheson, 681 A.2d 392, 395 (Del.1996)); Brandywine River Prop., Inc. v. Maffet, 2007 WL 4327780, at *3 (Del. Ch. Dec. 5, 2007).

FN83.Cove on Herring Creek Homeowners' Ass'n v. Riggs, 2005 WL 1252399, at *1 (Del. Ch. May 19, 2005) (quoting Paxson Commc'ns Corp. v. NBC Universal, Inc., 2005 WL 1038997, at *9 (Del. Ch. Apr. 29, 2005)).

FN84.Brandywine River, 2007 WL 4327780, at *3.

FN85.Rhone-Poulenc, 616 A.2d at 1196. Ambiguity does not exist simply because the parties do not agree on a contract's proper construction. United Rentals, Inc. v. Ram Holdings, Inc., 2007 WL 4496338, at *15 (Del. Ch. Dec. 21, 2007).

FN86.See Twin City Fire Ins. Co. v. Delaware Racing Ass'n, 840 A.2d 624, 630 (Del.2003); Bond Purchase, L.L.C. v. Patriot Tax Credit Props., L.P., 1999 WL 669358, at *3 (Del. Ch. Aug. 16, 1999).

UPDATE: Here is a scholarly analysis of the case and related commentary by Professor Larry Ribstein, one of the leading experts in the country on LLCs and other "uncorporations".

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