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

Dweck v. Nasser, C.A. No. 1353-VCL (Del. Ch. March 10, 2010), read letter decision here.

Prior decisions of the Court of Chancery involving this matter have been highlighted on this blog here.

This short three-page letter decision refused to apply the Statute of Frauds to an oral agreement that was terminable by either party at any time "upon performance of an act which is within the control of one of the parties." The Court reasoned that because the "performance of the agreement could be completed within one year without breach by either party", the Statute of Frauds did not bar its enforcement. 

In a previous decision in this matter, the Court of Chancery ruled that the oral agreement still being disputed in the instant ruling, (which is based in part on an unsigned draft shareholders' agreement), could not serve the purpose of a "voting agreement" due to the requirement of DGCL Section 218(a) that voting agreements or voting trusts be in writing. Nonetheless, the Court observed, nothing prevents the application of another state's contract law, such as New York in this case, to issues such as contract formation at the same time that the DGCL governs the validity of the corporate governance implications of the contract.

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Pfeiffer v. Toll, C.A. No. 4140-VCL (Del. Ch. March 3, 2010), read opinion here. This scholarly decision upheld state law claims against directors for insider trading. The Court of Chancery rejected the argument that federal law preempted state law for such claims. For anyone who wants to know the latest Delaware law on insider trading claims, and the Brophy line of cases, this is must reading. The Court cited in its decision to nationally prominent corporate law professor Stephen Bainbridge. See Slip op. at 35, 36, and 41 (citing Stephen M. Bainbridge, Securities Law: Insider Trading 15-16 (2d ed. 2007)). Of course, regular readers of this blog know that the Delaware Court of Chancery and the Delaware Supreme Court have cited to Professor Bainbridge's scholarship many times in prior opinions.

The good professor has already penned thoughtful commentary on this opinion with extensive insight and analysis.We are fortunate to have this nationally recognized expert's review of this case. (It makes my job easier). Thus, I commend to you Professor Bainbridge's discussion of this case, especially  regarding the interface between state and federal law in connection with insider trading, available on his blog here and here.

P.S.  Professor Larry Ribstein, another prolific, nationally recognized expert whose scholarship is often cited by the Delaware Courts, has just provided his scholarly insights on this case here.

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Jarvis v. Elliott, C.A. No. 4753-CC (Del. Ch. March 5, 2010), read opinion here. This 18-page decision is as fun as it gets when it comes to reading judicial decisions.

Although the amounts involved in this case are more fitting for a small claims court, and the primary legal issues are replevin and conversion, the main reason I include this decision on this blog--which seeks to cover all the key decisions on corporate and commercial law from Delaware's Chancery Court and Supreme Court, is due to the memorable manner in which the opinion is written. It includes a combination of serious adjudication mixed with multiple references to famous race car drivers, movies about race cars and other indications that the author of this opinion is quite familiar with the industry from which the parties in this case arrive at the Court. This decision also highlights the reality that not all business disputes in Chancery are billion dollar disputes among Fortune 100 companies. The Court in this case awarded a total of $1,260.67--though the opinion is just as thoughtfully written as if it were one of the many major disputes the Court handles.

The opening line to the ruling deserves to be quoted: "Success on the track does not guarantee success off the track. With regret that a winning team fell apart, I must now sort through the wreckage of a failed relationship...."

The Court explained that replevin was typically not within its jurisdiction but that it retained it in this case under the "whole case or controversy" doctrine based on initial partnership claims. Before defining the elements of a replevin action,  the Court began its analysis thusly: "My analysis will be swifter than Richard Petty's race-clinching pit stop at the 1981 Daytona 500. The chassis of this case is a replevin action". 

The Court also referred in footnotes to famous movies featuring racing. See footnotes 50, 51 and 52. Demonstrating a firm grip on the details of the racing industry, the Court acknowledged towards the end of its decision the importance of backup engines and backup cars by the following reference: "Just ask Jimmie Johnson, who recently won one of the 2010 Daytona 500 qualifiers in a backup car."

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On March 1, 2010, Vice Chancellor Noble issued a long-awaited post-trial decision on the validity of the implementation of a net operating loss carry forward (“NOLs”) rights plan. Selectica, Inc. v. Versata Enterprises, Inc., et al., C.A. No. 4241-VCN,  read opinion here

Kevin Brady, a highly regarded Delaware litigator, prepared this synosis.

In his 71-page opinion, Vice Chancellor Noble validated Selectica’s adoption of the NOL pill as a valid exercise of the Board’s business judgment under Unocal Corp. v. Mesa Petroleum Co., 493 A. 2d 946 (1985).

Background

Selectica provides enterprise software solutions for contract management and sales configuration systems. Trilogy, Inc. also specializes in enterprise software solutions. Versata Enterprises, Inc. a subsidiary of Trilogy, provides technology powered business services. All three are Delaware corporations. Selectica became a public company in 2003 and since that time it has failed to turn a profit. What it did generate, however, was an estimated $160 million of NOLs.

In 2008, Trilogy made three proposals to acquire Selectica; all were rejected. In October 2008, Trilogy began making open-market purchases of Selectica stock and on November 10, 2008 Trilogy informed Selectica that it had purchased more than 5% of Selectica’s outstanding stock. Within a week, Trilogy had increased it’s ownership to over 6%. On November 16, 2008, the Selectica Board met to discuss the Trilogy situation and to consider amending Selectica’s 2003 poison pill. The Board unanimously passed a resolution amending the poison pill decreasing the beneficial ownership from 15% to 4.99% “while grandfathering in existing 5% shareholders and permitting them to acquire up to an additional 0.5% (subject to the original 15% cap) without triggering the NOL pill.”

Trilogy continued making open-market purchases “buying through the NOL Pill” bringing its total ownership to 6.7%. Trilogy then proposed that Selectica agree to, among other things, buy Trilogy’s shares back, accelerate payment of its debt and pay Trilogy $5 million for settlement of outstanding issues. While the Selectica Board was considering Trilogy’s settlement offer, the Board asked Trilogy to agree to a standstill as to any additional open-market purchases by Trilogy while the Board used the ten-day clock under the NOL Pill to determine whether to consider Trilogy’s purchases as “exempt” under the rights plan, or else how Selectica would go about implementing the pill.” The NOL Pill permitted the Board to declare Trilogy an “Exempt Person” if the Board determined that Trilogy would not “jeopardize or endanger the availability to the Company of the NOLs . . . .” Another option for the Board included exchanging the rights (other than those held by Trilogy) for shares of common stock. If the Board took no action, then at the end of the ten day period, “the rights would ‘flip in’ automatically, becoming exercisable for $36 worth of newly-issued common stock at a price of $18 per right.”

Trilogy refused to enter into a standstill agreement and Selectica’s Board rejected Trilogy’s settlement offer. On December 31, 2008, the Board concluded that the NOL Pill should go into effect. On January 2, 2009, the Board delegated authority to the Independent Director Evaluation Committee (the “Committee”) “to effect an exchange of the rights under the NOL Pill and to declare a new dividend of rights under an amended rights plan (the “Reloaded NOL Pill”).”

Thereafter, the Committee determined that Trilogy should not be deemed an “Exempt Person”, and that its purchase of additional shares should not be deemed an “Exempt Transaction”, that the exchange of rights for common stock (the “Exchange”) should occur and that a new rights dividend on substantially similar terms ought to be adopted. The Committee passed resolutions adopting the Reloaded NOL Pill and instituting the Exchange, which doubled the number of shares of Selectica common stock owned by each shareholder of record, other than Trilogy and Versata. This reduced Trilogy and Versata’s beneficial holdings from 6.7% to 3.3%.

Selectica Seeks a Declaratory Judgment in the Court of Chancery

Selectica filed an action in the Court of Chancery seeking a declaratory judgment that the actions of the Board and the Committee in adopting the NOL Pill, authorizing the Exchange, adopting the Reloaded NOL Pill and issuing a new rights dividend were valid under Delaware law and were appropriate exercises of their fiduciary responsibilities under Unocal. In particular, Selectica argued that the Board acted reasonably “in concluding that the NOLs constituted a potentially valuable asset that was threatened by Trilogy’s actions, and that the adoption of the NOL Pill, implementation of the Exchange, and adoption of the Reloaded NOL Pill and declaration of a new rights dividend were not preclusive but were reasonable and proportionate responses to the identified threat.”

Trilogy counterclaimed seeking a declaratory judgment that the NOL Pill and Reloaded NOL Pill were invalid, void and unenforceable “either because (1) they are both anti-takeover devices that, either per se or on the facts of this case, preclude an effective proxy contest; or (2) they were not a reasonable and proportionate response to a reasonably perceived threat because the Board failed to establish that the NOLs had a value worth protecting and that this value was threatened by Trilogy’s purchases.” Trilogy challenged Selectica’s argument that the Unocal standard had been met by arguing that the Selectica directors “established neither that the NOLs had a value worth protecting, nor that this value was threatened by Trilogy’s purchases.” Trilogy also sought an order enjoining or rescinding the Exchange and requiring Selectica to redeem permanently the new rights dividends issued under the Reloaded NOL Pill as well as money damages for breaches of fiduciary duty. 

 Poison Pills and the Unocal Test

The issue before the Court was the reasonableness of the Board’s decision to adopt “a low-threshold poison pill in order to protect assets of speculative and questionable value absent an explicit plan for how such value might be realized.” The Court stated that under the Unocal test:

[t]here is an enhanced duty which calls for judicial examination at the threshold before the protections of the business judgment rule may be conferred. Such enhanced scrutiny operates to ‘ensure that a defensive measure to thwart or impede a takeover is indeed motivated by a good faith concern for the welfare of the corporation and its stockholders’ and that the board did not act ‘solely or primarily out of a desire to perpetuate themselves in office.’

Under the Unocal test, in order to be afforded the protection of the business judgment rule in this situation, the directors had to show that: (i) that they had reasonable grounds for believing (through good faith and reasonable investigation) that a danger to corporate policy and effectiveness existed; and (ii) the defensive measure was reasonable in relation to the threat posed and not coercive or preclusive.

First Prong of Unocal -- Preservation of NOLs as a Valid Corporate Objective

Under the first prong of Unocal, the Board had to show that it had reasonable grounds for concluding that a threat to a corporate objective existed. However, the Court first had to determine whether the preservation of NOLs was a valid corporate objective. The Court was quick to point out that an NOL Pill was not your typical poison pill designed to prevent hostile takeovers because the principal function of an NOL Pill was to prevent the inadvertent forfeiture of potentially valuable assets. Moreover, determining whether NOLs were valuable assets cannot be done in isolation because NOLs derive their value from future taxable income.

Thus, the Court stated that “[g]ranting judicial sanction to low-threshold poison pills employed for the purpose of protecting NOLs guarantees the somewhat unpalatable outcome of acquiescing to the expansion of the universe of reasonable takeover defenses in order to protect assets of questionable, even dubious, value.”

However, the Court went on to note that “as NOL value is inherently unknowable ex ante, a board may properly conclude that the company’s NOLs are worth protecting where it does so reasonable and in reliance on expert advice.” The Court found that there was ample evidence to suggest that the Board placed considerable reliance on advice of outside experts in making a determination as to the value of the NOLs and there was no evidence that the Board’s reliance on the expert advice was unreasonable. As a result, the Court concluded that “the protection of company NOLs may be an appropriate corporate policy meriting a defensive response when threatened. Indeed, the protection of corporate assets against an outside threat is arguably a more important concern of the Board than restricting who the owners of the Company might be.”

Trilogy argued that Selectica failed to satisfy the first prong because there was no expert advice as to the precise value of the NOLs to Selectica. The Court rejected that argument concluding that such evidence was not necessary because:

[i]n order to conclude that a serious threat existed, the Board needed only reasonably conclude that the NOLs were a legitimate asset worth protecting. The Board recognized that the NOLs were material relative to the then-market value of the Company, and that the NOLs, if preserved, had a long window during which they would be available for use. If perhaps somewhat optimistic, they had rational expectations for the Company’s near-term profitability.

In looking at the expert advice Selectica received, the Court concluded that “the Board was reasonable in concluding that Selectica’s NOLs were worth preserving and that Trilogy’s actions presented a serious threat to their impairment.”

Second Prong of Unocal – Reasonable Response to Perceived Threat

Under the second prong of Unocal, the Court was required to evaluate whether the board’s defensive response to the threat was preclusive or coercive and, if not, whether it was “reasonable in relation to the threat” identified. This requires an evaluation of: “(i) the importance of the corporate objective threatened; (ii) alternative methods for protecting that objective; and (iii) impacts of the ‘defensive’ action and other relevant factors.”

The Court stated that “[a] defensive measure is ‘coercive’” where it is “aimed at ‘cramming down’ on its shareholders a management-sponsored alternative” and a defensive measure is preclusive where it “operate[s] to unreasonably preclude a takeover” or “preclude[s] effective stockholder action” — specifically, where the measure “makes a bidder’s ability to wage a successful proxy contest and gain control either ‘mathematically impossible’ or ‘realistically unattainable.’”

Trilogy argued that not only is the NOL Pill more preclusive that prior pills evaluated by Delaware courts, a pill with such a low threshold in conjunction with a staggered board “renders the possibility of an effective proxy contest realistically unattainable.” In rejecting Trilogy’s argument, the Court stated that: “[t]o find a measure preclusive (and avoid the reasonableness inquiry altogether), the measure must render a successful proxy contest a near impossibility or else utterly moot, given the specific facts at hand.” The Court found that based upon the record, the NOL Pill and Reloaded NOL Pill were neither coercive or preclusive and thus do not meet that standard.

Having found that the defensive measure was neither coercive or preclusive, the Court turned to the proportionality test which “requires the focus of enhanced judicial scrutiny to shift to ‘the range of reasonableness.’” Trilogy argued that the Board failed to meet the standard because there was an inadequate assessment of the impact of the adoption of the NOL Pill and the Board failed to consider whether there were alternative more narrowly-tailored methods for protecting the NOLs. The Court, however, rejected Trilogy’s argument, finding the there was sufficient evidence that the Board met its obligations to evaluate the reasonableness of its response relative to the threat, stating that, “Unocal and its progeny require that the defensive response employed be a proportionate response, not the most narrowly or precisely tailored one.”

Postscript: The Harvard Law School Corporate Governance Forum provides commentary on the case here. Professor Steven Davidoff, writing as The Deal Professor, provides his insights and analysis about the case here.

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Cline v. Grelock, C.A. No. 4046-VCN (Del. Ch. March 2, 2010), read letter decision here. This relatively short ruling from the Court of Chancery involves comparatively small amounts in dispute but is noteworthy for general principles that are applicable to larger fights. This case is also an indication of the smaller business lawsuits handled by Chancery and the challenge confronted by counsel and the Court to limit the hugely expensive cost of litigation and trial, based on the minimum work that needs to be done in any case, in proportion to the amount at stake in the case.

The most efficient manner to approach this short decision is to highlight in bullet points a few key legal concepts addressed and refer those interested to the whole ruling at the above link.

• Two former co-owners (and former life-long friends) dispute their respective ownership interests in a failed business that one of the co-owners dissolved without authorization of the plaintiff, and started a new business that did not include the plaintiff.
• Despite being listed on the company's tax returns as a 50% owner, the Court did not credit plaintiff with that interest because plaintiff failed to make his capital contribution in that (or any) amount. The form of entity was an LLC.
• Generally, a partner is accountable for profits earned using partnership assets to start a new business which excluded a former partner. However, if no capital contribution was made to the former partnership, there is no claim to the new business.
• In this case, the amount of capital the former partner would have contributed, far exceeded the value of any purported interest he may have had in the new business. Thus, no damages could be proven on that claim.
• The improper dissolution by one partner was a breach of fiduciary duty that prevented him from seeking damages against his former partner who failed to make a capital contribution (presumably based on unclean hands.)
• Damages do not need to be proven with precision and the difficulty of proof does not equate with no relief.
• The former partner was still a guarantor on assets he no longer had an interest in, thus the Court required that the parties work in good faith with the bank to have him removed as a guarantor, but failing that, the Court required the party using the asset to indemnify the former partner, including the provision for attorneys'  fees and costs in the event it became necessary to enforce the indemnity.
• Costs were assessed against the partner who dissolved the former business without authority, which the Court determined was a breach of fiduciary duty

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In Sunrise Ventures, LLC v. Rehoboth Canal Ventures, LLC, No. 4119 (Del. Ch. March 4, 2010), read letter decision here, the Court of Chancery clarified the definition of a "contract under seal", which the Delaware Supreme Court recently addressed in the Whittington case summarized here, as a special type of contract that will enjoy a statute of limitations lasting 20 years.

The key "take away" legal nuggets that make this relatively short decision noteworthy can be highlighted in the following brief bullet points:

• In order to enjoy the long statute of limitations available to "contracts under seal", the word "SEAL" must be affixed next to the signature lines of the contract's signatories.
• In this case, the Court rejected the argument that such special status can be enjoyed by those contracts that have the mere inclusion of the word only in the "testimonium clause". (i.e., the introductory phrase at the top of some signature lines which provides: "In Witness Whereof, the parties have set their Hand and Seal, this ___ day of...")
• Though not directly ruling on this issue, the Court was skeptical of the argument that the requirements of a "contract under seal" could be satisfied if less than all the signature lines included the word "seal" next to them.

The procedural context of this case was the denial of a motion for reargument. The opinion itself which the losing party sought to reargue, was either not remarkable enough or did not cover a topic within the usual scope of this blog, so we did not provide a summary. Yes, the decision on the motion for reargument was more noteworthy than the main opinion for purposes of this blog's coverage. The main opinion sought to be reargued can be found at 2010 WL 363845 (Del. Ch. Jan. 27, 2010).

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Banet v. Fonds de Regulation et de Controle Cafe Cacao, C.A. No. 3742-CC (Del. Ch. March 12, 2010), read letter decision here. Prior Chancery decisions involving this matter have been highlighted on this blog here. The parties have also been engaged in extensive litigation in the New York courts.

The latest iteration of this matter involves a declaratory judgment action, pursuant to Chapter 65 of Tiitle 10 of the Delaware Code, seeking a ruling that Banet is not a stockholder of New York Chocolate and Confections Company ("NYC3"), and that Lion Capital Management, LLC ("LCM") is not a creditor of NYC3.  Due to the application of res judicata and judicial estoppel, the Court does not directly address the substance of  those claims. The background facts involve the parties' participation in a chocolate factory in New York.

Chocolate lovers everywhere can appreciate the opening sentence of the Court's letter decision: "The parties in this long-running dispute are locked in a fight over the status of their legal relationship, and, unfortunately, there is no amount of chocolate that can ease the pain."

This concise letter decision provides a helpful analysis and application of the elements of three important legal principles:

• res judicata (n.28)
• judicial estoppel (n.35)
• declaratory judgment actions (n.20)

The prodecural posture of this case was presented to the Court as cross-motions for summary judgment and the lengthy and tortuous prior litigation history between the parties, and the many prior court decisions both in Delaware and in New York were reviewed in the context of this Court's application of the above principles.

One noteworthy aspect of the res judicata discussion was the Court's observation that the named parties in the prior suit need not be identical. Rather it suffices for there to be privity with a party in the prior adjudication. Privity in this context is defined as one having a "close or signficant relationship" with another. (n. 31). Moreover, as noted in other recent Delaware decisions, res judicata also bars claims that "could have been asserted" in the prior action. (n. 32).

Judicial estoppel barred Banet from claiming stock ownership because in a prior ruling this Court relied on  Banet's argument that LCM was the owner of shares. Thus, Banet cannot now argue that he is the owner of the same shares. The Court explains in detail why prior adjudications and prior contrary positions taken by the plaintiff required that summary judgment be granted in favor of defendants.

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In Aveta v. Bengoa, No. 3598-VCL (Del. Ch. March 1, 2010), read letter decision here, the Court of Chancery clarified its prior decision, summarized here, regarding the scope of an arbitration clause. This 3-page letter ruling supplements a prior 43-page opinion from the Court  linked above(which is pending appeal before the Delaware Supreme Court.)

The very limited thrust of this decision is to confirm that based on the arbitration clause at issue, the Court had the authority to determine the scope and validity of the arbitration provision because that power was not delegated in the agreement to the arbitrator. The Court cited for this position both the decision in James and Jackson, LLC v. Willie Gary LLC , 906 A.2d 76, 78-79 (Del. 2006),  and 10 Del. C. Section 5703.

The Court also determined that the agreement did not allow the parties to expand the issues to be litigated before the arbitrator beyond those initially presented by the deadline provided in the agreement, and as for the substantial delay caused by one party, the Court provided a remedy for that delay in its prior opinion.  In closing, the Court explained that the arbitrator can determine what information it will--or will not--consider in deciding the issues and the Court declined to "intrude on the arbitral process by ruling on this question."

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PT China LLC v. PT Korea LLC, No. 4456-VCN (Del. Ch., Feb. 26, 2010), read letter decision here. Many thanks to Peter Ladig, one of the Delaware counsel of record in this case, for forwarding this decision to me the same day it was issued. (The photo below is of the Kent County Courthouse, where the Court of Chancery hears cases in Dover, although a new Courthouse is under construction.)  This 29-page decision should be included in the tool box of every Delaware litigator who needs to know about obtaining jurisdiction over a "manager" of a Delaware LLC who may not have any other contacts with Delaware.

Threshold Issue: Whether personal jurisdiction can be imposed on a Singapore resident based on Section 18-109 of the Delaware LLC Act, and if so, if the exercise of such jurisdiction comports with due process prerequisites?

Consent Statute for LLC Managers

Analogous to the consent statute for directors of corporations at 10 Del. C. Section 3114, managers of Delaware LLCs are deemed to consent to the personal jurisdiction of Delaware courts pursuant to Section 18-109 when they agree to serve as a manager of an LLC, and when the suit is "involving or related to the business of the limited liability company or a violation by the manager...of a duty to the limited liability company, or any member...." Even so, due process must still be satisfied.

"Manager" is defined broadly in Section 18-101(10) to include a person who "participates materially in the management of the limited liability company." Obviously this covers a rather broad class of people, including one who may not be formally bestowed with the appellation of manager as that term is often used in a colloquial sense.

Is Due Process Satisfied if Section 18-109 Imposes Jurisdiction for Claims "Relating to Business and Affairs of the LLC" as compared to Fiduciary Duty Claims Against a Manager?

Delaware Courts have previously determined that if claims against a manager of an LLC relate to his or her fiduciary duty obligations, then due process considerations are satisfied when Section 18-109 is used to imposed jurisdiction. See footnote 22 and cases cited. The more nuanced issue in this case is whether the same conclusion can be reached when the claims are not necessarily based on fiduciary duty violations. Prior cases suggest a consideration of three factors to address this issue: (i) do the allegations focus on the rights, duties and obligations of the manager; (ii) is the matter "inextricably bound up in Delaware law"; and (iii)  Delaware has a strong interest in providing a forum for disputes relations to actions of managers of a limited liability company formed under its law in discharging their managerial functions.

Sub-Issue:  Do Contractual Claims Bar Fiduciary Duty Claims Based on the Same Conduct due to the "Primacy of Contract Law in Delaware" over Fiduciary Claims Involving Matters Based in Contract Rights and Duties.

Prior decisions of this Court have recognized that "a contractual claim will preclude a fiduciary duty claim, so long as 'the duty sought to be enforced arises from the parties' contractual relationship'", due to the primacy of contract law. See fns. 32 to 34 for cases cited. The appropriate question to ask in order to analyze this issue is "whether there exists an independent basis for the fiduciary duty claims apart from the contractual claims, even if both are related to the same or similar conduct." See fn. 34.

The Court explained that it was not necessary to find that the claims against the manager were based on fiduciary duties in order to apply Section 18-109 to impose jurisdiction. Rather, so long as the action "involves the manager's rights, duties, and obligations to the company", due process will be satisfied under the consent statute. See fn. 35.  There was no issue in this case about whether the operative agreement limited fiduciary obligations and related liability. Compare generally, Kelly v. Blum decision by Chancery highlighted earlier this week here.

The Court reasoned that the instant dispute is "intertwined with the defendant's [manager's] managerial position", and coupled with "... the potential usefulness of his involvement in this suit, and Delaware's interest in adjudicating disputes involving the management of its limited liability companies...", the Court found justification for exercising jurisdiction in this matter consistent with "constitutional standards of fairness and substantial justice."  See fns. 43-44. See generally, In Re USACafes, L.P. Litigation, 600 A.2d 43, 52-53 (Del. Ch. 1991). The Court noted parenthetically, however, that it was not passing judgment on whether the contract-based claims would prevail at a later stage of the proceedings in terms of being plead sufficiently.

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In Global Link Logistics, Inc. v. Olympics Growth Fund, III, L.P., C.A. No. 4444-VCP (Del. Ch., Feb. 24, 2010), read letter decision here, the Court granted plaintiffs’ entire fee request based on a fee-shifting provision.

Danielle Blount, an associate in our firm, prepared this case summary.

The Court found no support for the argument that the plaintiffs’ filings and the brevity of the documents demonstrated the unreasonableness of plaintiffs’ attorneys’ fee request. The Court dismissed defendants’ contentions and relied upon the following facts: (1) that the plaintiffs were opposed by multiple sets of defendants; (2) the arbitration was highly contentious; and (3) a balance of $9 million remained unpaid when plaintiffs commenced the action. The Court concluded that plaintiffs were justified in relying on expensive counsel to obtain confirmation of the arbitration award. The Court did not find as a justifiable basis to dispute a fee request, the disparity of the amounts expended by each side, or an argument premised upon not needing “such an expensive partner to bill so many hours.”

Delaware courts evaluate the reasonableness of fee requests pursuant to eight factors articulated in Rule 1.5(a) of the Delaware Lawyers’ Rules of Professional Conduct. The factors to be considered in determining the reasonableness of a fee include the following:

1. the time and labor required, the novelty and difficulty of the questions involved and the skill requisite to perform the legal service properly;

2. the likelihood, if apparent to the client, that the acceptance of the particular employment will preclude other employment by the lawyer;

3. the fee customarily charged in the locality for similar legal services;

4. the amount involved and the results obtained;

5. the time limitations imposed by the client or by the circumstances;

6. the nature and length of the professional relationship with the client;

7. the experience reputation, and ability of the lawyer or lawyers performing the services; and

8. whether the fee is fixed or contingent.

Delaware Lawyer’s Rules of Professional Conduct, Rule 1.5(a).

Although the confirmation of the arbitration award was unopposed, the Court found that the plaintiffs had good reason “to take every procedural step, submit every pleading, and file every motion, brief, and affidavit to obtain confirmation.” Upon determining that plaintiffs’ lawyers and law firms were “commensurate with the amount at issue” and the expertise of [d]efendants’ counsel”, the Court held that the relatively high hourly rates charged were appropriate. The Court stated that the amount charged for obtaining confirmation of the arbitration award was relatively high, however it was not unreasonable in view of the size of the judgment at stake, the legal resources defendants used against plaintiffs and defendants’ efforts to delay confirmation.

In its holding, the Court relied upon the reasoning in EDIX v. Mahani to support the award of the full amount of fees requested. 2007 WL 417208 (Del. Ch., Jan. 25, 2007). In EDIX, upon reviewing the reasonableness inquiry of a request for attorneys’ fees under a contractual fee shifting provision, the Court remarked that the acts of defendants elongated the litigation. In the present case, Vice Chancellor Parsons determined that the defendants could have minimized plaintiffs’ attorneys’ fees by promptly consenting to the confirmation of the arbitration award. Instead, as in EDIX the defendants chose to draw out the conflict by raising defenses and seeking to delay entry of the judgment. Ultimately, the court determined that the “defendants’ actions and the amount at issue created a situation in which plaintiffs could not take anything for granted in their prosecution of the matter.”

For another recent decision addressing the reasonableness of fees based on a fee-shifting provision in an agreement, see Concord Steel summarized here.
 

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Kelly v. Blum, No. 4516-VCP (Del. Ch., Feb. 24, 2010), read opinion here. This 49-page opinion of the Delaware Court of Chancery deserves more extensive treatment--that I hope to provide soon, but for the time being, I will highlight a few bullet points regarding issues of law addressed by the Court that warrant closer reading for most lawyers who make their living in the fields of business litigation.

• Confirmation of prior Delaware decisions that in the absence of an LLC Agreement provision to the contrary, both members and managers of an LLC owe traditional fiduciary duties of loyalty and care to each other and the entity. See footnote 69.
• The Court found "substantial compliance" with a notice provision in the agreement to be sufficient. See pages 22 and 23.
• The two exceptions to the requirement of being a member or shareholder before pursuing a derivative action.
• Analysis of whether a claim is direct or derivative.
• Elements of a defamation claim.

UPDATE: Professory Larry Ribstein provides an insightful analysis of the case here  (which may obviate the need for me to provide a fuller synopsis myself this weekend.)

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Agilent Technologies, Inc, v. Kirkland, No. 3512-VCS (Del. Ch. Feb. 18, 2010), read 93-page opinion here.This magnum opus by the Delaware Court of Chancery was initially issued under seal but is now available for your reading pleasure.

A longer overview of this case will be provided soon, but in the meantime, I wanted to make this opinion available for downloading. For anyone interested in the latest iteration of Delaware law on misappropriation of trade secrets and the remedies available for breach of the Delaware Uniform Trade Secrets Act, this decision is must reading.

As a side note, students of Delaware law will observe that although not granted by the Court in this case, the trade secrets statute is one of the only bases on which the Court of Chancery is vested with authority to grant punitive damages.

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Gelof v. Prickett, Jones & Elliott, P.A., No. 4930-VCS (Del. Ch., Feb. 19, 2010), read letter ruling here.

Holding: 

This letter decision from the Delaware Court of Chancery explains why the claims made in this case were not within its limited jurisdiction. That is, despite the claim of a breach of fiduciary duty, there was no equitable jurisdiction.

Rationale

This case describes the nuances of the limitations on the jurisdiction of the Delaware Court of Chancery. The Court determined that despite incantations of terminology that "sounds like" it would fit within the Court's equitable jurisdiction, the claims only sought a legal remedy and were not based on an equitable right. Nor was there a statutory basis for the Court to exercise jurisdiction. Thus, the case was transferred to the Delaware Superior Court, the state's trial court of general jurisdiction. The recent Chancery decision in Sokol reached a similar conclusion, finding a lack of juridisdiction based on similar facts. That case was highlighted on this blog here.

The Court "paints in shades of grey" the reasoning for this decision that clarifies those types of fiduciary duties that are not of the variety that fit within the confines of this specialty Court's jurisdiction. The distinction the Court makes is between the type of fiduciary duty that includes managing the assets of a beneficiary, and the separate form of relationship that "merely" involves trust being placed in another, such as one seeking medical or legal advice, for example.

The stereotypical fiduciary relationship over which the Court of Chancery often exercises its limited jurisdiction is that between a director of a corporation and its shareholders. This case, however, dealt with a claim of professional negligence. Although the lawyer/client relationship does have a fiduciary aspect, it is not the type of fiduciary relationship that fits within the constricted jurisdiction of the Court of Chancery.

Bottom line:

Although other cases summarized on this blog over the years have defined what types of "business" relationships create fiduciary duties, this decision focuses on the more nuanced aspect of what types of fiduciary relationships allow the Court of Chancery to exercise jurisdiction over them due to alleged claims regarding either misfeasance or nonfeasance in that relationship. In this case, the remedy sought was purely legal and the fiduciary claim was identical to the negligence claim. As the Court reasoned:

What equity polices are fiduciaries who actually take control over and make decisions regarding the assets of other persons.

Slip op at 6. The claims in this case did not involve one person taking control over and making decisions regarding the assets of another person.  In further support of its conclusion, the Court  quoted from a law review article as follows:

In any of the[] paradigmatic forms [of the fiduciary relationship], a
beneficiary entrusts a fiduciary with control and management of an asset. Ideally, for the beneficiary, this relationship would be governed by specific rules that dictate how the fiduciary should manage the asset in the beneficiary’s best interests. In fact, however, the fiduciary’s obligations are open-ended. Because asset management necessarily involves risk and uncertainty, the specific behavior of the fiduciary cannot be dictated in advance. Moreover, constant monitoring of the fiduciary’s behavior, which would protect the beneficiary, often is prohibitively costly . . . . The fiduciary relationship exposes a beneficiary/principal to two distinct types of wrongdoing: first, the fiduciary may misappropriate the principal’s asset or some of its value (an act of malfeasance); and second, the fiduciary may neglect the asset’s management (an act of nonfeasance). Each type of wrongdoing is controlled by imposing a legal duty upon the fiduciary.

Slip op. at  7 (citing Robert Cooter & Bradley J. Freedman, The Fiduciary Relationship: Its Economic Character and Legal Consequences, 66 N.Y.U. L. REV. 1045, 1046-47 (1991) (emphasis added)).

UPDATE: Though not referring to this case, a recent post by Professor Ribstein here addresses several types of relationships that are referred to as fiduciary relationships.

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Dawson, et al. v. Pittco Capital Partners, L.P., et al.,  No. 3148-CC (Del. Ch.,Feb. 15, 2010), read letter decision here.

Kevin Brady, a highly regarded Delaware litigator, provided this synopsis.

In a short discovery-related letter opinion, Chancellor Chandler granted plaintiffs’ motion to compel full interrogatory responses from defendants related to, among other things, the factual and legal bases (including each element) of each defense of the defendants’ four affirmative defenses: failure to state a claim, laches, waiver, and unclean hands. Additionally, one of the defendants had apparently resisted production of documents that were in the possession of its wholly-owned subsidiary, which was not a party to this litigation. Apparently finding no Court of Chancery decision on point, Chancellor Chandler cited Delaware federal case law interpreting Federal Rule of Civil Procedure 34 noting that “Federal Court decisions are ‘of great persuasive weight in the construction of parallel Delaware rules’ due to the analogous nature of the Court of Chancery Rules and the Federal Rules of Civil Procedure.” The Chancellor rejected the defendant’s position and required it to produce the requested documents from the wholly-owned subsidiary.
 

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Whittington v. Dragon Group L.L.C., No. 2291-VCP (Feb. 15, 2010), read opinion here.

Previous decisions of the Delaware courts in the long line of cases involving this internecine warfare among family members fighting over their interests in various business entities, have been summarized on this blog and can be found here.

This latest iteration by the Delaware courts in this matter comes to us after remand by the Delaware Supreme Court involving an important High Court ruling that the applicable statute of limitations for claims on a contract “under seal” is 20-years. See summary of Delaware Supreme Court decision here.

In addition to defining laches and applying its elements such as “unreasonable delay,” the Court of Chancery in this decision concluded that laches would not bar a claim that was brought a little after 3-years from the date that “inquiry notice” was imputed, in light of the statute of limitations that was 20-years long.

Also helpful for litigators is the definition by the Court of Chancery of “inquiry notice” at page 11 of the slip opinion.

Also of practical use for future reference is the definition by the Court of Chancery of the doctrine called “law of the case” and how that compares and differs from the obligation of the trial court after remand by the Supreme Court to apply new rulings of law. See Slip Op. at 8 to 10.
 

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In Re: Sunbelt Beverage Corp. S’holder Litig., Cons. No. 16089-CC (Feb. 15, 2010), read letter ruling denying motion for reconsideration here. Read revised opinion here.

 In this short letter ruling, the Court denies a Motion for Reconsideration by the defendants of a decision that was previously summarized on this blog here. In sum, the Court rejected the argument that it misapprehended a value in the discount of cash flow analysis of an expert that was referenced in the original opinion, related to beta values.

The Court also rejected an argument that it did not apply the correct statutory interest rate applicable in an appraisal case. Specifically, the Court referred to Section 262(h) of Title 8 of the Delaware Code for the statutory legal rate that applies, as supported by Section 2301 of Title 6 of the Delaware Code. The Court noted that the 2007 amendment to Section 262(h) codified an approach the Court of Chancery has long had the authority to use, to award interest at a rate of 5% above the Federal Reserve Discount Rate.

Nonetheless, the Court did issue a revised opinion to clarify that the interest should be compounded quarterly, but denied a request to make any other changes to the original opinion. The revised opinion issued on February 15, 2001 is available here.
 

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Stornawaye Capital LLL v. Smithers, No. 18845-VCN (Del. Ch., Feb. 12, 2010), read letter decision here.

This relatively short letter decision addresses several procedural and substantive matters that are  worth highlighting via bullet points for inclusion in the toolbox of those who toil in the vineyards of business litigation.

• An argument of unilateral mistake was made and rejected. A requirement of that defense is that "the mistake occurred regardless of the exercise of due care" (n. 2).
• However, "failure to read documents cannot provide a basis for avoiding obligations they impose." (n. 3). This is especially so when the person involved, as here, is an intelligent and educated person.
• Rule 17(a) deals with a transfer involving the real party in interest prior to the commencement of the suit.
• Rule 25(a) applies when there has been a transfer of interest during the pendency of the action.
• Rule 24 governs motions to intervene. In essence, the court granted the motion to intervene in order to allow those who held claims to the property, however  tenuous, to defend the foreclosure action in light of the named party not being in a position to adequately represent the interests of others who claimed a right in the property at issue.

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Kurz v. Holbrook, No. 5019-VCL (Del. Ch., Feb. 9, 2010), read opinion here. This 80-page Delaware Court of Chancery opinion decided an expedited claim based on DGCL Section 225, challenging the election of board members.

Important Groundbreaking Issues Addressed.

This opinion is must reading for anyone who would seek to remove a sitting director or try to reduce the number of directors on a board. This decision addresses for the first time whether a bylaw amendment can reduce the size of a board. See, e.g., Slip op. at 24. This decision is also required reading due to its treatment of the issues that arise in connection with the right to vote shares that are held in street name, some of which are addressed authoritatively by a Delaware court for the first time. See, e.g., Slip op. at 60. The "underdeveloped" topic of "third-party vote buying" in connection with corporate elections is also addressed in a scholarly fashion, noting that the analysis is different than what might apply in the political arena. See, e.g., Slip op. at 64-65.

One of the best ways to highlight an opinion of "law review article length" for purposes of a blog, is to use the overview of the case provided by the Court itself in the opinion. The Court's introduction to the case follows verbatim:

This post-trial opinion resolves competing requests for relief under Section 225 of the Delaware General Corporation Law (the “DGCL”). 8 Del. C. § 225. At stake is control of the board of directors (the “Board”) of EMAK Worldwide, Inc. (“EMAK” or the “Company”).

Prior to December 18, 2009, the Board had six directors and one vacancy. On December 18, one director resigned, creating a second vacancy. The plaintiffs contend that on December 20 and 21, Take Back EMAK, LLC (“TBE”) delivered sufficient consents (the “TBE Consents”) to remove two additional directors without cause and fill three of the vacancies with Philip Kleweno, Michael Konig, and Lloyd Sems. Incumbent director Donald Kurz is a member of TBE. The TBE Consents, if valid, would establish a new Board majority.

The defendants contend that on December 18, 2009, Crown EMAK Partners, LLC (“Crown”) delivered sufficient consents (the “Crown Consents”) to amend EMAK’s bylaws in two important ways. First, the Crown Consents purportedly amended Section 3.1 of the bylaws (“New Section 3.1”) to reduce the size of the Board to three directors. Because Crown has the right to appoint two directors under the terms of EMAK’s Series AA Preferred Stock, reducing the board to three, if valid, would give Crown a Board majority. Second, the Crown Consents purportedly added a new Section 3.1.1 to the bylaws (“New Section 3.1.1”) providing that if the number of sitting directors exceeds three, then the EMAK CEO will call a special meeting of stockholders to elect the third director, who will take office as the singular successor to his multiple predecessors. The defendants contend that the bylaw amendments are valid and that the next step is for the EMAK CEO to call a special meeting.

I hold that the bylaw amendments adopted through the Crown Consents conflict with the DGCL and are void. They were therefore ineffective to shrink the Board or to require the calling of a special meeting. I hold that the TBE Consents validly effected corporate action. The Board therefore consists of incumbent directors Kurz, Jeffrey Deutschman, and Jason Ackerman, and newly elected directors Kleweno, Konig, and Sems. One vacancy remains.

In addition to seeking relief under Section 225, the parties have asserted a panoply of claims, cross-claims, and third-party claims, and they have amassed an extensive record relating to those claims. My decision addresses only the requests for relief under Section 225, and I have sought to avoid resolving factual disputes that could have collateral implications if the other claims proceed. Contemporaneously with the issuance of this opinion, I am entering a partial final judgment under Rule 54(b) to implement my decision, thereby facilitating a prompt appeal should the defendants wish to pursue it. 

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In an 89-page post-trial decision in Great American Opportunities, Inc. v. Cherrydale Fundraising, LLC, C.A. No. 3718-VCP (Del. Ch. Jan. 29, 2010), read opinion here, Vice Chancellor Parsons found that the defendant tortiously interfered with the plaintiff’s contractual relationships as to three former employees of an acquired company by enticing or encouraging them to breach several provisions in their employment contracts and that the defendant willfully and maliciously misappropriated certain of the acquired company’s trade secrets.

Kevin Brady, a highly regarded Delaware litigator, provided this synopsis.

Background
Great American Opportunities, Inc. (“Great American”), Cherrydale Fundraising LLC (“Cherrydale”) and Kathryn Beich, Inc. (“KB”) were competitors in the product and service-based fundraising industry. Great American wanted to increase its sales force through the addition of KB’s sales force, so Great American entered into an Asset Purchase Agreement with KB on April 24, 2008 and paid $9.3 million in exchange for, among other things, all of KB’s information on past, present, and potential customers, including contact information, fundraising needs, cost and margins on products sold, account disputes and resolution, and the likelihood of customers conducting similar fundraisers in the future.

Great American’s claims arise from recruiting efforts by Cherrydale and its representatives prior to and subsequent to the acquisition of KB. The trade secret information from KB at issue included, among other things: (i) KB’s Consultant Schedule, which was a list of KB’s sales reps personal information (home address, telephone numbers, etc.); (ii) KB’s Ranking Report, which contained sales volume figures of KB employees; (iii) customer contact lists.

Tortious Interference Claim
Under Delaware law, proof of tortious interference with contractual relations requires a showing of: (i) a valid contract about which the defendant has knowledge; (ii) an intentional act by defendant that is a significant factor in causing the breach of the contract without justification; and (iii) which causes injury.

Delaware courts also recognize a cause of action for tortious interference with prospective contractual relations which requires a showing of: (a) a reasonable probability of a business opportunity or prospective contractual relationship; (b) intentional interference by a defendant with that opportunity; (c) proximate cause; and (d) damages.

Great American argued that Cherrydale tortiously interfered with KB’s employment contracts by inducing certain individuals to breach noncompete and nonsolicitation clauses as well as other contractual provisions. Great American also argued that Cherrydale interfered with its prospective contractual relations with former KB customers by allowing and encouraging certain employees to retain KB customer information and use it to foster Cherrydale’s sales efforts. Cherrydale responded by arguing that Great American did not establish tortious interference with any contract because it did not show that the relevant employment contracts were assignable, that Cherrydale wrongfully interfered with any employment or customer contracts, or that any of those contracts were breached. The Court agreed with Great American finding that Cherrydale did tortiously interfere with KB’s employment contracts causing injury to Great American.

Misappropriation of Trade Secrets
Under the Delaware Uniform Trade Secrets Act (“DUTSA”), Great American had to prove: (i) that it possessed information sufficiently secret and valuable to give it a competitive advantage; (2) that it took reasonable efforts to maintain the secrecy of that information; and (3) that Cherrydale knowingly acquired such information by “improper means.”

With respect to its claims for misappropriation of trade secrets, Great American argued that Cherrydale misappropriated Great American’s Consultant Schedule, the Ranking Report, the Order Status Report, and other confidential and proprietary reports as well as KB customer contact and purchasing information. Cherrydale countered by arguing that Great American did not establish that the information at issue constituted trade secrets or was misappropriated by Cherrydale because such information was used solely by independent contractors whose acts cannot be attributed to Cherrydale.

For the Consultant Schedule to qualify as a protectable trade secret, Great American had to show that it “[derived] independent economic value by virtue of its not being generally known or readily ascertainable by proper means.” The Court found that Great American failed to show that the Consultant Schedule – and the hire dates it contained – had independent economic value by virtue of its secrecy and thus the Consultant Schedule was not a trade secret.

The Ranking Report contained a frequently updated list of KB’s sales reps ranked by volume of sales paid. The Court found that the Ranking Report was not generally accessible outside of KB and reasonable efforts were made to maintain its secrecy. As a result, the Court found that the Ranking Report constituted a trade secret that was misappropriated by Cherrydale.

With respect to the customer lists, the Court determined that they did contain important, nonpublic information, such as the names, addresses, and phone numbers of contacts at each organization as well as the types and volume of product purchased by each customer and thus they constituted “trade secrets that were misappropriated by Cherrydale, whose top management both knew of and encouraged the retention and use of such information.”

Damages
While the Court found that Great American proved tortious interference and misappropriation of trade secrets, it also found that Great American failed to prove actual damages. However, DUTSA allows recovery for the unjust enrichment caused by misappropriation, so the Court awarded Great American compensatory damages in the amount of $61,538.

In addition, the Court found that “Cherrydale acted maliciously with intent to harm KB and, indirectly, Great American through its questionable and illegal recruiting efforts, including Cherrydale’s misappropriation of trade secrets.” For a finding of willfulness, under 6 Del. C. § 2003(b), the Court could award exemplary damages in the amount of two times the compensatory damage award. As a result, the Court awarded Great American an additional $61,538 plus one half of its reasonable attorneys’ fees incurred in connection with this litigation. The Court also sanctioned Cherrydale for contempt regarding the Preliminary Injunction and awarded Great American its attorneys’ fees and expenses incurred in connection with its motion for contempt.

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Air Products and Chemicals, Inc. v. Airgas, Inc., Del. Ch., No. 5249 (Complaint filed Feb. 4, 2009), read complaint here. This Complaint in the Delaware Court of Chancery was filed to force Airgas to reply in a meaningful manner and to seriously consider the all cash offer of Air Products to buy all outstanding shares of Airgas. Airgas has consistently rebuffed all overtures by Air Products. So far, "playing nice" has not worked, so now Air Products is trying the "tough love" approach.

The Complaint provides a helpful roadmap for what one needs to allege in order to challenge a "just say no" position in reply to an offer to buy a company. One goal of the Complaint is to trigger Revlon duties of the board. It is certain that one defense of the directors is that Revlon should not be triggered because its company is "not for sale".

Other reports about this new suit and related commentary can be found here.

One of the unusual aspects of this case is that a contemporaneous suit  was filed against the law firm that filed the Chancery lawsuit for Air Products, the venerable Cravath firm, claiming that the Cravath firm has a conflict of interest in representing Air Products because Airgas regards itself as a client of Cravath, having paid it about $2 million dollars over the years, and allegedly paying Cravath $320,000 as recently as a few months ago. That separate suit alleging a conflict was filed in Philadelphia. One might speculate that the suit was not filed in Delaware and it was not filed as a motion to disqualify, because the Delaware decisions recently have not granted many motions to disqualify. See, e.g., cases summarized on this blog here.

The 18-page complaint recounts the many efforts of Air Products to "convince Airgas to like it" and the repeated examples of Airgas spurning the advances of Air Products. Air Products explains why it would make good "business sense" for the two entities to combine and why the directors of Airgas have a fiduciary obligation to take the all-cash offer seriously. The relief requested includes the following:

• compel the formation of a special committee to evaluate the offer and negotiate, with its own independent legal and financial advisors
• enjoining the directors from "impeding, thwarting, frustrating or interfering with" the proposed deal; and
• finding that the directors breached their fiduciary duties by not negotiating with Air Products, and not forming a special committee, and not informing themselves adequately about the details of the offer

For those lawyers who maintain "form files" (electronic or otherwise) for exemplary samples of complaints of this nature, this might be one to consider for inclusion in that file.

UPDATE: The Wall Street Journal Law Blog provides an update as of Feb. 17, on recent developments in this matter here. Philadelphia litigator Maxwell Kennerly on his Litigation & Trial Blog here, has an excellent discussion of the conflicts issue, and addresses in an insightful manner what I refer to as the "PA v. DE tactics" being employed by at least one of the parties in this case. On Feb.19, 2010, The Philadelphia Inquirer provided an update on this matter in an article by Harold Brubaker and Chris Mondics that quotes your truly, here.

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In Concord Steel, Inc. v. Wilmington Steel Processing, Co., Inc., et al., No 3369-VCP (Del. Ch. February 5, 2010), read decision here, the Delaware Court of Chancery awarded attorneys' fees based on a provision in an asset purchase agreement that afforded reasonable attorneys' fees to the prevailing party. Our blog summary of the post-trial decision in this case, granting damages and affirming a prior injunction on a covenant not to compete, can be found here.

Issues Addressed

1. Was the amount of fees sought reasonable based on Rule 1.5?
2. Did the statutory limit of 20% collected on a debt instrument, based on Section 3912 of Title 10 of the Delaware Code, apply to the fee request pursuant to the provision of an asset purchase agreement?

Analysis

1. The Court applied the factors in Delaware Lawyers' Rule of Professional Conduct 1.5 to assess the reasonableness of fees. The factors in the rule include the following:

• the time and labor required, the novelty and difficulty of the questions involved, and the skill requisite to perform the legal services properly;
• the fee customarily charged in the locality for similar legal services;
• the amount involved and the results obtained;
• the experience, reputation, and ability of the lawyer or lawyers performing the services; and
• whether the fee is fixed or contingent.

Several relatively recent Chancery decisions were referred to by the Court in connection with a review of issues such as the percentage of time spent by senior partners, whether the number of attorneys working on the matter amounted to overstaffing, and the hours spent in comparison to the complexity or simplicity of the litigation. See., e.g., footnotes 15, 17, 21 and 23.

Notable was the Court's observation that no Delaware case has found "block-billing" to be objectionable per se. The Court also concluded that it was not unreasonable to bill for two attorneys conferring with each other, or for an attorney who did not examine witnesses to bill for time spent at trial. Nor did the Court find it unreasonable to use two attorneys from outside counsel and two attorneys from local counsel for most of the work on the case over about two years. However, the Court found that there was an overuse of senior partners based on the percentage of hours charged by senior partners being 98 percent of total hours billed. The assumption, one might infer, is that the Court expects associates to do most of the work, perhaps, at least in terms of the percentage of total hours charged.

2. Section 3912 of Title 10 of the Delaware Code governs the total amount of attorneys' fees that can be collected in suits brought to enforce notes, mortgages, invoices or "other instrument of writing."  This last catch-all phrase was interpreted to refer to evidence of a debt. The Court reasonsed that the asset purchase agreement in this case was not an instrument of debt, but  rather the suit in this case was initiated to enforce a covenant not to compete. The Court distinguished other cases that involved collection on an invoice or a suit for collection of an amount certain, which was dissimilar to the facts in this matter.

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In Sloan v. Segal, No. 2319-VCS (Del. Ch., Jan. 27, 2010), read letter decision here, the Court of Chancery adhered to its prior opinion after the Supreme Court remanded for clarification. The prior trial court opinions in this case were highlighted on this blog here.

The primary and short reason I include this ruling on the blog is for its discussion of the difference between how a witness was actually used and offered at trial, compared to the description of how the role of that witness was described in the pre-trial stipulation (which were not the same).

Overview
This letter ruling is based on the remand from the Supreme Court which held that it was improper for the trial court to “exclude certain deposition testimony.” That testimony was in the form of a deposition by the expert for the Petitioner. The deposition was not offered into evidence during the Petitioners’ case-in-chief. In the pretrial stipulation, as the Supreme Court noted, Respondent Louis Segal agreed that the deposition of that expert could be admitted despite the fact that the deposition had not been conducted as a trial deposition.

Issue upon Remand
The issue upon remand was whether the inclusion of the deposition testimony of the Petitioner’s expert, Dr. Ayden Bill, would have changed the trial court’s decision.

Analysis
The Petitioners indicated at the pre-trial conference that they would only use Dr. Bill as a rebuttal witness and that the pretrial stipulation said that Dr. Bill’s testimony could come in either live or by deposition. However, the Court and counsel for the Respondent were given the impression that because he was a rebuttal witness it was expected that the rebuttal witness would appear live to address the case presented by the other party.

The Supreme Court reasoned that the original pre-trial stipulation regarding the introduction of Dr. Bill’s deposition had never been altered.

In its decision after remand, the Court of Chancery explained that it read the entire deposition testimony of Dr. Bill and concluded that: “Nothing in it persuades me that the measured conclusions I previously reached were erroneous. At best, Dr. Bill speculates that Mrs. Sloan might have had some unexpressed change of heart and desired to leave wealth to the Petitioners Frank and Jack Sloan, despite: (1) A total absence on the effort on their part to resume contact with her; and (2) The total lack of any effort by Frank and Jack to foster a relationship between their children and their grandmother, Mrs. Sloan. Indeed, Dr. Bill admits he is speculating in this regard.”
Moreover, the Court adds in support of its conclusion to “adhere to [its] previous decision,” that: “all in all, Dr. Bill provides no rational basis to conclude Mrs. Sloan had any intention to leave her wealth to the two sons who abandoned her and whose sole reaction to her aging and change of residence to Florida involved maneuvering to try to secure wealth at her disposal.”

Conclusion
The Court also referred to the testimony of three other doctors that did support a finding that the Codicil was a product of the true wishes of Mrs. Sloan. The finding was also supported by medical records and the concession by the Petitioners that Mrs. Sloan had no reason to reward them. This all supports the view that she was competent when she expressed the clear intent to leave them nothing.  

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In a letter opinion In the Matter of Texas Eastern Overseas, Inc., No. 4326-VCN (Jan. 20, 2010), Vice Chancellor Noble denied a Motion to Stay Pending Appeal filed by Texas Eastern Overseas, Inc. (“TEO”). Read letter decision here. The Court's prior decision was highlighted here.

Kevin Brady, a highly regarded Delaware litigator, prepared this synopsis.

 This matter arose out of a request by AmeriPride Services Inc. for the appointment of a receiver for TEO, a dissolved Delaware corporation, which the Court granted on November 20, 2009. (See link above.) TEO’s predecessor-in-interest, Valley Industrial Services, Inc. (“VIS”), owned and operated an industrial cleaning facility in California that is now owned by AmeriPride. Under VIS’s ownership, hazardous substances were released from the facility into the soil and groundwater. After AmeriPride spent significant sums remediating the facility, it filed an action in California seeking contribution from TEO. Vice Chancellor Noble granted AmeriPride’s petition and appointed a receiver for TEO which then sought certification of an interlocutory appeal and a stay pending appeal. The Court of Chancery denied that request on December 23, 2009. TEO then filed this motion to stay pending appeal of the Court’s final order.

Under Delaware Supreme Court Rule 32(a) a stay pending appeal is initially directed to the trial court’s discretion. This can be a “catch-22” because of the inherent tension in this exercise in that it requires the trial court to analyze the likelihood for success on appeal after it has already determined the merits of the action. In Kirpat, Inc. v. Delaware Alcoholic Beverage Control Commission (741 A.2d 356 (Del. 1998)), the Delaware Supreme Court set forth four factors that the trial court must consider when deciding a motion to stay: 1) the likelihood of success on the merits of the appeal; 2) whether the petitioner will suffer irreparable injury if the stay is not granted; 3) whether any other interested party will suffer substantial harm if the stay is granted; and 4) whether the public interest will be harmed if the stay is granted. The Kirpat Court also stated that “in deciding a motion for a stay, the trial court should balance all pertinent considerations together instead of allowing a definitive determination under one factor, such as the likelihood of success on appeal, to control. If the several irreparable harm factors favor granting a stay, “then a court may exercise its discretion to reach an equitable resolution by granting a stay if the petitioner has presented a serious legal question that raises a ‘fair ground for litigation and thus for more deliberative investigation.’”

After analyzing the Kirpat factors, Vice Chancellor Noble denied the request for a stay stating that “even with the Court’s attention directed to the irreparable harm factors, on balance, they do not tip in favor of a stay…. TEO will suffer no harm if a stay is not granted—it will merely be a vehicle through which AmeriPride will seek recovery from the insurers. On the other hand, neither the public nor AmeriPride will suffer harm if a stay is granted…. Moreover, the Court has already explained in the Letter Opinion that it does not view this case as presenting a serious legal question that raises a fair ground for further litigation.”

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Brinckerhoff v. Texas Eastern Products Pipeline Co., LLC, C.A. Nos. 2427-VCL, 4548-VCL (Del. Ch. Jan. 15, 2010), read opinion here. 

Kevin Brady and Ryan Newell of the Connolly Bove firm prepared this synopsis.

In a consolidated matter, the Court of Chancery approved a settlement and reduced the request from plaintiffs’ counsel for fees and expenses from $19.5 million to $10 million for two actions related to a transaction and subsequent merger, which had as its primary goal extinguishing the plaintiffs’ standing to bring a derivative action. Brinckerhoff v. Texas Eastern Products Pipeline Co., LLC, C.A. Nos. 2427-VCL, 4548-VCL (Del. Ch. Jan. 15, 2010). The Court analyzed the settlement with “significant scrutiny” involving two hearings because the parties asked the Court to approve a Cox Communications settlement (referring to In re Cox Communications, Inc., 879 A.2d 604 (Del. Ch. 2005)) that would resolve not only the litigation related to the merger but also the derivative action.

The Court spent a great deal of time identifying the parties and key players in the challenged transactions. For brevity purposes, the parties are described and defined at the end of this summary.

First Settlement Hearing Unsuccessful

At the first hearing, the Court determined that the record was inadequate so the parties successfully supplemented the record for the second settlement hearing. In discussing the situation created by the two actions, Vice Chancellor Laster used the phrase pas de trois quoting Vice Chancellor Strine’s reference from In re Cox Communications. Vice Chancellor Laster then identified his concerns:

[T]he record established that the special committee focused repeatedly on the Derivative Action, embraced the premise that the claims had significant value, but then approved a deal in reliance on a fairness analysis that afforded no value whatsoever to those very same claims. These and other factors left me to wonder about the good faith of the special committee and brought to mind Chancellor Allen’s admonition, offered in a different context, that “due regard for the protective nature of the stockholders’ class action [and to which I would add derivative actions as well], requires the court, in these cases, to be suspicious, to exercise such powers as it may possess to look imaginatively beneath the surface of events, which, in most instances, will itself be well-crafted and unobjectionable.” It did not require much suspicion or imagination to think that extrinsic factors might have colored the judgment of the special committee and plaintiffs’ counsel when agreeing to a Cox Communications settlement. The lure of a premium transaction, the self-evident benefits of settlement to the controller and other defendants, and the prospect of an easy end to the litigation – coupled with a large fee – create powerful pressures. No one need cross the line of collusion or conscious shirking for these forces to have an effect. “[H]uman nature may incline even one acting in subjective good faith to rationalize as right that which is merely personally beneficial.” (citations omitted).

The Challenged 2006 Transactions: The Sale and the Joint Venture

In 2006, Enterprise LP (1) acquired the Pioneer Plant and all of Teppco Partner’s gas processing rights for $38 million, and (2) along with Teppco, agreed to form a joint venture (the “JV”) to own Jonah Gas Gathering Company (“Jonah”). While Merrill Lynch, which was hired by the Teppco Audit Committee to provide a fairness opinion on the Pioneer Sale, opined that the $38 million purchase price was fair, Merrill Lynch did not consider Teppco’s rights under the processing contract after the Jonah acquisition. Simmons & Co., which was hired by Enterprise to provide a fairness opinion, valued the deal at $780 million by taking into consideration Teppco’s plans to expand Jonah’s gathering and processing systems. On March 31, 2006, the Pioneer sale closed with Enterprise paying only $38 million.

At the same time as the Pioneer sale, the JV proceeded with EPCO employees who were under the control of Daniel Duncan (who controlled both Teppco and Enterprise) negotiating the terms of the JV. In addition to Teppco contributing Jonah to the JV, both Teppco and Enterprise committed to provide half of the funding. In an important deal point, Jonah’s value was “based on Teppco’s historic cost of investment, not Jonah’s value as a going concern.” Using that valuation, Teppco was credited with a capital contribution of approximately $800 million for the purchase price of Jonah, $250 million in prior investments, and an additional amount for Teppco’s portion of the future financing. In the aggregate, this amounted to Teppco owning 80% of the JV. Enterprise was credited with $208 million, or roughly 20% of the financing. Had Jonah been valued as a going concern, plaintiffs alleged that the post-expansion JV was worth about $2.2 billion. For Enterprise to remain a 20% owner, it would have had to more than double its $208 million capital contribution. The plaintiffs did not discount the value for lack of control because Teppco and Enterprise agreed that Enterprise would manage the daily operations.

Teppco expected Goldman Sachs, which had been hired by Teppco to explore financing alternatives, to render a fairness opinion for this transaction but Goldman Sachs declined. After Duncan convinced that directors of Teppco and Enterprise that his motives were not biased and that a fairness opinion was unnecessary, the Teppco Audit Committee approved the deal. Simmons, however, did provide a fairness opinion for Enterprise.

The Derivative Action

Plaintiffs brought the Derivative Action alleging: (1) breach of fiduciary duty against Teppco directors related to the JV and Pioneer Sale; (2) aiding and abetting of breaches of fiduciary against Enterprise; and (3) disclosure violations related to Teppco’s LP and an exchange transaction.

From late 2006 to early 2009, the parties engaged in motion practice (with count three being dismissed), extensive discovery, and mediation. Just before agreeing to mediate, Duncan and members of Enterprise management decided to pursue a merger with Teppco. Enterprise made its initial offer in March of 2009 wherein each Teppco LP unit would be converted into 1.043 Enterprise LP units plus $1 for total consideration at Enterprise’s then-current market value of $21.89 per LP unit. This offer was rejected by the Teppco Audit Committee as “unacceptably low because, among other things, it inadequately valued Teppco’s business and did not take into account the potential value of the [Derivative Action].”

The Merger and Resulting Litigation

In April 2009, defendants’ counsel informed plaintiffs’ counsel of the potential merger. The parties agreed to adjourn the mediation for sixty days and allow the parties to negotiate a deal. On April 29, 2009, Teppco announced publicly that Enterprise had made a merger proposal, plaintiffs filed the Merger Action. Instead of taking any action to expedite or enjoin the action, plaintiffs entered into what Vice Chancellor Laster described as “the Cox Communications minuet,” by which he was referring to a situation:

in which real litigation activity ceases and a special committee engages in coordinated two-track negotiations, one with the controller over the deal and the second with plaintiffs’ counsel over the litigation. If the special committee and the controller close in on a transaction, then the plaintiffs’ counsel gets a heads up so that the three sides can agree simultaneously on terms. The plaintiffs’ claimed causal role in generating the transactional benefits – which the defendants concede to ensure consideration for a global release – in turn supports a fee award for plaintiffs’ counsel.

Negotiations quickly brought the parties to a deal on an exchange ratio of 1:24. Thereafter, counsel for the defendants and the plaintiffs entered into a memorandum of understanding to settle all pending litigation in consideration for the closing of the merger. Importantly, the converse was not true – the closing of the merger was not contingent upon the settlement of the litigation.

Credit Suisse opined that value was fair to the unaffiliated Teppco unitholders – but this analysis did not consider the value of the Derivative Action. The Teppco Special Committee, Teppco Audit Committee, and Teppco GP board all approved and ultimately recommended it to the Teppco LP unitholders. On August 6, 2009, the parties submitted a formal settlement stipulation.

Resolution of the Actions

As an initial matter, the Court discussed the direct and derivative nature of the actions noting that “as a result of the Merger, the distinctions between a derivative action on behalf of Teppco for the indirect benefit of its LP unitholders and a class action on behalf of those same Teppco LP unitholders have blurred. Regardless, “Delaware law recognizes an exception to the continuous ownership requirement when ‘a principal purpose of the merger was the termination of the then pending derivative claims.’” Despite the Court recognizing that after the merger the Derivative Litigation could have continued “as a de facto class action on behalf of holders of Teppco LP units as of the effective time,” the Court recognized that “eliminating the Derivative Action was a principal purpose for the Merger” and that settlement was a practical decision.

Fairness of the Settlement

In considering the fairness of the settlement, the Court noted that “[a] transactional settlement that follows the Cox Communications paradigm requires particular scrutiny because of the nigh-on formulaic nature of the process . . . .” In such a situation, the litigation brought by plaintiffs’ counsel will likely drive the deal price upward and plaintiffs’ counsel is incentivized to agree to the escalated deal price. Defendants’ counsel are also encouraged to reach an agreement as they generally obtain a broad release. As a result, counsel for both parties tend to have their interests align very early and accordingly both recognize the need to develop a “favorable record of settlement negotiations.” The real issue then becomes: how much did the plaintiffs’ lawyers add to transactional negotiations and how much should they get in return for their claims?

The problems of aligned interests are exacerbated where the transactional settlement will resolve both the transaction and a litigation. The Court noted that this case represented an example of that scenario:

The defendants knew they faced a real claim that had survived a motion to dismiss. They were in the midst of discovery and looking towards a trial and potentially adverse result. They thus had even greater incentives to use a transaction to resolve the litigation. Meanwhile, absent an exception to the traditional doctrine of claim extinction by merger, the closing of a transaction could leave the plaintiffs’ lawyers high and dry. The plaintiffs here did not raise a peep about continuing the Derivative Action but rather accepted the ready-made settlement opportunity. Everyone had ample reason to “settle” otherwise viable claims in exchange for the “benefits” provided by the proposed deal.

Accordingly, Vice Chancellor Laster stated that “the Court must give significant scrutiny to Cox Communications settlements, and particularly those that simultaneously resolve pending derivative claims.”

Plaintiffs’ Claims

The record developed in the Derivate Action led the Court to believe that the claims were very strong. As for the Merger Action, the claims were not as strong as they were controlled by terms in the LP agreement that were very favorable to defendants. A term of the LP agreement essentially allowed the defendants to rebuke any challenge to the merger so long as it was approved by a majority of the Teppco Audit Committee members. Nonetheless, even though the Court found that the claims in the Merger Action were not as strong as the claims in the Derivative Action, they still represented a “meaningful litigation threat.”

Plaintiffs alleged damages as high as $2 billion. After review of a detailed record, the Court concluded that the Derivative Action could be worth approximately $100 million. In analyzing the consideration provided in the merger, the Court was troubled that the financial advisors failed to address whether the merger price was fair in light of the Derivative Action. The Court said: “[a]lthough I am persuaded that the Merger benefited the Teppco LP unitholders, it is not possible to determine the degree to which the terms of the Merger compensated them for the Derivative Action. Put bluntly, the Merger could well have been the deal that the Special Committee would have negotiated anyway.” Despite some misgivings, the Court considered the fact that the special committee was comprised of “independent, outside directors with no ties to the controller [who] appear to have acted in good faith to negotiate the terms of a premium transaction.” In addition, prior to the Cox Communications mode, the plaintiffs had pursued the Derivative Action with vigor, thereby creating a valuable litigation asset that may have prompted the merger.

Taking into consideration all of these facts, the Court concluded that, in a close call, “the Teppco Special Committee used the Derivative Action as an effective negotiation tool to increase the Merger consideration and obtain a fair result.” Accordingly, the Court approved the settlement.

Attorneys’ Fees

Even though the defendants agreed not to oppose plaintiffs’ counsel’s request for $19.5 million in fees and $1.5 million in expenses, the Court was required to make its own independent analysis. In analyzing the Sugarland factors and in particular the level of contingency risk the plaintiffs took, the Court noted that in pursuing the Derivative Action the plaintiffs’ counsel undertook real contingency risk, engaged in significant discovery including document review and depositions. However, the Court stated that when the parties shifted into Cox Communications mode, the plaintiffs’ risk was substantially mitigated. In the end, the Court found the $19.5 million figure to be excessive.

The Court awarded plaintiffs’ counsel $10 million – which represents 10% of the benefits conferred by the Derivative Action, stating that ten percent “reflects the plaintiffs’ substantial litigation effort while recognizing that the bulk of the litigation remained. . . . Like Vice Chancellor Strine, I believe that higher percentages are warranted when cases progress further or go to the distance to a post-trial adjudication.”

The Parties

• Teppco Partners L.P. (“Teppco”) – The nominal defendant in the Derivative Action, Teppco is a master limited partnership in the oil and gas industry. On October 26, 2009, Teppco became a wholly owned subsidiary of Enterprise Products Partners, L.P. (“Enterprise”).
• Enterprise – A defendant in both actions, Enterprise is also a master limited partnership in the oil and gas industry.
• Texas Eastern Products Pipeline Company, LLC (“Teppco GP”) – Defendant Teppco GP was Teppco’s sole general partner.
• Enterprise Products GP, LLC (“Enterprise GP”) – Defendant Enterprise GP is Enterprise’s general partner.
• Daniel L. Duncan (“Duncan”) – A self-made billionaire oil and gas entrepreneur, Duncan controlled both Teppco and Enterprise. In February 2005, Duncan acquired 100% of Teppco GP, which he then transferred to Enterprise GP Holdings, L.P. (“Enterprise Holdings”) in May 2007. Duncan serves as the Chairman of Enterprise GP. He also controls EPE Holdings GP, Enterprise Holdings (through EPE Holdings GP), Teppco GP (through Enterprise Holdings), Enterprise Holdings GP (through Enterprise Holdings), and EPCO, Inc. Duncan is a defendant in both actions.
• EPCO, Inc. (“EPCO”) – A defendant in both actions, EPCO, Inc. was largely (if not wholly) owned by Duncan and his family. Controlled by Duncan, EPCO staffed Enterprises GP and Teppco GP with all of their employees, including Teppco GP’s executives.
• Teppco GP Directors – Named as individual defendants in the Derivative Action were the directors of Teppco GP at the time of filing. These individuals “had obvious connections to Duncan or Enterprise, and a majority had conflicts that were facially compromising for purposes of any transaction between Teppco and Enterprise.” Similarly, named as individual defendants in the Merger Action were the Teppco GP directors at the time of filing.
• Teppco Audit Committee – Initially comprised of inside directors – including two who were named defendants in the Derivative Action – Delaware counsel was able to add two independent outside directors when the merger was being considered.

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Harris v. RHH Partners, LP, et al., No. 1198-VCN, (Del. Ch., January 27, 2010), read letter decision here. A prior decision in this case by the Delaware Court of Chancery was highlighted here.

Why This Short Ruling is Noteworthy

This decision in noteworthy because it applies a statute that, comparatively speaking, does not enjoy a copious body of case law interpreting it. The statute in question is the dissolution statute for LPs, Section 17-802 of Title 6 of the Delaware Code. Decisions interpreting this dissolution statute have also been applied by analogy to the counterpart statute in the Delaware LLC Act, Section 18-802. These statutes allow for one to petition to dissolve an LP or an LLC when: "it is not reasonably practicable to carry on the business in conformity with the partnership [or LLC] agreement."

Background

This case involved two parties who owned an LP, called RHH Partners, that in turn owned the personal residence of the sole limited partner who owned 99% of the LP. The remaining 1% was owned by a former friend who was also the general partner. Harris, the 99% owner and general partner, was a New York lawyer by training and appeared in this case pro se, as did the general partner.

Court's Reasoning

Despite a general purpose clause authorizing the LP to operate "for all lawful purposes", the Court  found after hearing testimony that the purpose of the LP "was not entirely clear" though it likely evolved over time. The Court concluded that: "its purpose, however ill-defined, ceased to exist", and therefore, based on Section 17-802, the court held that "it is not reasonably practicable for RHH to carry on the business in conformity with the partnership agreement."

Moreover, the Court reasoned that: (i) leaving the two partners "in any kind of business relationship would serve no useful purpose"; and (ii) there is no apparent purpose for the LP; and (iii) using the LP as a vehicle to own Harris' residence "has no cognizable relationship to any business purpose for which RHH might exist."

Winding-up

Ordering dissolution did not end the discussion. For the winding-up aspect of the case, the Court divided ownership of the sole asset of the LP, the personal residence of Harris, in the same proportion as the two men owned the LP. Thus, Harris received a "99 % fee simple interest " in the real estate, and the other partner received a "1% undivided fee simple interest". The Court noted that before distribution of the assets could be made, Section 17-804 required that creditors be paid.

Postscript

Notwithstanding the unusual procedural aspect of both parties appearing pro se, thus resulting in a less developed factual record and fewer formal legal arguments presented, the issue the Court addressed is sufficiently important, and the case law on the dissolution statute sufficiently meager--by comparison to many corporate statutes for example, that this ruling merited a quick overview.

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Mitsubishi Power Systems Americas, Inc. v. Babcock & Brown Infrastructure Group US, LLC, No. 4499-VCL (Del. Ch., Jan. 22, 2010), read opinion here. The Court of Chancery's prior decision granting a TRO was summarized here.

Because this decision applies New York substantive law and is based solely on New York law, we will only provide a cursory review of this matter.

Procedurally, the Court ruled on a Motion for Judgment on the Pleadings pursuant to Rule 12(c) regarding counterclaims and some affirmative defenses of Babcock & Brown. This 36-page opinion contains many detailed factual background matters that would only be worth summarizing if we were discussing the entire opinion. A simplistic statement of the underlying facts is that it deals with a dispute over the terms of two agreements to buy wind turbines involving large amounts of money and problems with the quality and delivery dates of the products.

The claims and defenses that were dismissed based on New York law include the following:

• Breach of contract
• Breach of Implied Duty of Good Faith and Fair Dealing
• Fraud
• Negligent misrepresentation
• Equitable estoppel 

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NewRadio Group LLC v. NRG Media LLC, et al., C.A. No. 4951-VCL (Del. Ch., January 27, 2010), read letter decision here.

Kevin Brady, a highly regarded Delaware litigator, prepared this synopsis.

In this Court of Chancery decision, Vice Chancellor Laster struck language from a proposed confidentiality stipulation because he found the language to be “overbroad” and an “invalid prior restraint.” This is an issue that he has raised in a number of cases literally since the day after he took the bench in October 2009.

The offending language in the NewRadio case was as follows: “the confidentiality restrictions contemplated by the Stipulation would continue to be binding throughout and after the conclusion of the Litigation, including without limitation, any appeals therefrom.” In other confidentiality stipulations, Vice Chancellor Laster has struck the following language:  “[i]n the event that any discovery material is used in any court proceeding in this litigation or any appeal therefrom, said discovery material shall not lose its status as confidential through such use.”

Vice Chancellor Laster noted that the provision in NewRadio “makes no exception for information that becomes part of the public record. By its terms, the Stipulation purports to have me trump the common law right of access by ordering that all materials designated by the parties as ‘Confidential’ would remain under seal, regardless of how they were used. I take no comfort in my ability or the ability of another court to hold the Stipulation inapplicable to particular documents or to release them from seal. Absent such a ruling, public materials will ostensibly remain protected and sealed, and parties will risk contempt if they treat the public record as public.”

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Global Link Logistics, Inc. v. Olympus Growth Fund III, L.P.,  No. 4444-VCP (Del. Ch. Jan. 29, 2010),  read opinion here.

David Felice, of Ballard Spahr, represented one of the parties in this matter, and prepared this synopsis.

In a summary proceeding to confirm an arbitration award, the Court of Chancery dismissed with prejudice a cross-claim for adjudication of proportionate fault among co-defendants to an arbitration proceeding, holding that the moving co-defendants should have first raised the issue at arbitration and, by failing to have done so, were barred from seeking to hold their co-defendant disproportionately liable for a $7 million fraud award.  In addition, the Court dismissed without prejudice defendants’ cross-claims for pro rata contribution and to pierce the corporate veil as not ripe. This decision is noteworthy for litigators who agree to resolve disputes through binding arbitration because the issue of proportionate fault as between and among co-defendants must be resolved in the arbitration proceeding or the parties risk exposure to a potentially disproportionate share of the damages award.

Background

The dispute presented itself in the form of a complaint to confirm an arbitration award and how payment of the arbitration panel’s $7 million damage award for fraud should be allocated among the three defendants who were found to be jointly and severally liable for fraud. Through a Stock Purchase Agreement (“SPA”) executed in 2006, Plaintiffs acquired Global Link Logistics, Inc. (“Global Link”) from Olympus Growth Fund III, L.P., Olympus Executive Fund, L.P. (collectively, “Olympus”) and CJR World Enterprises, Inc. (“CJR”). Global Link, based in Atlanta, Georgia, “engages in the international shipping business as a non-vessel operating common carrier under licenses from the Federal Maritime Commission.” Plaintiffs claimed that sometime after the SPA closed, they received notice that Global Link was engaged in split-routing – a practice where Global Link requested that trucking companies deliver cargo to a location different from the information provided to the ocean carrier. Plaintiffs also claimed that this practice was a violation of the Shipping Act. Alleging ignorance of the practice of split-routing, Plaintiffs initiated an arbitration proceeding to recoup the entire purchase price, more than $128 million, claiming: (i) that defendants breached the representations contained in the SPA and (ii) fraud through the intentional concealment of the split-routing practice. Defendants argued that the practice had been disclosed during due diligence and, in any event, is not a violation of the Shipping Act.
Following arbitration, the panel awarded Plaintiffs approximately $6 million for breach of the representations contained in the SPA – with each of the sellers being held responsible for paying an amount proportionate to their share in Global Link at the time of the sale. On the fraud claim, the panel found Olympus and CJR jointly and severally liable and awarded Plaintiffs approximately $7 million (the “Fraud Award”). The panel was not asked to nor did it render a finding of proportionate fault for the Fraud Award.

Plaintiffs filed a complaint to confirm the award in accordance with the Delaware Uniform Arbitration Act. Through an Amended Answer, Olympus asserted cross-claims against CJR: (i) for contribution toward the Fraud Award for the full amount based on CJR’s proportionate fault in accordance with 10 Del. C. § 6302(d); (ii) for contribution of CJR’s pro rata share of the Fraud Award; and (iii) to pierce CJR’s corporate veil and to hold its sole stockholder liable for any amount CJR may owe. CJR and its sole stockholder filed separate motions to dismiss the cross-claims, arguing that 10 Del. C. § 6306(d) barred Olympus from pursing a claim for contribution for any amount greater than CJR’s pro rata share of the Fraud Award and that any claims for pro rata contribution and to pierce the corporate veil were not ripe.

Analysis

The Court held that an arbitration award constitutes a judgment under the Delaware Uniform Contribution Among Tort-Feasors Law (“DUCATL”) and that Olympus’ failure to raise the issue of proportionate fault by way of a cross-claim in the arbitration precluded Olympus from attempting to litigate the issue in court. Through its cross-claim, Olympus attempted to hold CJR liable for more than its proportionate share of the Fraud Award under 10 Del. C. § 6302(d), which states: “[w]hen there is such a disproportion of fault among joint tort-feasors as to render inequitable an equal distribution among them of the common liability by contribution, the relative degrees of fault of the joint tort-feasors shall be considered in determining their pro rata shares.” CJR moved to dismiss the cross-claim as being barred by the requirements of 10 Del. C. § 6306(d). Section 6306(d) states: “[a]s among joint tort-feasors against whom a judgment has been entered in a single action, subsection (d) of § 6302 of this title applies only if the issue of proportionate fault is litigated between them by cross-complaint in that action.”

Noting that there was no Delaware case law addressing the interplay between the Delaware Uniform Arbitration Act and the DUCATL, the Court concluded that “an arbitration award should be deemed a judgment for purposes of the DUCATL at least in the circumstances of this case.” (Op. at 10). The Court reasoned that the very limited grounds upon which an arbitration award could be modified or vacated “suggest that such awards have sufficient finality to warrant affording them the status of a judgment.” Id. In addition, the Court noted “perhaps most importantly, if I were to accept the Olympus Parties’ argument, it would open the door to duplicative litigation and seriously undermine the judicial efficiency and cost and time savings afforded by arbitration.” Id. Based on this rationale, the Court concluded that the cross-claim “clearly exemplifies the type of duplicative litigation and inefficient use of judicial resources that § 6306(d) was designed to prevent.” Id. at 11. However, the Court did limit its holding as being applicable “only to the situation before me, namely, that in which the cross-claim defendant (here, CJR) in a later-filed proportionate fault cross-claim under 10 Del. C. § 6302(d) was a party to the arbitration and could have been named in a cross-claim by the cross-claim plaintiff in the arbitration proceeding.” Id. at 13-14.
Based on the fact that neither Olympus  nor CJR had paid any portion of the Fraud Award, the Court concluded that the cross-claim for pro rata contribution from CJR was not ripe. Similarly, because the contribution claim was not ripe, the Court found that the veil-piercing cross-claim would not be ripe, if ever, until CJR failed to pay its apportioned pro rata share of the Fraud Award. Accordingly, the two remaining cross-claims were dismissed without prejudice.
 

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CA, Inc. v. Ingres Corp., No. 4300-VCS (Del. Ch. Jan. 26,  2010), read letter decision here. The Court of Chancery's120-page prior decision in this matter was highlighted here.

This letter decision was initially designed to resolve issues presented by competing proposed orders to implement the December 2009 decision of the Court linked above. In the process of presenting two competing orders, the parties both agreed that the Court had made an erroneous finding of fact in its prior opinion. This letter ruling concludes that the decision of the Court would  not have been different regardless of the erroneous fact finding even though the Court candidly admits that it overlooked statements at oral argument and deposition testimony on the particular fact involved.

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Amirsaleh v. Board of Trade of the City of New York, No. 2822-CC (Del. Ch., January 19, 2009), read opinion here. Read summaries on this blog of the several prior opinions of the Court of Chancery in this case here. In this latest opinion, the Court presumed the reader's familiarity with the background facts recited in the Court's November 2009 opinion.

Overview

This 24-page Court of Chancery decision provides a descriptive post-trial analysis of the application of the implied covenant of good faith and fair dealing that Delaware imposes on all contracts--without exception. The claim for breach of the covenant was ultimately rejected in the context of allegations that a deadline was "selectively extended" to assist "connected" people.

Background

This dispute arose out of the merger, on January 12, 2007, of the New York Board of Trade ("NYBOT") with and into CFC Acquisition Company, a wholly owned subsidiary of IntercontinentalExchange, Inc. ("ICE").  In connection with the merger, NYBOT owners (known as members) were effectively given the option of being cashed out or receiving a combination of ICE common stock and cash in exchange for their membership interests. NYBOT members expressed their merger consideration preference by completing and timely submitting an election form to a third-party. The combination of ICE common stock and cash was worth more than the option of only straight cash, so most members naturally did not prefer to be cashed out.

The initial deadline for the election was January 5, 2007. Many members missed the deadline. Thus, the deadline was extended until January 18, 2007. However, some members still missed the extended deadline.

Plaintiff submitted his form late and it was rejected as untimely, thus he was cashed out instead of receiving the combination of common stock. He then sued claiming a breach of the implied covenant of good faith and fair dealing.

The Court's November 2009 opinion, cited as 2009 WL 3756700 (Del. Ch. Nov. 9, 2009), explained in great detail the contours of  the good faith and fair dealing covenant. The current opinion decided whether the evidence presented at trial satisfied the prerequisites for breach of that obligation. It did not.

Highlights

Although the demarcations of the applicable law were set forth in the November 2009 decision, the latest opinion is helpful for its highlighting of the factual situations that are illustrative of "what one should do" when there are financial repercussions for failing to meet deadlines and under what circumstances allowing only "selective" extensions of that deadline may be considered bad faith and a violation of the covenant of good faith and fair dealing.

Prerequisites to Finding Bad Faith Based on Facts of This Case

The Plaintiff failed to present at trial sufficient evidence to satisfy his burden of proof that the acceptance of less than all of the late elections amounted to bad faith. In order to establish bad faith the Court determined that the Plaintiff was required to show (but did not),  the following:

(i) that the decision to allow a limited extension of the deadline was motivated by bad faith; and (ii) that it was the result of a culpable mental state. See. 2009 WL 3756700 at *5-6.

The Court explained that the Plaintiff could have demonstrated the foregoing by showing that the decision to open a late acceptance window was: (i) solely based on the fact that certain "connected members" failed to get their forms in on time; or (ii) that certain "connected members" received special treatment in submitting late elections, including holding open the window until all  "connected members" had submitted their elections.

Four Examples Not Demonstrating Bad Faith

The Court explained that bad faith (the absence of good faith) would not be found if it appeared that the decision to accept late submissions fell within the following categories: (i) it was driven by considerations of customer satisfaction balanced against leaving enough time to calculate and distribute the merger distribution by the January 29, 2007 distribution deadline required by the merger agreement; or (ii) if it appeared that defendants made reasonable efforts to give all members making late elections the same or substantially similar assistance turning in their late forms. See n. 11. Nor would bad faith be found if: (iii) defendants had failed to accept any late election form; or (iv) if defendants accommodated all late filers (as this would have exceeded the implied covenant's requirements.) See n. 18

Court's Reasoning and Holding

The Court found that opening a late election acceptance window was not motivated by a desire to help "connected members" but rather was intended to accommodate all members who missed the deadline. Moreover, the people whom the Plaintiff claimed were "connected' and the object of the defendants' alleged favoritism, were not "connected" at all, as the Court explained after careful analysis of the relationships involved, spanning many pages of this opinion.  

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Robotti & Co. LLC v. Liddell, No. 3128-VCN (Del. Ch., Jan. 14, 2010), read opinion here. See summary of Court of Chancery's prior Section 220 decision involving these parties here.

This 43-page Delaware Court of Chancery decision could serve as a “mini-law review article” that explains the current Delaware law on a wide range of issues important to those involved in corporate derivative litigation, and directors who want to understand the standards by which their conduct will be reviewed by the courts.

Background

The factual and procedural background of this matter is that it is a class and derivative action challenging a stockholder rights offering ("Offering"). The shareholder plaintiff alleges that the directors of the company set the Offering at a deliberately and inadequately low price that would trigger anti-dilution provisions in the agreements governing the stock options and warrants of the controlling shareholder. The shareholder plaintiffs argued that the triggering of the anti-dilution provisions resulted in a benefit being enjoyed by the directors that was not shared by the other shareholders and therefore, was a self-dealing transaction. The Court found, however, that the complaint failed to state a claim because the anti-dilution provisions did not change or challenge the pre-existing contractual rights of the directors which left them in substantially the same position they were in before the rights Offering. Thus, the shareholder did not sufficiently allege disloyal conduct by, for example, showing that the directors acquiesced  to the wishes of the controlling shareholder.

This cursory review will simply highlight key aspects of the Court’s opinion so that the interested reader can decide to review the full text of the decision on their own at the above link.

Court’s Summary of Issues in Case and Its Four-Part Holding

The Court described this case as one that “ultimately boils down to an alleged breach of the duty of loyalty and whether or not the defendants obtained a personal benefit through the Offering.” The Court’s reasoning and analysis can be summarized in four parts: (1) The Court cannot draw a reasonable inference from the facts that the Offering’s trigger of the anti-dilution provisions and their effect upon the options worked a material personal gain to the directors at the expense of the public stockholders. Nor did the plaintiff plead sufficient facts to support a claim that the directors acted in bad faith by consciously disregarding their fiduciary duties. (2) Because the court cannot reasonably infer from the facts that the directors received a personal gain by way of the collateral consequences of the Offering or consciously disregarded their duties, their decision to consummate the Offering is protected by the business judgment rule. (3) Of equal importance, the plaintiff has not duly alleged that the controlling shareholder dominated the board as it approved the Offering. (4) The derivative claims were barred because the plaintiff failed to plead that the board of directors were either interested or under the control or domination of an interested party as of the time it asserted the derivative claims.

Court Declines to Convert Motion to Dismiss into Motion for Summary Judgment

Robotti requested that the Court treat the motion to dismiss by the defendants as one for summary judgment because the defendants relied upon documents that were neither integral to, nor incorporated within, the complaint. The Court declined the invitation to treat the motion as one under Rule 56 as opposed to Rule 12(b)(6), which would have given the parties a reasonable opportunity to present all material relevant to a summary judgment motion. The Court observed that matters beyond the complaint may generally not be considered in a ruling on a motion to dismiss except in the following instances: “(1) When such documents are integral to, and incorporated within, the plaintiff’s complaint; or (2) When the documents are not being relied upon for the truth of their contents.” See footnote 49.

Direct v. Derivative Claims 

The opinion contains a thorough discussion and analysis of the differences between a direct as compared to a derivative claim. Referring to recent Delaware Supreme Court opinions on the topic, the Court explained that an initial inquiry in determining between a direct and derivative claim requires the following two questions to be addressed: “(1) Who suffered the alleged harm - - the corporation or the shareholders individually; and (2) Who would receive the benefit of the recovery or other remedy?” See footnotes 55 and 56.

The Court discussed the recent cases that have analyzed whether a dilution in the value of corporate stock and overpayment by fiduciaries is direct or derivative. The recent decision in Gentile v. Rossette, 906 A.2d 91 (Del. 2006) was described as involving a controlling shareholder who caused the company to issue the controlling shareholder’s stock in return for debt forgiveness. The Supreme Court in Gentile held that both the corporation and the shareholders were harmed by the overpayment and due to the dual nature of the harm, the claims in that class were both derivative and direct.

Analysis of Bad Faith and Breach of Duty of Loyalty Claims

The Court described a methodology for analyzing allegations of bad faith within the context of a duty of loyalty claim as being recently clarified by the Delaware Supreme Court in Lyondell Chemical Co. v. Ryan, 970 A.2d 235 (Del. 2009). The Court of Chancery explained as follows:

“Mere gross negligence, which includes the failure to inform oneself of available material facts, cannot constitute bad faith. Bad faith, and thus a breach of the duty of loyalty, can arise only when a fiduciary consciously disregards his or her responsibilities. The Court in Lyondell imposed a high standard on any plaintiff advancing such a claim, and recognized a “vast difference between an inadequate or flawed effort to carry our fiduciary duties and a conscious disregard of those duties.” It concluded that fiduciaries in this context breached their duty of loyalty only if they “knowingly and completely fail to undertake their responsibilities.”

In this case, the Court found that Robotti never claimed that the defendants “knowingly and completely” failed to undertake their responsibilities, nor may any such inference be drawn from the complaint.

Business Judgment Rule Applies

This opinion provides a robust discussion of the business judgment rule, its applicability, and the pleading requirements under Rule 23.1.

Notably, this is the first Delaware decision that cites to the current version of the highly regarded four volume treatise on the business judgment rule recently published by Stephen A Radin and which is cited at footnote 89 by the Court as follows: 1 Stephen A. Radin, et al., The Business Judgment Rule: Fiduciary Duties for Corporate Directors 110 (6th ed. 2009).

Referring to the Radin treatise, the Court defines the business judgment rule as follows:

“The business judgment rule, as a general matter, protects directors from liability for their decisions so long as there exists a ‘business decision, disinterestedness and independence, due care, good faith and no abuse of discretion and a challenged decision does not constitute fraud, illegality, ultra vires conduct or waste.’ There is a presumption that directors have acted in accordance with each of these elements, and this presumption cannot be overcome unless the complaint pleads specific facts demonstrating otherwise. Put another way, under the business judgment rule, the Court will not invalidate a board’s decision or question its reasonableness, so long as its decision can be attributed to a rational business purpose.” See footnote 91.

The Court found that Robotti had been unable to allege that defendants were interested in the transaction and it also failed to allege bad faith or conscious disregard of fiduciary duty. Moreover, although Robotti may have plead a failure to act with due care and on an informed basis regarding the transaction, such a conclusion would be unhelpful in light of the provision in the charter pursuant to Section 102(b)(7) which would preclude a claim for damages on that ground.

Demand Excusal

The Court also conducted an analysis under Rule 23.1 and found that the derivative claims did not satisfy that rule. Footnote 95 and 96 made it clear that the applicable time period to determine whether the pre-suit demand requirement was futile was when the first derivative claim was presented--which was in the second amended complaint. The composition of the Board at that time when the first derivative claim was filed made the Rales v. Blasband case applicable. See 634 A.2d 927, 933-34 (Del. 1993). Under Rales, the Court explained that the relevant inquiry is only whether the board can exercise its independent and disinterested judgment in responding to a demand, where, as here, the majority of the directors responsible for that decision have since been replaced.

Definitions to Determine "Interested" or "Independent" Directors

The Court provides a helpful discussion and definition of the term “interested” for purposes of pre-suit demand upon the board. Likewise for pre-suit demand purposes, the Court provides a useful definition to determine whether a director is "independent" for purposes of a pre-suit demand analysis. See footnote 98: “The mere fact that a director receives some benefit that was not shared generally by all shareholders is insufficient; the benefit must be material.”

For purposes of demand excusal analysis, rather, the plaintiff must show that the alleged benefit was “significant enough in the context of the director’s economic circumstances, as to have made it improbable that the director could perform her fiduciary duties to the . . . shareholders without being influenced by her overriding personal interest.” See footnote 99.

Regarding the independence of a director, the Court emphasized the contextual aspect of the inquiry, which requires a Court to ask “whether the directors are so ‘beholden’ to an interested director or interested controlling shareholder, that ‘their discretion would be sterilized.’ Motivations such as friendship may influence the inquiry, but in order for friendship alone to neutralize the independence of a director, the ‘relationship must be of a bias-producing nature.’” See footnote 101.

The Delaware Supreme Court has required that a complaint identify a relationship between a disinterested director and the interested director or controlling shareholder “that is so close that one could infer that the ‘non-interested director would be more willing to risk his or her reputation than risk the relationship with the interested director.’” See footnote 103.

The Court analyzed the factual situation as it related to each board member at the time the derivative claim was made in the second amended complaint, and found that the complaint did not adequately justify excusal of a pre-suit demand.

Conclusion

Thus, because the Court found that a majority of the board at the time of the derivative claim was both independent and disinterested, Robotti did not sufficiently plead demand futility and to that extent his derivative claims were dismissed. In addition, the claim for self-dealing by interested fiduciaries failed as a matter of law and the facts did not support an inference that the directors consciously disregarded their fiduciary duties or entirely abdicated their responsibilities. Therefore, the complaint was dismissed.

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A new voluntary arbitration procedure for new cases is coming to the Delaware Court of Chancery. It will provide a new streamlined, "lightening fast" litigation timetable for the adjudication of certain types of business disputes that fit within the parameters of the new rules. Highlights of the new arbitration rules were presented last month by Chancellor Chandler to the Delaware Bar and are available here. This new procedure is voluntary and gives new meaning to the term "alacrity". It is designed to provide another option to litigants seeking expedited or summary proceedings for certain business disputes that fit the new "streamlined" process provided for in the new rules that will become effective on February 1, 2010. The actual new rules are available here.  Key points about the new procedure and rules include the following:

• As a prerequisite for cases seeking money damages, the amount in controversy must exceed one million dollars.
• The arbitrator will be a permanent sitting member of the Court.
• A preliminary conference will be scheduled within 10 days of the commencement of the case to address procedural and substantive aspects of the case.
• The statutory authority for the parties to consent to this procedure is 10 Del. C. Section 349.
• The arbitration hearing will generally "occur no later than 90 days following receipt of the petition". See Del. Ch. Ct. R. 97(c).
• The arbitration proceedings will be confidential.
• Discovery and motion practice are expected to be limited.
• Appeals will be directly to the Delaware Supreme Court
• Filing and hearing fees are as follows: $12,000 for filing the petition, and $6,000 for each day of arbitration (to be shared by the parties). See Order of Jan. 4, 2010 establishing fee schedule here.

This new "rocket docket" allows for an exciting and creative method to obtain an adjudication from a member of the Court at "lightening speed" for the right type of case.

UPDATE: Professor Larry Ribstein comments on the new rules here. The Sunday News Journal in Wilmington had an article about the new arb rules on March 7, 2010 here.

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For anyone interested in what an Order from the Delaware Court of Chancery approving a class action settlement looks like, a recent one in the case of Norfolk County Retirement System v. First American Corporation, is available here.

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In Re The Dow Chemical Company Derivative Litigation, Cons. No. 4339, (Del. Ch., Jan. 11, 2010), read opinion here.

Kevin Brady and Ryan Newell of the Connolly Bove firm prepared this synopsis.

On January 11, 2010, a year after a major corporate battle between the Dow Chemical Company (“Dow”) and Rohm & Haas Company (“ROH”) regarding a $19 billion merger, Chancellor Chandler dismissed derivative claims including Caremark-type allegations against Dow’s current directors and officers for failure to adequately plead demand futility under Court of Chancery Rule 23.1.

Anatomy of the Deal -- “Ticking” Fee but No “Financing Out” or MAE Clause

In December 2007, Dow entered into a memorandum of understanding with Kuwait’s Petrochemicals Industries Company (“PIC”) for a joint venture referred to as “K-Dow.” Dow was to receive $9 billion in cash following the transfer of 50% interest in five Dow commodities chemical businesses. In July 2008, Dow entered into an $18.8 billion merger agreement wherein it would acquire all of ROH at $78 per share. The closing was scheduled to occur within 2 business days of receiving regulatory approval. Because Dow recognized that “uncertainty” regarding any aspect of the deal would be a death knell for the deal, Dow did not condition the closing on a financing or any other traditional “outs.” Dow assumed the risk of a material adverse effect in the chemical industry and financial markets. The merger agreement, however, did contain traditional penalties for delay or failure to close including specific performance and substantial “ticking” fees (interest on the cash portion of the deal which was estimated to be approximately $3.3 million per day).

As for financing, Dow had $9 billion from PIC, $4 billion from Berkshire Hathaway Inc. and the Kuwait Investment Authority, and a $13 billion bridge loan (available to be drawn upon if the ROH merger closed before K-Dow closed even though Dow’s position publicly was that the ROH merger was not contingent upon the closing of K-Dow).

Tightening of Credit Markets -- Dow’s Picture Worsens

In July 2008, Dow’s earnings were strong, however, by 2009 Dow’s outlook and the economy in general took a downward turn. Dow’s credit ratings nearly fell to junk bond levels, which possibly meant that either Dow did not have the necessary cash reserves for the ROH deal or, if it closed, Dow would be insolvent following several credit defaults. Dow nonetheless proceeded with pre-closing plans for both K-Dow and ROH.

In late November 2008, Dow received approval for K-Dow from Kuwait’s Supreme Petroleum Council (the “SPC”) to close, which was slated for January 2, 2009. That approval was later rescinded by the SPC (without giving any reason) in late December 2008 – which prompted Dow to quickly issue a press release stating that the ROH closing was not contingent upon K-Dow. (Allegedly, behind the SPC’s rescission were inferences of “external interference,” “politicizing” of the oil industry, and other suspicions that suggested bribery on Dow’s behalf.)

Dow Tries to Extend the Closing

As of January 9, 2009, the only remaining regulatory approval needed was that of the FTC. According to the Plaintiffs, Dow lobbied the FTC to delay approval and also asked ROH to extend the closing deadline. Neither request succeeded. The FTC granted final antitrust clearance for the transaction on January 23, 2009, which triggered a closing no later than January 27, 2009. Two days before closing, Dow refused to close citing two reasons: (i) a change in the economic climate; and (ii) the likelihood that the combined Dow-ROH entity would fail. ROH sued Dow on January 26, 2009 for specific performance. That litigation settled before as trial was about to start and the merger closed on April 1, 2009 “on substantially altered financial terms.”

Derivative Claims

Plaintiffs brought a litany of claims including breaches of fiduciary duties by the Directors for: “(a) approving the [ROH] Transaction, (b) misrepresenting the relationship between the [ROH] and K-Dow transactions, (c) failing to detect and prevent alleged bribery in connection with the K-Dow transaction, (d) failing to detect and prevent the alleged misrepresentations, (e) failing to detect and prevent insider trading, and (f) failing to prevent the payment of allegedly excessive and wasteful compensation.”

Demand Excusal

Plaintiffs, in bringing a derivative action, must satisfy Court of Chancery Rule 23.1 by either making a pre-suit demand or alleging demand futility. The Court stated that the purpose of the demand requirement “is not to insulate [directors] from liability; rather … to preserve the primacy of board decisionmaking regarding legal claims belonging to the corporation.” Demand is futile and therefore excused “only if a majority of the directors have such a personal stake in the matter at issue or the proposed litigation that they would not be able to make a proper business judgment in response to a demand.”

The Court also noted that while the procedural posture was a motion to dismiss, the more liberal standard of Rule 12(b)(6) did not apply. Because the claims were derivative, the motion must be considered under Rule 23.1: “demand futility under Rule 23.1 is ‘logically the first issue [for all derivative claims] and if plaintiffs cannot succeed under the heightened pleading requirements of Rule 23.1 . . . there is no need to proceed to an analysis of the merits of the claim’ under Rule 12(b)(6).” Moreover, two different demand standards applied to Plaintiffs’ claims. For the claims regarding a board action -- the Directors’ approval of the ROH merger -- the Court applied the Aronson test. For claims regarding board inaction (Caremark claims), the Court applied the Rales test.

Approval of the ROH Merger

Under Aronson, Plaintiffs were required to “plead particularized facts that raise a reasonable doubt either (i) that a majority of the directors who approved the transaction in question were disinterested and independent, or (ii) that the transaction was the product of the board’s good faith, informed business judgment.”

First Prong of Aronson

Plaintiffs allege that demand was excused as futile because half of the board failed the test of being disinterested or independent because of their relationships with director Liveris – yet they did not allege that Liveris was interested in the transaction. Plaintiffs pointed to Liveris’ role as a director at Citigroup – which was the named bank among many that were to provide the bridge loan if needed. Under this theory, the Court noted that Liveris potentially had a conflict of interest if ROH had forced Dow to draw upon the bridge loan to close and had Dow consequently gone into bankruptcy. However, this was merely a potential conflict and does not reasonably lead to the conclusion that a conflict existed. With no conflict of interest, there was no interested director and “without an interested director, the Court stated that the independence of the remaining directors need not be examined. Plainly put, the beholdenness or dominance of any director is irrelevant because there is no fear that the dominating director, without a personal or adverse interest, will do anything contrary to the best interest of the company and its stockholders.” With Plaintiffs failing to meet the burden under Rule 23.1, the Court held that the majority of the Directors were disinterested and independent.

Second Prong of Aronson

The Court held that the complaint failed to indicate that the Directors were not adequately informed. To survive the second prong of Aronson, the “‘plaintiffs must plead particularized facts sufficient to raise (1) a reason to doubt that the action was taken honestly and in good faith or (2) a reason to doubt that the board was adequately informed in making the decision.’”

The Court found that “[n]othing in the complaint indicates the Dow board was not adequately informed about the transaction with [ROH].” Taking into consideration the economic times, the Court noted that “[e]ven accepting all the well-pled allegations as true, plaintiffs do not rebut or address the accepted facts that the board was negotiating in a seller’s market and [ROH] demanded certain deal protections.” The Directors made a decision to enter the merger agreement without a financing contingency because they did not want ROH to seek another partner. The Plaintiffs focused on the “substantive content of the directors’ decision” as opposed to the process. As Chancellor Chandler stated in Citigroup, “substantive second-guessing of the merits of a business decision . . . is precisely the kind of inquiry that the business judgment rule prohibits.”

The Court stated:

“To show that a disinterested and independent board acted outside the bounds of business judgment, plaintiffs must show that directors acted in bad faith. Recently, the Supreme Court clarified the concept of bad faith in Lyondell Chemical Co. v. Ryan, noting that ‘[i]n the transactional context, [an] extreme set of facts [is] required to sustain a disloyalty claim premised on the notion that disinterested directors were intentionally disregarding their duties.’ Plaintiffs must show that defendants completely and ‘utterly failed’ to even attempt to meet their duties.”

While the Plaintiffs claimed that the directors misrepresented the connection between ROH and the K-Dow deals, the Court found no misrepresentation of the relationship. Thus, having failed to show reasonable doubt that the Directors did not exercise valid business judgment, the Court held that Plaintiffs failed to satisfy the second prong of Aronson. Coupled with the failure to prove either interestedness or lack of independence, the Court dismissed with prejudice the claim for breach of fiduciary duties regarding the ROH merger.

Caremark Failure to Supervise

Demand futility for the Caremark monitoring claims was governed by Rales wherein:

[D]efendant directors who face a “substantial likelihood of personal liability” are deemed interested in the transaction and thus cannot make an impartial decision. But “[d]emand is not excused solely because the directors would be deciding to sue themselves.” Rather, “demand will be excused based on a possibility of personal director
liability only in the rare case when a plaintiff is able to show director conduct that is ‘so egregious on its face that board approval cannot meet the test of business judgment, and a substantial likelihood of director liability therefore exists.’”

The core of Plaintiffs’ Caremark claims was that the failure to monitor subjected Dow to be exposed to liability for 1) bribery allegations in K-Dow; 2) misrepresentations regarding the need for K-Dow to close to provide financing for ROH; and 3) insider trading and waste allegations.

To prevail on their claim for oversight liability, Plaintiffs

must show that the directors knew they were not discharging their fiduciary obligations or that the directors demonstrated a conscious disregard for their responsibilities such as by failing to act in the face of a known duty to act.” Furthermore, the test is “rooted in concepts of bad faith; indeed, a showing of bad faith is a necessary condition to director oversight liability.” Only an “utter failure” will satisfy a showing of bad faith. Moreover, because Dow has adopted a Section 102(b)(7) provision in its charter, plaintiffs must plead particularized facts showing bad faith in order to establish a substantial likelihood of personal directorial liability.

K-Dow Bribery Allegations

Plaintiffs claimed that the Directors failed to detect and prevent bribery related to K-Dow was “supported” by an unsubstantiated charge made by a Kuwaiti Parliament member. Nonetheless, at the motion to dismiss stage the complaint contained facts that allowed the Court to infer that bribery may have occurred. However, Plaintiffs failed to plead the “red flags” that would give the Directors a basis for suspicion. Plaintiffs argued that because members of Dow’s management may have been involved with bribery issues in the past (Dow paid a fine to the SEC in January 2008), the Board should have suspected similar behavior here. However, the Court rejected that argument because it was found that the prior infractions involved different members of management, a different country, and a different transaction.

Lacking both the knowledge of and reason to suspect bribery, the Directors could not have consciously disregarded their duty to supervise. Nor did Plaintiffs plead facts to suggest an “utter failure” to supervise insiders or that any director acted with anything but good faith. Accordingly, Plaintiffs failed to “allege facts that establish a substantial likelihood of director liability due to oversight liability under Citigroup . . . .” The bribery claim was dismissed with prejudice.

Interestingly, in footnote 85, the Court noted that Dow had set up policies to prevent improper dealings with third parties in its Code of Ethics which expressly prohibited unethical payments to third parties. Plaintiffs also made allegations that defendants permitted their corporate governance policies to be compromised. The Court said in essence that you can’t have it both ways – “Plaintiffs cannot simultaneously argue that the Dow board ‘utterly failed’ to meet its oversight duties yet had “corporate governance procedures” in place without alleging that the board deliberately failed to monitor its ethics policy or its internal procedures.”

Director(s) Domination or Control of Board

Finally, Plaintiffs argued that nonetheless Liveris faced a substantial likelihood for failing to supervise and that he dominated and controlled a majority of the Directors. Without reiterating its reasons, the Court held that Plaintiffs had not pled facts sufficient to show that Liveris, like the other directors, was subject to a substantial liability of interest. Having no conflict, it was irrelevant whether he dominated and controlled a majority of the Directors.

In conclusion, having failed to establish that even one director faced a substantial likelihood of liability, Plaintiffs were unable to show that the board was dominated, controlled, and improperly influenced. Thus, under Rales, Plaintiffs failed to establish that demand was excused so the claims were dismissed.

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In Re Sunbelt Beverage Corp. Shareholder Litigation, Consol. C.A. No. 16089-CC (Del. Ch., Jan. 5, 2009), read opinion here.

Kevin Brady, a highly regarded Delaware litigator, provided this synopsis.

The Court  of Chancery in this opinion addressed a consolidated breach of fiduciary duty and appraisal proceeding arising out of a 12-year old cash-out merger of SBC with and into Sunbelt Beverage Corporation. Plaintiff Goldring alleged that Sunbelt’s board of directors violated their fiduciary duties in cashing her out at an unfair price, for which she sought rescissory relief or in the alternative, an appraisal of her shares of Sunbelt stock, plus interest, costs, expert fees and attorneys’ fees.

In 1997, Goldring held approximately 14.9% of the shares of Sunbelt stock. Sunbelt formerly was a division of McKesson Corporation that in 1988 began to divest its wine and spirits operations. McKesson approached Ray Herrmann, the former Vice-Chairman of McKesson Wine & Spirits, to see if he would be interested in purchasing McKesson Wine & Spirits. Herrmann organized a group of investors, including investment funds from the private investment firm of Weiss, Peck, and Greer (“WPG”), to purchase McKesson Wine and Spirits.

In 1997, McKesson and WPG sold their last remaining shares of Sunbelt stock. Sunbelt’s board convened a week later, on August 6, 1997, to discuss a proposed business alliance with Young’s Market. Before the conclusion of the meeting, the board authorized Sunbelt to obtain a fairness opinion for a $45.83 per-share offer for Goldring’s stock. After a week’s work on the project, Hempstead & Co. had completed its valuation of Sunbelt and prepared a fairness opinion for a proposed Sunbelt stock transaction at $45.83 per share. On December 12, 1997, Goldring filed her appraisal action in Delaware but the action was stayed while an arbitration proceeding went forward in New York. Following the conclusion of the arbitration, the stay was lifted and Goldring’s appraisal action and her common law breach of fiduciary duty action proceeded in Delaware.

At trial in April 2009, Goldring’s expert valuations were: (i) a discounted cash flow analysis ($114.04 per share); and (ii) a comparable transactions analysis ($104.16 per share). Defendants’ expert’s valuations were: (i) a discounted cash flow analysis ($36.30 per share); (ii) an analysis of earlier transactions involving Sunbelt stock ($45.83 per share); and (iii) an asset based approach ($42.12 per share).

The Court found that the defendants failed to show any semblance of a fair process with respect to the merger. The Court found that the defendants failed in meeting their burden of demonstrating that the merger was entirely fair, as they did not use “any of the procedural devices that could temper … the application of the entire fairness standard, such as a special negotiating committee of disinterested and independent directors or a majority-of-the-minority stockholder vote provision.” Moreover, the merger included “no procedural protections designed to ensure arm’s-length bargaining or to approximate a fair valuation procedure. There was no special committee, no opportunity for genuine negotiations regarding the merger consideration, and no dissemination of material information that would level the playing field and prevent Goldring from becoming a drastically disadvantaged minority shareholder.” However, the Court found that rescissory damages were not appropriate because of “significant issues related to complexity and implementation…” The company’s portfolio was “too complex to unscramble and, ultimately, rescission is an equitable remedy that a court of equity will only grant, as an exercise of discretion, when that remedy is clearly warranted.”

Turning to the appraisal action, the Court focused on the fact that the defendants obtained a “highly suspect” fairness opinion for the proposed merger consideration of $45.83 because the opinion was produced in approximately one week (during which time, the lead appraiser for Hempsted was working on at least one other matter that precluded him from working extensively and meaningfully with Sunbelt representatives). As a result, the Court followed Goldring’s expert and awarded $114.04 per share in money damages as an adequate substitute remedy.

With respect to Goldring’s request for fees and costs, the Court determined that the equitable result would be for defendants to pay Goldring’s court costs and expert witness fees which amounted to over $840,000. The Court rejected her request for attorneys’ fees because in order to shift fees, the Court had to find bad faith on the part of defendants which the Court could not find here. The Court also awarded interest at the legal rate (5% greater than the Federal Reserve discount rate as measured during that period of time), compounded quarterly.
 

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Xu Hong Bin v. Heckmann Corp., No. 4802-CC (Del. Ch., January 8, 2010), read letter decision here. The Delaware Court of Chancery previously granted partial summary judgment in favor of Xu on one of the counterclaims by Heckmann. Read summary of that prior decision in this case here. This ten-page letter decision from the Delaware Court of Chancery contains important analysis and recitation of Delaware law on both advancement and indemnification.

Key Issue

One of the key issues addressed by the Court was whether the provisions in the bylaws that allow the board to impose reasonable conditions prior to advancing legal fees were consistent with or contrary to the right to advancement contained in the Certificate of Incorporation.

Legal Analysis

The Court determined that there was no violation of Delaware General Corporation Law Section 109(b) in connection with the provisions in the bylaws that allowed the board to impose reasonable conditions on advancement, for two reasons. First, because the Court determined that the bylaw provisions were drafted and made effective contemporaneous with the provisions in the charter regarding advancement rights. Second, both documents were in effect when Xu began his service as a director and he should have been aware of the advancement provisions when he began his service as a director.

The Court observed that there was no requirement in Delaware law that all of the terms regarding advancement rights to which a person is entitled must be in one document. To the contrary, no such authority was presented to the Court.

Moreover, in light of Xu previously prevailing on Count III of Heckmann's counterclaims, the Court granted summary judgment in his favor for indemnification with respect to Count III.

However, the Court denied a request for “fees on fees” in the instant advancement proceedings because Xu did not prevail on his pending claim for advancement to the extent that the Court upheld the arguments of Heckmann on the issue of conditions precedent to advancing fees, contrary to the position argued by Xu--the net effect of which was to allow Heckmann to impose reasonable conditions prior to granting advancement rights.

Procedural Commentary

The Court observed as a procedural matter that fee advancement actions are especially appropriate for summary judgment proceedings because the entitlement of a party to advancement can be determined by applying the allegations contained in the pleadings to relevant corporate documents. Likewise, indemnification is also appropriate at the summary judgment stage where there are no material factual disputes germane to indemnification.
                                                                              

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Envo, Inc. v. Walters, No. 4156-VCP (Del. Ch., Dec. 30, 2009), read opinion here.

Overview
The Delaware Court of Chancery began this opinion by describing it as a case that “resembles a corporate version of a shell game.” The plaintiff alleged six causes of action against various combinations of the parties stemming from an Asset Purchase Agreement (“APA”) entered into in 2005 by the predecessor of Envo, called Environmental Solutions Group Inc. (“Old Environment”) and ESG, Inc. (“ESG”), a non-party. One of the defendants was a similarly named entity called E S G, Inc. (The nuanced difference in the name between these two entities is the space between the initials of the name.) Although the parties closed on the APA in 2005, Envo has yet to receive any payments for the assets it sold.

Procedural Posture
This case is before the Court of Chancery on a motion to dismiss the claim for reformation, as well as arguments based on laches and lack of subject matter jurisdiction.

Summary of Holding
This Court found that Envo did not state a claim for reformation but that Envo did demonstrate sufficient justification for a remedy that only equity can afford, and on the basis of that conclusion, as well as the “clean-up doctrine,” the Court determined that it had subject matter jurisdiction over this litigation.

Claims Presented
The APA called for Old Environment and Envo, as its successor, to receive $300,000. Although the parties closed in 2005, as of the filing of the amended complaint, defendants have still not paid a single dollar towards the $300,000 purchase price specified in the APA. The first count sounds in fraud and alleges that defendants Walters and Aylor falsely represented that they owned ESG and that ESG would pay Envo the $300,000 purchase price called for in the APA knowing that they did not own ESG and lacked the authority to bind ESG to purchase the assets of Envo. Envo further alleges that Walters and Aylor intended for Envo’s representatives to rely on their representations and that Envo’s representatives reasonably did so rely.

Envo also alleges that because Walters and Aylor signed the Promissory Notes providing the consideration for the purchase of Envo’s assets on behalf of a corporation that was not in good standing and took possession of those assets, a contract for the purchase price should be implied between Walters and Aylor on one side, and Envo on the other.

The amended complaint also includes theories of quasi-contract, unjust enrichment and promissory estoppel based on allegations that Walters and Aylor took possession of and currently operate an environmental consulting business formerly run by Envo and that some or all of Envo’s assets have been transferred but Walters and Aylor have not paid anything for the environmental consulting business. Envo also seeks a constructive trust on the assets sold through the APA and the profits generated by these assets as a remedy for this claim.

Legal Analysis
The Court addressed the issue of subject matter jurisdiction under Rule 12(b)(1). The Court recited the truism that the Court of Chancery is a court of limited jurisdiction and can acquire subject matter jurisdiction over a case in three ways:

(1) the invocation of an equitable right; (2) a request for an equitable remedy when there is no adequate remedy at law; or (3) a statutory delegation of subject matter jurisdiction. See footnotes 10 to 13 for supporting authority.

The Court performs its analysis based on the substance of the complaint, therefore, if a legal remedy capable of affording to the plaintiff full, fair and complete relief is available, the Court will not accept jurisdiction even if some type of traditional equitable relief has been presented as a “kind of formulaic ‘open sesame’ to the Court of Chancery.”

Because the motion to dismiss for failure to state a claim of reformation is intertwined with the motion to dismiss for lack of subject matter jurisdiction, the Court addressed the reformation claim first.

The reformation claim was based on allegations of mutual mistake and as a result Envo bears the additional pleading burden under Rule 9(b), which requires the averments of fraud or mistake to be stated with particularity. The elements that must be satisfied for a successful complaint alleging reformation on grounds of mutual mistake include the following:

(1) the terms of an oral agreement between the parties; (2) the execution of a written agreement that was intended, but failed, to incorporate those terms; (3) the parties’ mutual - - but mistaken - - belief that the writing reflected their true agreement; and (4) the precise mistake.

The Court determined that Envo failed to meet at least the first two of the four elements and thus has not met Rule 9(b)’s requirement stating the circumstances constituting the alleged mistake with particularity.

The claims for equitable fraud or negligent misrepresentation were explained to differ from common law fraud in that the claimant need not show that the respondent acted knowingly or recklessly - - innocent or negligent misrepresentations or omissions suffice. See footnote 26.

However, the primary “policy trade-off” for the reduction in the state of mind required to recover for negligent misrepresentation is that the law “pares down the class of potentially liable defendants.” That is, in order for equitable fraud or negligent misrepresentation claims to prevail, there must be one of the following circumstances: (1) a special relationship between the parties over which equity takes jurisdiction, such as a fiduciary relationship; or (2) justification for a remedy that only equity can afford.

The constructive trust remedy was defined as one imposed by a Court of equity “as a remedy to correct the unlawful vesting, or assertion of, legal title,” and may be imposed “upon specific property or identifiable proceeds of specific property, and even money so long as it resides in an identifiable fund to which the plaintiff can trace equitable ownership,” but for purposes of conferring equity jurisdiction on the Court of Chancery, the request for a constructive trust  will prevail “only if the plaintiff can show that full and fair relief requires a restoration of title to specific property or identifiable proceeds of specific property.” See footnotes 30 to 32.

The Court compared the damages available based on a common law claim of fraud, compared with the damages available on a negligent misrepresentation or equitable fraud claim. Citing to the Restatement (Second) of Torts, Section 549 (1977), the  Court observed that damages for fraud include the benefits of the contract. By contrast, however, damages for negligent misrepresentation do not include the benefit of the plaintiff’s contract with the defendant. (citing Restatement (Second) of Torts, Section 552(B)(1977)).

The Court reiterated the truism that punitive damages are beyond the authority of the Court of Chancery to award, even under the ”clean-up doctrine.” See footnote 38. The Court also noted that there may be some limited situations not applicable here where the Court of Chancery may have authority to award exemplary or punitive damages by statute (citing as an example 6 Del. C. Section 2003(b)).

The Court also discussed the defense of laches in the context of a six-year statute of limitations when a cause of action arises from a promissory note. For such a claim there is a six-year timetable pursuant to Section 8109 of Title 10 of the Delaware Code. The doctrine of laches authorizes the Court of Chancery to permit a claim to proceed beyond the statute of limitations but it also permits the Court to hold a plaintiff to a shorter period if, based on equity, “the plaintiff should have acted with greater alacrity, and when the plaintiff’s failure to seek equitable relief with alacrity threatens prejudice to the other party.” See footnotes 46 and 47.

The Court also discussed the doctrine of fraudulent concealment which allows for a statute of limitations to be tolled when: “there was an affirmative act of concealment or some misrepresentation that was intended to put a plaintiff off the trail of inquiry, until such time as the plaintiff is put on inquiry notice.” See footnote 50.

The Court reasoned that the statute of limitations was tolled for at least two months which would mean that the timing of the complaint's filing did not run afoul of the statute of limitations and there were no circumstances warranting a requirement that Envo should have acted with greater alacrity. Thus the motion to dismiss on the basis of laches was denied. In sum, other than the reformation claim, the motion to dismiss under Rules 12(b)(1) and 12(b)(6) for lack of subject matter jurisdiction and failure to state a claim, respectively, was denied.
 

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Wilt v. Kenyon, No. 4833-VCN (Del. Ch., Dec. 22, 2009), read letter decision here

This short letter decision from the Delaware Court of Chancery addresses whether counsel for the parties reached a binding settlement agreement.

Overview

The background of this case involves a two-member LLC. One of the members filed an action seeking appointment of a receiver to oversee the dissolution and liquidation of the LLC. Although the parties agreed to the appointment of a receiver, in principle, in November 2009, there were difficulties encountered in the precise terms for the form of order. One of the issues was whether the receiver would be able or authorized to sell the business as a going concern. During a subsequent teleconference with the Court, counsel for the parties informed the Court that there was only one remaining issue. Shortly after the conference with the Court, counsel for Kenyon informed counsel for Wilt that they would relent and accept Wilt’s position on the one remaining issue--thus resulting in a full and complete agreement as to the settlement.

Thereafter, however, counsel for Wilt informed counsel for Kenyon that they would insist on a prior form of order. Thereafter, the Court instructed the parties to set forth their views on whether or not an agreement on the settlement had been reached, and this letter decision resolved that issue.

Summary of Short Letter Ruling

The Court referred to a 1956 decision from the Court of Chancery for the position that:

“Attorneys of record in a pending action, such as Wilt’s attorney and Kenyon’s attorney, who agree to a compromise of a case are presumed to have lawful authority to make such an agreement. Accordingly, when opposing attorneys orally agree to compromise and settle a lawsuit, a binding contract may be created.” See footnotes 2 and 3.

The Court determined that when Kenyon’s counsel notified Wilt’s counsel that his client had agreed to relent on the only remaining open issue regarding the power of the receiver to sell the business as an operating entity, all issues at that point were resolved and a binding Settlement Agreement had been reached. Thus, the Court required the parties to submit a final form of order implementing this letter decision and that the form of order should also include the “final text of the Settlement Agreement.”

POSTSCRIPT: For other recent decisions of the Court of Chancery addressing the enforceability of settlement agreements reached by or with counsel, see cases highlighted on this blog here. The Fox. v. Paine case at the foregoing link in particular should be noted by those often engaged in business litigation, as it recognizes that in Delaware extrinsic evidence can be admissible even to interpret unambiguous contracts in two instances: (i) to review undisputed facts to put the agreement in context; and (ii) to confirm the Court's conclusion that there is no ambiguity in the agreement.

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 A Court of Chancery Order dated January 4, 2010, establishing a fee schedule for a new system of arbitration, is available here.  A prior blog post describing the proposed arbitration procedures in the Court of Chancery, with a copy of the proposed new rules, is accessible here.

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Francis Pileggi and Kevin Brady have written an article highlighting the "Top 5" key corporate and commercial cases for 2009 from Delaware's Chancery Court and Supreme Court . The article, available here, first appeared in the Delaware Law Weekly. Their article about the top corporate and commercial cases in Delaware for the first six months of the year was published in the ABA's Business Law Today magazine, available here.

A review of key corporate and commercial decisions in Delaware for each of the last four years (2005 through 2008) has appeared on this blog for the benefit of litigators and lawyers who follow these areas of Delaware law. Each of those prior annual overviews can be accessed here.

In addition to the corporate and commercial cases from 2009 highlighted in the above-linked two articles, the following Delaware decisions that did not make it into our “top 5 article” from among the 260 or so corporate and commercial decisions in 2009 that we covered on this blog, nonetheless should be of interest to those who want to keep updated on the latest corporate and commercial rulings from Delaware’s Court of Chancery and Supreme Court.

The following format merely identifies the issues addressed in other noteworthy cases from 2009 and provides hyperlinks to a fuller overview of each case as well as a link to each opinion.

Delaware Supreme Court Opinions

Gantler v. Stephens. This Delaware Supreme Court decision made it clear that fiduciary duties are also imposed on officers of corporations in addition to directors.

General Motors Corporation v. Grenier. In this opinion, the Delaware Supreme Court addresses issues related to whether or not the trial court properly allowed expert testimony after a Daubert hearing.

Olson v. Halverson. This Delaware Supreme Court decision affirmed that the statute of frauds applies to oral LLC agreements that cannot be performed within one year.

Whittington v. Dragon Group LLC. The Delaware Supreme Court establishes a bright line rule in this opinion for the creation of "contracts under seal" to which a 20-year statute of limitations applies.

Delaware Court of Chancery Decisions

Case Financial, Inc. v. Alden, No. 1184-VCP (Del. Ch., Aug. 21, 2009). Chancery Court Discusses Procedural Requirements for Parent Corporation to Pursue Claims Against Directors of Wholly-Owned Subsidiary.

Concord Steel, Inc. v. Wilmington Steel Processing Co., Inc., No. 3369-VCP (Del. Ch. Sept. 30, 2009). Chancery Enforces Restrictive Covenant and Grants Permanent Injunction.

Duthie v. CorSolutions Medical, Inc., et al., No. 3048-VCN (Del. Ch., June 16, 2009). Chancery Court Modifies Advancement Award Based on Changed Circumstances.

eBay Domestic Holdings, Inc. v. Newmark, No. 3705-CC (Del. Ch. Oct. 29, 2009). Chancery Court Rejects Request for Fees and Costs Despite Granting Second Motion to Compel Discovery Against eBay. (This is only one of many pre-trial decisions in this case that was tried in December 2009).

JAKKS Pacific, Inc. v. THQ/JAKKS Pacific, LLC, No. 4295-VCL (Del. Ch. May 6, 2009). Chancery Court Denies Books and Records Demand for LLC.

Julian v. Julian, No. 4137-VCP (Del. Ch. Sept. 9, 2009). Chancery Court Addresses: Aiding and Abetting Fiduciary Duty of LLC Manager; Right of LLC Member to Resign; and Arbitrability. (This is one of several decisions in this matter.)

Latesco, L.P. v. Wayport, Inc., No. 4167-VCL (Del. Ch. July 24, 2009). Court of Chancery Rules on Issue of First Impression: Do Fiduciary Duties Apply in the Context of a Right of First Refusal Agreement Between a Corporation and its Shareholders.

Lola Cars Int'l Limited v. Krohn Racing, LLC, No. 3379-VCN (Del. Ch. Nov. 12, 2009). Court of Chancery Decides Fiduciary Duty Claims Against LLC Manager and Allows Dissolution Claim to Proceed and Clarifies Standards for Member to Seek Dissolution of LLC.

Mickman v. American International Processing, L.L.C., Del. Ch., No. 3869-VCP (July 28, 2009). Chancery Court Grants Access to General Ledger and Right to Obtain Photocopies Based on Terms of LLC Agreement but Denies a Request for Attorneys’ Fees.  (A separate decision in this matter was highlighted on this blog here.)

NACCO Industries Inc. v. Applica Incorporated, No. 2541-VCL (Del. Ch. Dec. 22, 2009). Chancery Retains Jurisdiction over Claims of False Disclosures in Schedule 13D Filings Despite Federal Jurisdiction over Exchange Act Violations by Hedge Funds; and Allows Claim of Damages to Proceed Despite Payment of Termination Fee to Losing Bidder
 

State Line Ventures, LLC v. RBS Citizens, No. 4705-VCL (Del. Ch. Dec. 2, 2009). This letter decision of the Delaware Court of Chancery must be read by any Delaware lawyer serving as "local counsel", and more importantly, should be required reading for any non-Delaware lawyer (or any out of state attorney) who requests a Delaware lawyer to be his or her "local counsel". 

Stockman v. Heartland Industrial Partners L.P., No. 4227-VCS (Del. Ch. July 14, 2009). Court of Chancery Grants Advancement Rights and Allows Indemnification Claims. 
 

In Re: Trados Incorporated Shareholder Litigation, No. 1512-CC (Del. Ch. July 24, 2009). Post-Berger Class Action Survives Motion to Dismiss Where Common Stockholders Received Nothing and Preferred Stockholders Received $52 Million.

Triton Construction Co., Inc. v. Eastern Shore Electrical Services, Inc., No. 3290-VCP (Del. Ch. May 18, 2009). Chancery Addressed the Duty of Loyalty and other Fiduciary Duties of Departing Salaried Employees, as well as the Duty to Preserve Electronic Data and related claims.

Wayne County Employees’ Retirement System v. Corti, No. 3534-CC (Del. Ch. July 24, 2009). Court of Chancery Dismisses Fiduciary Duty Claims Regarding Vivendi Deal.

Xu v. Heckmann Corporation, No. 4673-CC (Del. Ch. October 26, 2009). Chancery Court Discusses Fiduciary Duty of Director to Disclose Information While Negotiating Release with Corporation and Whether Lack of Disclosure Could Invalidate the Release.

Five Recent Chancery Court Decisions on Electronic Discovery Issues.

Beard Research Inc. v. Kates, (May 29, 2009). Court Awards Fees For Spoliation of Evidence.

Grace Brothers Ltd. v. Siena Holdings, Inc. (June 2, 2009). Court Granted Motion to Compel Emails of Directors and Addresses Failure to Preserve

Omnicard Inc. v. Mariner Health Care Management Co.. (May 29, 2009).The Court Defines the Duty to Preserve Electronically Stored Information and Imposes Adverse Inference for Spoliation

TR Investors, LLC, et al. v. Genger, 2009 WL 4696062 (Dec. 9, 2009). The Court Imposed Harsh Penalties for Spoliation of Evidence in Violation of a Status Quo Order.

Triton Constr. Co., Inc. v. Eastern Shore Electrical Services, Inc. (May 18, 2009). The Court Addressed Spoliation of Evidence and the Duty to Preserve Evidence.

UPDATE: Professor Bainbridge kindly links to this post here, and Kevin LaCroix adds a link here after discussing his Top 10 D & O Cases of 2009.

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Deloitte LLP v. Flanagan, No. 4125-VCN (Del Ch., Dec. 29, 2009), read opinion here.  Prior Delaware opinions dealing with the Deloitte firm and its former partners have been highlighted on this blog here.

Overview

This Delaware Court of Chancery opinion addresses claims against a former Deloitte partner for breach of contract, breach of fiduciary duty and fraud in connection with allegations of insider trading with information obtained from clients for whom Deloitte performed audit services.

Procedural  Posture

The procedural context was a motion for partial summary judgment which was granted in favor of Deloitte. The Court's description of the standard for summary judgment, and it various nuances, is more complete than I have seen in most opinions, including reference to Rule 56(c) that allows for partial summary judgment on liability only. See Slip op. at 6 and 7.  Also explained is the well-established truism that breach of contract claims are especially appropriate for summary judgment motions. See footnotes 52 and 53.

Issues Addressed

The agreement that the former Deloitte partner involved in this case signed with Deloitte required him to refrain from trading in the shares of companies for whom Deloitte provided audit and related services. Also required contractually was a periodic reporting of the shares held by all Deloitte partners. The Court was satisfied with the evidence presented of multiple examples of the former partner both failing to abide by this contractual obligation and misrepresenting his non-compliance. The same evidence also satisfied the elements for a breach of the elements of a fiduciary duty claim, but at this stage, when only liability was being decided, the Court determined that it need not delve into the issue of whether the contract claim and fiduciary duty claim overlapped, or whether one needed to be chosen over the other. See page 17 and footnote 68. See also footnote 78 discussing the AICPA standards for auditors, requiring independence and the need to avoid the appearance of impropriety.

The Court also discussed the elements of common law fraud compared with equitable fraud (also  sometimes called negligent misrepresentation.) See pages 18 and 21.

The definition of the term "scienter" was discussed in the context of fraud claims related to insider trading. See page 21. This discussion includes an excellent weaving of the elements of a state law claim with concepts often used in connection with securities law claims. Also notable was the defendant's use of his Fifth Amendment right not to incriminate himself 800 times in his deposition and the Court's observation that in a civil case (unlike in a criminal case), the exercise of that right may result in an adverse inference. See footnote 90.

UPDATE: Francine McKenna on her blog Re:The Auditors here, provides insightul background details as well as follow-up on this interesting case. Also, the Chicago Tribune has a story here about the efforts of the defendant to have the Court's opinion sealed.

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NACCO Industries Inc. v. Applica Incorporated, No. 2541-VCL (Del. Ch. Dec. 22, 2009), read opinion here

This 63-page Delaware Court of Chancery decision rules on a Motion to Dismiss in connection with claims for damages arising out of a failed acquisition attempt and a terminated Merger Agreement between Applica Incorporated and NACCO Industries, Inc. The Court dismissed the claims for breach of the implied covenant of good faith and fair dealing, aiding and abetting a breach of fiduciary duty and equitable fraud. The Court allowed to proceed to trial claims for breach of contact, tortious interference with contract, fraud (faulty disclosures in SEC filings) and civil conspiracy.

Brief Factual Background

Applica initially entered into a Merger Agreement with NACCO but Applica terminated that agreement and agreed to be acquired by affiliates of Harbert Management Corporation. After a bidding contest, NACCO lost, and now seeks damages and other relief relating to that unsuccessful bidding contest. Harbert Management Corporation is an investment manager that oversees a hedge fund complex. The complaint names various entities affiliated with Harbert that were involved in the transaction and because many of those funds operate under the name “Harbinger,” the Court refers to those affiliated entities collectively as Harbinger. The Harbinger principals were previously dismissed from the suit for lack of personal jurisdiction. Applica markets, distributes and sells small household appliances. Prior to being taken private by Harbinger, the common stock of Applica traded on the New York Stock Exchange. NACCO is a holding company whose shares trade on the NYSE as well.

In 2005, NACCO approached Applica about a strategic transaction with Hamilton Beach. The parties signed a Non-Disclosure Agreement and exchanged confidential information but Applica broke off talks, inviting NACCO to re-approach in early 2006. In early 2006 Applica and NACCO began merger discussions anew and NACCO agreed to standstill provision that limited ability to act unilaterally to acquire Applica. About seven months later, when NACCO found itself in a bidding contest for Applica, the consequences of agreeing to the Standstill Agreement proved critical, because NACCO at the time was competing against Harbinger who was not similarly restricted, and had used its freedom to acquire a large block of Applica stock. In September 2006, Harbinger announced a bid to acquire all of the Applica shares it did not yet own.

Despite the Non-Disclosure Agreement that NACCO and Applica had signed, NACCO alleges that Applica disclosed confidential information to Harbinger to assist it in its acquisition of Applica. NACCO alleges that because Applica senior executives were at risk of losing their jobs in a deal with NACCO and Hamilton Beach, Applica insiders favored a Harbinger deal as a financial buyer likely to retain them.

Harbinger made several Schedule 13D filings in which it failed to disclose or inaccurately disclose its intentions with respect to its increasing purchases of Applica stock to a nearly 40% stake as well as its outgoing communication from Applica management and its communications with Applica management to avoid the restrictions of the Florida Control Shares Act that would have prevented Harbinger from voting its shares due to its newly acquired percentage of ownership. Although its August 2006 Schedule 13 filings continued to state that Harbinger was holding its shares for investment purposes without any plan to control Applica, on September 14, 2006, Harbinger offered to acquire all of the outstanding shares of Applica that Harbinger did not already own for $6 a share and at the same time amended its prior Schedule 13 forms. In October 2006, Harbinger again amended its Schedule 13D filings to state that as of September 14, 2006, its intent was to acquire all of Applica’s shares.

On September 15, 2006, Applica informed NACCO that the Harbinger bid was likely to be a superior proposal and engaged in merger discussions with Applica which was an exception to the “no-shop provision” in the Merger Agreement with NACCO but which otherwise limited the ability of Applica to explore competing transactions.

On October 10, 2006, Applica notified NACCO that it was terminating its Merger Agreement and would enter into a Merger Agreement with Harbinger. NACCO asserted that Applica had breached the no-shop provision and had failed to promptly advise of developments with Harbinger and that it had been mislead by the statements in the Schedule 13D filings of Harbinger.
Applica paid NACCO a $4 million termination fee and $2 million in expense reimbursement.
On November 2, 2006 Applica filed a preliminary proxy statement to solicit proxies in favor of the merger with Harbinger. The background section of the disclosures were much different from the disclosures in the Schedule 13D filings of Harbinger.

On November 13, 2006, NACCO filed this action against Applica and Harbinger seeking, among other things, a decree of specific performance and an order enjoining the Harbinger merger. NACCO sought expedited discovery in a trial but was informed that the Court’s calendar could not accommodate a full trial prior to the anticipated closing of the merger. NACCO then moved for a preliminary injunction but after an exchange of documents withdrew its injunction application in December.

A separate action filed by NACCO in federal court in Ohio also sought injunctive relief, but that new request for injunctive relief was denied and NACCO dismissed that federal case without prejudice. Between the end of December 2006 and January 2007, NACCO and Harbinger bid against each other for Applica. NACCO explained that it was at a disadvantage because while it was subject to a Standstill Agreement, Harbinger had acquired a 40% block of Applica’s stock. Thus, while Harbinger was effectively only bidding for 60% of Applica, NACCO was bidding for the entire company. That is, for every dollar that NACCO offered, Harbinger only had to match with sixty cents. On January 24, 2007, the stockholders of Applica approved the merger with Harbinger and NACCO terminated its offer.

Shortly after the stockholder approval of the merger with Harbinger, Applica and Salton entered into a Merger Agreement based on the efforts of Harbinger. In December 2007, the transaction closed and Harbinger owned 92% of the combined company.
In October 2007, NACCO amended its complaint and the individual defendants sought jurisdictional discovery. In February 2008, a Motion to Amend the Second Amended Complaint was filed and in May 2008 the motion was granted. In December of 2008, after Motions to Compel and jurisdictional discovery, the parties entered into a stipulation regarding jurisdictional facts. In the summer of 2008, the Court ruled that personal jurisdiction could not be obtained over the individual defendants.

Overview of Legal Analysis

 I. Breach of Contract

After discussing in great detail the references to the motive of the senior managers of Applica to favor the Harbinger deal which would allow them to keep their jobs, and the timing of confidential information that was obtained by Harbinger during a period when the Confidentiality Agreement applied, the Court concluded that at the early pleading stage it would be appropriate to draw reasonable inferences in favor of the plaintiff as opposed to weighing competing inferences that might later be determined to have legitimate explanations.

The Court also emphatically rejected the argument that there were “no damages” because NACCO subsequently lost the bidding war. The Court reasoned that:

“If embraced as grounds for a pleadings-stage dismissal, the defendants’ theory would have serious adverse ramifications for merger and acquisitions practice and for our capital markets. Parties bargain for provisions in acquisition agreements because those provisions mean something. Bidders in particular secure rights under acquisition agreements to protect themselves against being used as a stalking horse and as consideration for making target-specific investments of time and resources in particular acquisitions. Target entities secure important rights as well. It is critical to our law that those bargained-for rights be enforced, both through equitable remedies such as injunctive relief and specific performance, and, in the appropriate case, through monetary remedies including awards of damages.”

Although it received a bargained-for termination fee as is customary in merger agreements, the right to terminate the agreement by Applica without further liability was dependant upon Applica complying with its other obligations under the agreement.

 II. The Implied Covenant of Good Faith and Fair Dealing

The Court cited to well established Delaware law that when the subject at issue is expressly covered by the contract, a claim for the implied covenant of good faith and fair dealing does not apply. In this case, the merger agreement included detailed provisions governing the issues that have been raised; and the express terms that are claimed to have been violated leave no room for the implied covenant.

 IIII. Fraud

In Court IV, NACCO asserted a claim for common law fraud against Harbinger. The fraud claim turns exclusively on the statements that Harbinger made in its Section 13 filings between March and August of 2006.

  1. State v. Federal Jurisdiction

The fraud (faulty disclosure) claim raises a jurisdictional issue of whether a Delaware Court can provide a common law fraud remedy for false statements in a filing required by the Exchange Act. The Delaware Supreme Court has held that such a remedy exists and that the Court of Chancery has the ability to enforce such a remedy where the Delaware entity has been accused of fraud. See Rossdeutscher v. Viacom, Inc., 768 A.2d 8 (Del. 2001). See also 15 U.S.C. Section 78aa and 78bb.

In that Viacom case, Delaware’s High Court explained that the “federal statutory remedies of the Act over which the federal courts have exclusive jurisdiction are intended to coexist with claims based on state law and not preempt them.” Id. at 17. The Court also discussed and analyzed multiple decisions of the United States Supreme Court and other federal courts to support its ruling on this issue.

The Court of Chancery engaged in a thorough review of the applicable law on this jurisdictional issue and concluded that “the extent to which a state law claim necessarily raises a federal issue is inherently a question of degree, requiring a pragmatic judgment based on the particulars of the individual case.” Referring to multiple decisions regarding removal of cases from state court to federal court, the Court of Chancery reasoned that Section 27 of the Exchange Act does not confer exclusive jurisdiction on the federal courts to hear common law fraud claims based on statements in federal securities filings. The Court referred to multiple federal decisions in which plaintiffs have asserted both securities fraud under Rule 10b-5 or another federal provision and common law claims for fraud and misrepresentation.

Those decisions consistently exercised federal jurisdiction over the state law claim under a theory of supplemental jurisdiction (or its predecessors pendent and ancillary jurisdiction), not federal question jurisdictional under 28 U.S.C. Section 1331, nor exclusive Exchange Act jurisdiction under Section 27. This was compared to a claim to enforce Section 13 of the Exchange Act or asserting a claim for violation of Section 13 regarding false statements made in a Schedule 13D filings with related fraud claims under state law, a case in which the Court of Chancery would not have jurisdiction and which could only be heard in federal court. (citing Lowenschuss v. Options Clearing Corp., 1989 WL 155767, at * 2-3 (Del. Ch. Dec. 21, 1989) and Diceon Elecs., Inc. v. Calvary Partners, L.P., 772 F.Supp. 859 (D.Del. 1991)).

By contrast, the Court explained that “if a Delaware entity engages in fraud or is used as part of a fraudulent scheme, that entity should expect that it can be held to account in the Delaware Courts.” (Slip op. at 42.)

  2. Element of Falsity

For the pleaded fraud claim, NACCO was required to allege a fraudulent misrepresentation which Court of Chancery Rule 9(b) requires to be plead with particularity so that there is sufficient detail to apprise a defendant of the basis of the claim, although the state of mind of the defendant, including its intent, need not be plead with particularity. The pleading requirements also take into account whether “the facts lie more in the knowledge of the opposing parties than of the pleading party.” The Court also referred to the Restatement (Second) of Torts, Section 530, for the established law that “permits a misrepresentation regarding intent to form the basis for a fraud claim,” specifically quoting Section 530 as follows: “a representation of the maker’s own intention to do or not to do a particular thing is fraudulent if he does not have that intention.”

In sum, reading the complaint as a whole, the Court found that there were sufficient detailed allegations to plead that the disclosures of Harbinger in its Schedule 13 filings were false.

The Court also rejected an argument by Harbinger that in the “community of hedge funds” who frequently file Schedule 13Ds that one need not disclose any intent other than investment intent until one actually makes a bid. The Court observed that Harbinger could not offer legal support for their view but rather the recent persuasive rejection of that self-serving and formulistic interpretation was noted in the case of CSX Corp. v. Children’s Fund Mgmt. (UK) LLP, 562 F.Supp. 2d. 511 (S.D.N.Y. 2008), aff’d, 292 F.App’x 133 (2d. Cir. 2008)

  3. Reliance and Materiality

The Court noted that a false statement is not a strict liability offense but rather to plead a claim of fraud, one must have the “intent to induce the plaintiff to act or refrain from acting” and the plaintiff must in fact have acted or not acted “in justifiable reliance on the representation.” Of equal importance is that the false statement must have been material. Especially in the context of a fraud claim based on a statement in a filing required the Exchange Act, the reliance inquiry plays an important role to legitimize a Delaware Court in providing a remedy. Despite the “unusual and extreme facts” plead in the complaint, the Court admits that it is “frankly troubled by the reliance inquiry” and views it as a “close call.”

   4. Causally-Related Damages

The Court emphasized that to be actionable, a false statement must cause harm and that the necessary causal connection has two parts. First, the false statement must be a factual cause of the harm in the sense that the harm would not have occurred but for the false statement. Second, the false statement must be a legal cause of the harm, meaning that the false statement must be a sufficiently significant cause of the harm to impose liability. (citing Restatement (Second) of Torts, Section 548A, cmt. a-b.) As with the element of reliance, the Court viewed this question of causation of damages as a close one but at the Motion to Dismiss stage, similar to the reasoning on the reliance argument, the Court concluded that NACCO had sufficiently plead that its harm was causally connected to the false disclosures of Harbinger. In the reliance analysis, the Court was concerned with imposing an unfair burden on NACCO to prove “what might have happened” or to penalize a victim in insulating a wrongdoer who argues that the victim “should have known better.” (Slip op. at 54.)

IV. Equitable Fraud

Regarding Count V, in connection with the claim for equitable fraud, because NACCO is a sophisticated party and none of the defendants occupied a special relationship towards NACCO, nothing about the case suggests any equity that has traditionally moved this Court to relax the pleading requirements for fraud and therefore equitable fraud is not appropriately invoked in this case.

V. Count III for Tortious Interference of Contract

The Court declined to dismiss Count III for the tort of interference with contractual relations, which is intended to protect the economic interest of a promisee in the performance of a contract by making actionable any “improper” intentional interference with the performance of the promisor. The elements of a claim for tortious interference with contract are: (1) a contract; (2) about which defendant knew; (3) an intentional act that is a significant factor in causing the breach of such contract; (4) without justification; and (5) which causes injury.

In this case, based on the breach of contract analysis performed by the Court regarding Count I, the complaint adequately alleges that Harbinger knew about the no-shop clause, but nevertheless engaged in contacts and communications that violated those clauses. Elements three and four were also covered in the breach of contract analysis.

Similar to the related but different claim for tortious interference with prospective business relations, the Court of Chancery has explained that “claims for unfair competition and tortious interference must necessarily be balanced against a party’s legitimate right to compete,” but misrepresentations of fact “are not legitimate vehicles of competition.” (citing Agilent Technologies, Inc. v. Kirkland, 2009 WL 119865, at * 8 (Del. Ch. Jan. 20, 2009)).

The Court also cited to another decision in which the defendant was held liable for tortious interference where that defendant obtained an unfair advantage by using confidential information it had obtained from other defendants in violation of contractual agreements. See Cura Fin. Servs. v. Elec. Payment Exch., Inc., 2001 WL 1334188, at *18 (Del. Ch. Oct. 22, 2001).

VI. Count VI Regarding Aiding and Abetting a Breach of Fiduciary Duty

This claim was abandoned during briefing.

VII. Claim for Civil Conspiracy in Count VII

The elements of a claim for civil conspiracy are: (1) a confederation or combination of two or more persons; (2) an unlawful act done in furtherance of the conspiracy; and, (3) actual damage. It is well established that each conspirator is jointly and severally liable for the acts of co-conspirators committed in furtherance of the conspiracy.

It is essential that there be an underlying wrongful act, such as a tort or a statutory violation, but a breach of contract is not an underlying wrong that can give rise to a civil conspiracy claim. (citing Kuroda v. SPJS Holdings, LLC, 971 A.2d 872, 892 (Del. Ch. 2009)).

The Court explained that Delaware “recognizes the concept of efficient breach” (citing Allied Capital Corp. v. GC-Sun Holdings, L.P., 910 A.2d 1020, 1039 (Del. Ch. 2006)). The Court added that Delaware law generally elevates contract law over tort to allow parties to order their affairs and bargain for specific results, to the point where Delaware law enforces contractual provisions that eliminate the possibility of any tort liability short of actual fraud based on explicit written contractual representations (citing Abry Partners, 891 A.2d at 1061-64).

Thus, a claim of conspiracy to commit tortuous interference against the party to a contract would undercut the foregoing principles and replace the predictability of the parties’ agreement with a far less certain judicially created tort remedy; and recognizing such a “round-about claim” would circumvent the limitations on tort liability that are a fundamental aspect of Delaware law. Therefore, to the extent that Count VII asserts that Applica and Harbinger conspired to breach the Merger Agreement, the Court dismisses that claim as well as the claim that there is liability in tort for civil conspiracy to engage in tortious interference with that agreement.

However, NACCO argues that fraud provides the necessary underlying wrong and that Applica conspired with Harbinger to engage in fraud for which they should be liable. As previously explained, because there is a sufficient basis for the fraud claim, and for the foregoing reasons, there is a sufficient basis to state a claim for civil conspiracy based on fraud.

Conclusion

In conclusion, the Court required the parties to provide a scheduling order that would bring the matter to trial within 12 months. The Court also emphasized that this is a “pleadings-stage decision” and whether NACCO ultimately prevails and obtains a remedy will depend on the evidence presented, any defenses, and the ultimate equities of the case.

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Aveta, Inc. v. Bengoa, No. 3598-VCL (Del. Ch., Dec. 24, 2009), read opinion here. This Court of Chancery opinion issued on Christmas Eve was no present to the defendant. In essence, the Court imposed severe penalties on a party for failing to comply with a prior Order of the Court to commence arbitration proceedings pursuant to the parties' agreement. The Court's prior decision was highlighted on this blog here. In reply to a motion to enforce file by the plaintiff, the Court,  sua  sponte,  issued a Rule to Show Cause why the defendant should not be held in contempt due to his violation of a prior court order.  

The facts of this case are somewhat sui generis, thus I will only highlight the legal issues raised instead of dwelling on the factual background that is not likely to be repeated often.

•  The Court discussed the standard applicable for civil contempt proceedings as well as its reasoning for applying that standard in this case. Slip op. at 23-24.
•  Also relied on was the Court's inherent power to enforce its rulings. Id. at 28.
•  Defenses of novation and res judicata were soundly rejected. Id. at 32-33.
•  The contract interpretation principle of using subsequent conduct of the parties to determine "intent to be bound by a contract" was discusssed. Id. at 35
• The stiff penalty imposed as a result of the Court's conclusion that the defendant wilfully violated the Court's prior Order was a fine of $20,000 for each day that the arbitration proceedings were not commenced (starting 30 days from the day of this decision), as well as attorneys' fees.

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In In re 3Com Shareholders Litigation, C.A. No. 5067-CC (Dec. 18, 2009),  read letter decision here, the Court of Chancery denied a motion to expedite discovery in connection with a preliminary injunction seeking to enjoin the consummation of a merger between 3Com Corporation and a wholly-owned subsidiary of Hewlett Packard Company.

Kevin Brady, a highly regarded Delaware litigator, provided this synopsis.

Plaintiffs sought expedited discovery in order to collect facts to support their request to enjoin the Merger. The Court denied the motion to expedite because plaintiffs failed to state colorable disclosure claims or claims for breach of fiduciary duty, and because an adequate remedy (appraisal) existed for any purported fiduciary breach.

Background

To succeed a motion for expedited discovery, plaintiffs must establish: (i) a sufficiently colorable claim; and (ii) a sufficient possibility of threatened irreparable injury, as would justify imposing the extra costs of an expedited preliminary injunction proceeding. Plaintiffs here asserted two reasons: (a) 3Com’s management failed to make adequate disclosures in the December 4, 2009 proxy statement; and (b) the directors breached their fiduciary duties by approving the Merger because by its terms, the merger was structured to discourage or preclude competitive bids.

I. PLAINTIFFS’ FIVE DISCLOSURE CLAIMS

The Court noted at the outset that “[t]he most appropriate time to seek relief to remedy proxy disclosure violations is before the shareholder action related to the proxy occurs.” In this case, the stockholders’ meeting is scheduled for January 10, 2010 so the plaintiffs brought their challenge in a timely fashion. With respect to the requirement of irreparable injury, the Court stated that “[u]nder Delaware law, a material disclosure violation typically creates a per se irreparable harm because the approval of a transaction by uninformed or misinformed shareholders, and the resulting consummation of that transaction, cannot be adequately remedied by an award of damages.” As a result, the Court needed to address whether the plaintiff has demonstrated a sufficiently colorable claim with respect to the five alleged disclosure violations in the Proxy.

Management’s and Goldman’s projections

Plaintiffs alleged that: (a) the Proxy did not disclose cash flow measures, EBIT estimates, or EBITDA estimates from which cash flows could be derived, (b) the limited management projections that were disclosed in the Proxy differed from Goldman’s discounted cash flow analysis (“DCF Analysis”) in that management excluded stock-based compensation expense from its projections but Goldman included it in its DCF analysis, and (c) there was no disclosure of whether the management plan or the revised management plan incorporated the value of VAT refunds that 3Com expects to receive from the Chinese government.

The Court found that those challenges did not state a colorable claim because in the Proxy, 3Com management gave a complete description regarding the process they went through to obtain the Merger price, why management believed the Merger was fair and shareholders should vote in favor of it, as well as summarizing the work done by Goldman in rendering its fairness opinion. The Court stated that “[a] disclosure that does not include all financial data needed to make an independent determination of fair value is not . . . per se misleading or omitting a material fact. The fact that the financial advisors may have considered certain non-disclosed information does not alter this analysis.” The Court stated that the plaintiffs failed to show that the information that they did not receive would have altered the total mix of available information and may have even undermined the clarity of the summaries. In short, while there was a disagreement with Goldman’s methodology the Court found no disclosure violations.

The Revised Management Plan

Plaintiffs next claimed that management failed to explain why a Revised Management Plan was created and used by the Board and Goldman in evaluating the merger. The Court rejected that claim stating:

I am not convinced that failing to describe the reasons for the development and use of the Revised Management Plan was a material omission. In the Proxy, 3Com explains that both the Management Plan and the Revised Management Plan were provided to Goldman for purposes of its fairness review and that both were discussed by the Board in connection with its consideration of the Merger…. I am aware of no rule that precludes management or its financial advisor from using alternative sets of financial projections in evaluating the advisability and fairness of a merger.

Value of 3Com’s operating units

Plaintiffs claimed a disclosure violation by failing to do a “sum-of-the-parts” analysis and provide information as to the value of 3Com’s three operating segments. Under Delaware law, divisional information is material and must be disclosed where the purchaser utilizes such information in formulating its bid. However, the Court found no evidence that HP used such information in formulating its bid. Moreover, as to Goldman’s purported failure to conduct such an analysis, the Court stated that it was not aware of any requirement that Goldman had to perform such an analysis in preparing its fairness opinion. “Whether such an analysis is appropriate is best left to the discretion of investment bankers and company management. Declining to perform such an analysis does not create an obligation on the part of management to disclose divisional information.” The Court stated that the plaintiffs’ disagreement with the fairness opinion can be adequately addressed by an appraisal action.

3Com’s other strategic alternatives

Plaintiffs claimed that 3Com’s management failed to inform stockholders of the other strategic initiatives under consideration at the time it considered HP’s proposal. However, the Court rejected this claim because, “Delaware law does not require management ‘to discuss the panoply of possible alternatives to the course of action it is proposing . . . .’”

Goldman’s alleged deviations from accepted valuation practices

Plaintiffs also claimed that the analyses in Goldman’s fairness opinion deviated
from conventional practice without explaining why. In particular, they claimed that in Goldman’s DCF Analysis, Goldman: (a) treated stock-based compensation as a cash expense in its DCF Analysis even though it is normally not treated as such, (b) selected a weighted average cost of capital that was higher than 3Com’s cost of equity, and (c) increased the discount rates it used in valuing 3Com for the Merger over the discount rates it used when valuing 3Com for the 2008 Attempted Buyout even though 3Com had substantially strengthened its balance sheet in the interim period.

In rejecting this claim, the Court focused not on what Goldman did but rather on whether it was accurately described and appropriately qualified. Finding that it was, the Court said that as long as the work was disclosed, there is no need under Delaware law “to disclose any discrepancy between the financial advisor’s methodology and the Delaware fair value standard under Section 262 (or any other standard for that matter).”

Inconsistencies with the 2008 Attempted Buyout Proxy

Plaintiffs also argued that there were inconsistencies (with no explanation) in the Goldman valuation methodologies between the proxy issued by 3Com for the 2008 buyout and the current Proxy issued for the Merger. The Court rejected this claim stating that “[t]here is no rule that requires a financial advisor to follow the same protocol every time it renders a fairness opinion. There may be valid reasons that Goldman used a different approach when valuing 3Com in connection with the Merger.” Any problem with the fairness opinion can be adequately addressed in an appraisal action.

II. BREACH OF FIDUCIARY DUTY CLAIMS

Plaintiffs alleged that the 3Com directors breached their fiduciary duties in connection with the merger by: (a) including a no-solicitation and matching rights provision in the merger agreement, (b) including a $99 million termination fee that, along with a $10 million expense reimbursement fee, represents over 4% of the equity value of the merger, and (c) failing to make an effort to solicit other buyers before entering the merger agreement. The Court rejected those challenges noting that the Court of Chancery has repeatedly held that such provisions are standard merger terms and “are not per se unreasonable.”

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Cephalon, Inc. v. Johns Hopkins University, No. 3505-VCP (Dec. 18, 2009), read opinion here. This 36-page opinion from the Delaware Court of Chancery deserves a separate article in a publication dedicated to patent litigation but in this brief post we will highlight those aspects of the ruling that are likely to be of interest generally to those who make their living engaged in business litigation, otherwise categorized as corporate and commercial law.

Short Overview

In the context of a summary judgment motion, the Court ruled on the rights to a patent developed by a medical researcher at Johns Hopkins University (JHU) in connection with funding provided by Cephalon. The vice chancellor who authored this opinion often handled patent litigation as a lawyer before he joined the bench and has served as a mediator for cases pending before the United States Court of Appeals for the Federal Circuit (dealing with patent litigation). This decision also is indicative of the type of technology-related disputes to which the Chancery Court is formally receptive. See, e.g., 10 Del. C. Section 346 (vesting the Court of Chancery with jurisdiction to adjudicate proceedings initiated for the purpose of mediating disputes relating to technology--broadly defined to include without limitation, computer software licenses, biological or pharmaceutical or other technology that has commercial value, or the "intellectual property rights pertaining thereto...." See Section 346(c)(1).

Brief Background

The Court begins its opinion by describing this case as involving a "research relationship gone sour". Cephalon sponsored the leukemia research of Dr. John Small, a JHU employee, with whom Cepahalon entered into a separate consulting agreement. Years after the agreements expired, JHU applied for a patent on an invention by Dr. Small that allegedly was made with Cephalon property. After learning of the patent application, Cephalon filed suit seeking, inter alia, a declaratory judgment that it owned the invention described in the patent application. The Court granted in part and denied in part the motion for summary judgment filed by JHU, and found that: "... there is no substantial controversy that Small and JHU did not reduce the invention to practice directly ...." In addition, based on the applicable agreements among the parties, the Court found that JHU was entitled to summary judgment on the claims of ownership of the invention.

The opinion describes in great detail the medical, biological and related scientific terms at issue. For example, the project the parties were involved in focused on "the effect of two Cephalon compounds, CEP-5214 and CEP-7055, on FLT3."  See footnote 3 for a technical definition of FLT3, a member of the "receptor tyrosine kinase family". See also footnote17 for a comparison of the definitions of in vivo and in vitro. The research project involved in vivo experiments with mice and use of the compounds in vitro on human leukemic cells. The foregoing should give readers a small taste of the extensive technical, scientific discussion from the Court's opinion.

Procedurally, despite substantial factual issues on the eleven separate counts in the amended complaint, the Court permitted the parties to file a "narrow, partial" summary judgment motion on a contract interpretation issue that only required minimal discovery, but an early resolution of this issue would reduce long-term expenses for all parties. Limited discovery was permitted after the opening brief was filed.

Partial Summary Judgment Standard

After discussing the familiar standard applied to summary judgment motions, the Court acknowledged that even if the motion for partial summary judgment in this case were granted, all eleven counts of the complaint would still remain for trial. Thus, the court focused on subsection (d) of Rule 56.  In particular, if a trial is still necessary after a summary judgment motion, but the court still finds that there are uncontroverted facts, "it shall thereupon make an order specifying the facts that appear without substantial controversy... and direct further proceedings in the action that are just. Upon the trial of action the facts so specified shall be deemed established, and the trial shall be conducted accordingly." See Rule 56(d).

Legal Analysis

The  main agreement between the parties was governed by Maryland law and therefore will not be treated on this blog other than in passing. What is especially noteworthy, is that the Court relied on decisions of the U.S. Court of Appeals for the Federal Circuit for the definition of "terms of art in the field of intellectual property law" that were not defined in the parties' agreement, and as no evidence was presented as to their meaning, the Court relied on the opinions of that court to accord the terms "their usual meaning to persons in the field of intellectual property law, and patent law in particular." See footnote 62 referring to definitions of "conception" and "reduction to practice" in the field of intellectual property (noting that the U.S. Court of Appeals for the Federal Circuit has exclusive jurisdiction over appeals in patent cases and their decisions are relevant authority for matters relating to patent law). See also footnotes 70 and 71 (citing cases that define the elements that must be established to "demonstrate reduction to practice of an invention claimed in a patent application.")

The parties' consulting agreement involved in this case was governed by Delaware law. This was separate from the "primary" agreement governed by Maryland law. The Court observed the truism that in Delaware the "determination of whether a contract is ambiguous is a question for the court to resolve as a matter of law", often in ruling on a motion for summary judgment. (footnote 77). Moreover, although extrinsic evidence cannot be used to create an ambiguity where one does not exist on the face of the contract, it may be introduced to assist with "an understanding of the context and business circumstances under which the language was negotiated...." (footnote 83).

Holding

In sum, the Court granted JHU's motion for partial summary judgment: "... insofar as it seeks judgment on: (1) Cephalon's claim that it owned the autoimmune invention under the SRA because the invention was reduced to practice directly in the conduct of the Project and (2) Cephalon's claim that the SSA granted it ownership of the autoimmune invention."

The Court further concluded, pursuant to Court of Chancery Rule 56(d), that:

(1) it is without substantial controversy that the autoimmune invention was not reduced to practice directly in the conduct of the Project, and (2) Cephalon is not entitled to ownership of the autoimmune invention under the terms of the parties' SSA agreement. However, the Court clarified that it denied JHU's motion for partial summary judgment on Cephalon's claim that it is entitled to ownership of the autoimmune invention under the parties' separate SRA agreement because the invention was conceived directly in the conduct of the Project.

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A battle for control of Trans-Resources, Inc. (“TRI”) is interrupted by findings of contempt and spoliation of evidence resulting in severe sanctions. Unfortunately like many litigations in recent years, disputes on the merits can get overshadowed by e-discovery disputes. Prime examples include some of the most memorable e-discovery cases – Zubulake v. UBS Warburg, Qualcomm Inc. v. Broadcom Corp. and Coleman (Parent) Holdings, Inc. v. Morgan Stanley & Co. Inc., three cases where the Court, when faced with significant e-discovery problems, was forced to be creative is doling out sanctions. This case is another such example. 

Kevin Brady, a highly respected Delaware litigator, provided this synopsis.

TR Investors, LLC, et al. v. Genger, C.A. No. 3994-VCS, 2009 WL 4696062 (Del. Ch., Dec. 9, 2009), read opinion here, involves a dispute under 8 Del. C. §§ 220 and 225, where weeks after the case was settled, plaintiffs TR Investors, LLC, and others (collectively, the “Trump Group”) moved to reopen the matter and sought sanctions against defendant Arie Genger for intentionally causing computer “wiping” software to be installed and run on his desktop computer as well as TRI’s hard drives destroying a significant amount of information.

The Court of Chancery reopened the case and after a two-day hearing, found Genger in contempt because he had, through his agent, caused evidence that was on his computer as well as TRI’s computers (and which was subject to a status quo order) to be intentionally destroyed. In addition, the Court sanctioned Genger by, among other things, increasing his burden of proof, requiring him to provide corroborating evidence at trial (beyond just his own testimony), requiring him to produce certain documents to the plaintiffs that he had claimed were privileged, and awarding attorneys’ fees at a “suggested” level of $750,000.

Background

In 2008, Genger was the Chief Executive Officer of TRI and the Trump Group was a 47% owner of the outstanding stock of TRI. The Trump Group purchased an additional 19% bloc of TRI shares after which the Trump Group believed that it had voting control of TRI to remove the TRI board and install a new board. At a board of directors meeting held on August 25, 2008, the Trump Group delivered written consents of its shares and proposed to reconstitute TRI’s board. The practical effect of this proposal was to eliminate Genger’s control over TRI. Genger and two other directors rejected the proposal, believing that the Trump Group did not have the voting power to reconstitute the board.

Section 225 and 220 Actions and the Status Quo Order

On the same date as the Board meeting, TR Investors, LLC and others filed a Section 225 action asking the Court to, among other things: (a) declare that the Trump Group was the majority stockholder of TRI; (b) enjoin TRI from recognizing Genger as a director; (c) declare that the Trump Group, as the majority shareholder, was entitled to designate and elect two more of their designees to the TRI board, and to continue the terms of two directors; (d) declare that the TRI board was composed of their four designees; and (e) declare invalid any actions taken by a board not comprised of their designees from and after the delivery of their written consents.

The Trump Group also filed a Section 220 action asking the Court to, among other things, order TRI to permit the Trump Group to inspect and copy books and records from TRI. On August 28, 2008, the parties to the Section 225 action entered into a Standstill Agreement which provided that “no action will be taken to prosecute or defend any of the Litigations during the Term of this Agreement.” The next day, the parties submitted a stipulated status quo order which contained a provision that prohibited the parties from modifying or destroying any TRI-related information.

Preservation of TRI Information and Encryption of Genger’s Personal Information

In September 2008, in connection with the Section 225 action, TRI’s outside counsel worked with Genger to identify information on TRI’s computer system that was personal to Genger and not related to the business of TRI. Genger was concerned that if he lost control of TRI, the Trump Group would get access to his private information stored on TRI’s computers. Apparently, Genger had high level contacts within the Israeli government for whom he performed sensitive tasks relating to Israel’s national security and Genger used TRI’s computer system to create and receive documents related to these tasks.

TRI’s outside counsel collected electronic information from Genger’s TRI office and sent that information to the office of Genger’s personal counsel pending the outcome of the lawsuits. This was done not only to segregate the non-TRI documents and to protect Genger’s interest in keeping those documents confidential, but also to ensure that all of the documents related to TRI’s business were preserved for those managing the corporation and for possible use as evidence by the parties in the pending litigation. It was also done to identify Genger’s documents that were purely personal so that they could be encrypted in a manner that ensured that their confidentiality would be protected. As to non-personal documents, that information was preserved for use by TRI in its business and to ensure that it would be available if requested in the pending litigation.

Files Opened -- Data Temporarily Stored in Unallocated Space

In reviewing TRI’s files, TRI’s attorneys opened documents and e-mails that were potential targets for encryption to review their contents. This is important because, as the Court discussed, in dealing with electronic information, if a document is opened long enough for the program’s autosave feature to function, the computer system will create a temporary copy of that file. These temporary copies are different than normal user-created files, such as word-processing documents, which are stored on the active, or allocated, space of a computer where such information is visible to a user. As long as the file is open, a temporary copy is in the active or allocated space. When the file is closed (or deleted by the user), the temporary copy is moved to the inactive, or unallocated, space of the computer until the computer needs that space to store other information at which time the original temporary copy is overwritten. While information in the unallocated space is hidden from the view of normal users, it can be recovered with the aid of technology consultants making a forensic copy.

Information in Unallocated Space Destroyed in Violation of Status Quo Order

Oren Ohana, who had served for years as a technology consultant for both TRI and Genger, was contacted by Genger about the collection from TRI computer system. During the preservation of Genger’s electronic files and e-mails, parts of TRI’s computer system were “imaged” which would show a “snapshot” of all information on the system as of that date. However, no image of the entire TRI hard drive was made, only an image of the active files on the TRI system (the information on the unallocated space had not been imaged or reviewed.) Ohana informed Genger that during the review process, non-encrypted copies of Genger’s personal files may have been created and left on the unallocated space of his computer and the TRI server. At Ohana’s suggestion and with Genger’s permission, Ohana ran a wiping software program on the hard drive of Genger’s computer as well as TRI’s server permanently overwriting and erasing the data on the unallocated space of a hard drive.

About a month later and just after the parties settled the litigation, the Trump Group discovered that “wiping” software had been used to erase information on TRI’s computer system. Within days of discovering the use of the “wiping” software, the Trump Group filed a motion to reopen the case and for an order to show cause as to why Genger should not be held in contempt. Eventually, the action was reopened but Genger’s destruction of documents created a question about the adequacy of the factual record and what, if any, consequences, should result from his conduct.

A great deal of discovery was taken to determine whether any evidence was lost because of Genger’s conduct. Because no image of the entire TRI hard drive was made during the review process (only an image of the active files on the TRI system), the Court noted that it would be impossible for the Trump Group to determine exactly what was erased. However, plaintiffs were able to prove that important information about the litigation that should have existed (because it was discovered in other sources) no longer existed.

Court Finds Genger Guilty of Civil Contempt

The Trump Group filed a motion for civil contempt against Genger as well as spoliation of evidence. The Court noted that to establish civil contempt, the petitioning party bears the burden initially to demonstrate by clear and convincing evidence that the contemnors violated a Court order “of which they had notice and by which they were bound.” The Court found that Genger acted in contempt of Court by directing his agent Ohana to delete company-related information. The Court also found that the Trump Group had shown that Genger consciously violated the Status Quo Order, which prohibited him from destroying any TRI-related files. Genger had been made aware of that order, because of the work Genger did with TRI’s outside lawyers.

Moreover, the Court found evidence that “relevant documents have been lost due to Genger’s misconduct…. [and] recently produced documents … show that Genger likely deleted several other documents relevant to the § 225 action from TRI’s hard drive. Copies of those documents would likely have been on the unallocated space if they had not been erased.”

Court Finds Spoliation of Evidence

The Court stated that “[d]ispositive sanctions, including dismissal of claims or imposition of an adverse inference, are only appropriate where a party acts to “intentionally or recklessly destroy evidence, when it knows that the item in question is relevant to a legal dispute or it was otherwise under a legal duty to preserve the item.” (emphasis in original). Here the Court found that Genger intentionally caused the destruction of information he knew was relevant to the litigation in violation of the Status Quo Order and thus subject to a legal duty to preserve. The Court also found that Genger acted recklessly by approving the use of the wiping software to wipe the unallocated space. Moreover, the Court found that the Trump Group identified specific documents that existed and would have supported its position but for Genger’s destructive actions.

Court Awards Multiple Sanctions

As part of the court’s inherent power to fashion a remedy for such violations and in determining what remedy to award for spoliation, the Court considered: (1) the culpability of the spoliating party; (2) the degree of prejudice suffered by the aggrieved party; and (3) the availability of lesser sanctions that could both avoid unfairness to the aggrieved party and serve as an adequate penalty to deter such future conduct.

Here, although the Court believed that Genger was improperly motivated and intended to limit the Trump Group’s ability to gather evidence in its disputes with him, the Court also found that part of his motivation was to protect his confidentiality interests in his personal information. In addition, the Trump Group did not suffer a high degree of prejudice because Genger’s misconduct only affected the unallocated space on his computer and TRI’s server, while the active files, which were not deleted, contained a good deal of relevant information.

As a result, the Court determined that: (1) because Genger destroyed evidence that otherwise would have been available to the Trump Group, the Court determined that Genger must produce certain relevant documents to which he had claimed privilege; (2) Genger’s burden of proof would be increased by “elevat[ing] by one level the burden of persuasion upon Genger to prevail on any affirmative defense or counter-claim” that he has raised; (3) Genger had to provide corroborating evidence to prove a material factual issue at trial, “his mere word will be insufficient to meet his burden of persuasion;” and (4) Genger should pay the plaintiffs’ attorneys’ fees and suggested “as reasonable” an amount of $750,000 because this was “an amount that strikes me as reasonable in light of what was at stake, and that is consistent with my impression that both sides have engaged in overkill.” 

Supplement: The Electronic Discovery Law blog has an overview of the case here.

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Paolino v. Mace Security International, No. 4462-VCL (Del. Ch., revised December 14, 2009), read opinion here.

Short Introduction

 This decision provides an excellent analysis of the policy foundations for, and the important distinctions between, advancement and indemnification rights pursuant to DGCL Section 145. After explaining the important distinctions between advancement and indemnification, and the different timing considerations involved in addressing them, the Court stayed the claims for indemnification and after granting advancement rights, directed the parties to proceed summarily in the event that they were not able to agree on the amount of fees subject to advancement.

Brief Background

The factual setting involved the former CEO of a company that was terminated. The CEO initiated arbitration proceedings, claiming that he was wrongfully terminated, that he was defamed and that the company owed him money. Not content with playing defense, the company counterclaimed with various and sundry accusations against their former CEO. The company argued unsuccessfully that the former CEO should not be entitled to advancement of the fees incurred to defend its counterclaim against him, because, the company asserted, the counterclaims were part of the affirmative suit that the former CEO had filed initially.

Overview of Court’s Reasoning

The Court dissected and discarded with surgical precision the fallacies in the arguments by the company. Moreover, in an example of an apparent unintended consequence, the company can be said to have been “hoisted by its own petard” when it argued that one of the reasons the former CEO should not be entitled to advancement is because it was “not humanly possible” to separate the fees that were incurred in connection with the initial complaint he filed, compared to fees incurred to defend against the counterclaim.

After a thorough analysis to support its reasoning, the Court used the company's material representation to conclude at page 31 that:   “. . . because Mace has represented to me that it is impossible to distinguish between expenses incurred in connection with the Counterclaims and expenses incurred on affirmative claims, I conclude that all of Paolino’s reasonable expenses for the Arbitration must advanced.” The Court clarified that this was not the same as determining that Paolino had a right to advancement for the offensive claims be asserted, but rather defined the scope of what expenses Paolino could seek under his advancement right for the Counterclaim. The Court emphasized that “Mace has made representations to the Court and those representations have consequences.” The Court provides a very detailed and scholarly analysis of the caselaw that it relies on, and parses that caselaw to support its holding.

For example, the Court explains that for “purposes of determining whether someone is “defending” a proceeding, the operative question is not ‘who started the lawsuit?’ as Mace suggests, but rather, ‘has a claim been asserted against the covered person?’ If a claim has been asserted, whether as an initial claim, counterclaim, or a third-party claim, then the covered person is “defending.” The Court underscored the importance of analyzing for “coverage purposes,” each counterclaim as a separate cause of action to determine if it qualifies for advancement. To the contrary, analyzing a counterclaim with an “all-or-nothing” approach is against the public policy that animates Section 145.

Moreover, the Court reasoned that: “Just as it does not make sense to force a corporation to fund all of a covered person’s counterclaims simply because the corporation filed suit first, it does not make sense to relieve a corporation of its advancement obligations for all of the claims it asserts against a covered person, simply because the covered person sued first. To do so would deny the covered person the protection to which he or she is entitled and imposes significant cost, in the form of forfeiting advancement rights for counterclaims” on individuals who sought to enforce their own rights by filing suit.” (See slip op. at 17.)

Distinction between Covered Advancement Claims and Disputes Based Only on an Officer's Employment Agreement

The Court explained that neither the Delaware decision in Cochran v. Stifel Fin. Corp., 2000 WL 1847676 (Del. Ch. Dec. 13, 2000), aff’d in pertinent part, 909 A.2d 555 (Del. 2002), nor any other cases supported the argument that when an Employment Agreement is at issue “Section 145 goes out the window.” To the contrary, the Court emphasized that instead the Delaware cases demonstrate that “Section 145 will not apply when the parties are litigating a specific and personal contractual obligation that does not involve the exercise of judgment, discretion or decision making authority on behalf of the corporation.” See slip op. at 21-22. See also Reddy v. Electronic Data Systems Corp., 2002 WL 1358761 (Del. Ch. June 18, 2002).

The Court parsed the factual background and legal analysis in the Cochran and Reddy cases and the case of Zaman v. Amedeo Holdings, Inc., 2008 WL 2168397 (Del. Ch. May 23, 2008)  and related cases. The Court explained that in Zaman the Court rejected an argument that advancement was barred for the defense of claims that managers of the New York Palace Hotel had used company credit cards for personal expenses while acting in their managerial capacity. The Court in Zaman rejected the argument that the claims should be characterized as merely a dispute over contractual reimbursement, noting that the claims were “grounded in their alleged misuse of the substantial fiduciary responsibility they were given as key managerial agents.” Id. at *28. Notably, the Court in Zaman observed that if the defendants were ultimately shown “after an adjudication on the merits that the [plaintiffs] were in fact bilking the Palace Hotel and its owners with excessive credit card charges, they will not be entitled to indemnification for any judgments against them.” Id.

The Court highlighted the point that the Cochran case did not establish an exception to advancement rights when Employment Agreements were involved. Rather, Cochran’s holding “that a personal contractual obligation lacked the necessary nexus rested on both the specificity of the contractual obligation and the circularity of the covered person being obligated to make the called-for payment, then obtaining it back through indemnification. Section 145(b) prohibits precisely this circularity in derivative lawsuits by preventing a corporation from indemnifying a covered person for judgments recovered by the corporation.” See slip op. at 28.

The Court further explained that Cochran, Reddy and Zaman are consistent with the overarching test announced by the Delaware Supreme Court for determining whether a covered person has been sued “by reason of” his or her official capacity: “if there is a nexus or causal connection between [a claim] and one’s official capacity, those proceedings are ‘by reason of the fact’ that one was a corporate officer, without regard to one’s motivation for engaging in that conduct” (citing Homestore v. Taffeen, 888 A.2d 204, 215 (Del. 2005)).

In addition, the Court added that the “requisite connection is established ‘if the corporate powers used were necessary for the commission of the alleged misconduct’” (citing Bernstein v. TractManager, Inc., 9538.2d 1103 (Del. Ch. 2007)).
 

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Grunstein v. Silva, 2009 WL 4698541 (Dec. 8, 2009, Del. Ch.), read opinion here.

Maura Burke, an associate in our Wilmington office, prepared this synopsis.

The conflict in this Court of Chancery matter arose from the alleged breach of an oral partnership agreement which was formed to carry out the acquisition of a company. See id. at *1.  Compare generally, Olson v. Halverson, summarized here. (Delaware Supreme Court decision of December 2009 applying the statute of frauds to an oral LLC agreement.) Plaintiffs Grunstein and Dwyer alleged that they, together with Defendant Silva (the “Partners”), orally agreed to form a partnership for the purpose of acquiring a nursing home services company. See id.

Background

Plaintiffs alleged that they agreed to share profits and losses resulting from the acquisition and that “each partner would share in all the economic benefits received by any of them (or any entities controlled by them) resulting from the [acquisition].” See id. None of the terms, however, were ever memorialized in a written agreement signed by the parties. See id. at *2.

The Partners, initially through three business entities that were specifically created for the acquisition (“Acquiring Entities”), entered into a merger agreement with the target company. See id. Several amendments were made to the merger agreement, the third of which replaced the original Acquiring Entities with companies controlled by Defendant Silva (“Third Amendment”). See id. at *1. When the merger finally closed, the target company was owned solely by Silva’s companies. See id. at *4.

Central Focus of Claims

Plaintiffs asserted that Silva violated the partnership agreement by refusing to share the economic benefits of the acquisition with the Partners. See id. at *4. Silva maintained that no such partnership agreement existed and therefore he was not obligated to share distribution of the acquisition proceeds. See id. at *1.

Issues Addressed

The Plaintiffs asserted nine claims against Defendants. Defendants, in a motion to dismiss, challenged six of the causes of action including: breach of contract, breach of fiduciary duty, promissory estoppel, fraud, negligent misrepresentation, and tortious interference with contractual relations and business advantage. See id. at *5.

The following is a brief recap of the Court’s findings regarding Defendants’ motion to dismiss.

(a) Fiduciary duty: The Court dismissed the breach of fiduciary duty claims because Delaware law generally prohibits plaintiffs from asserting both a breach of contract and a breach of fiduciary duty claim under the same facts. See id. at *6. Plaintiffs argued that the claims should survive the motion to dismiss because they fell within the exception which allows assertion of fiduciary duty claims where “they depend on additional facts . . . are broader in scope, and involve different considerations in terms of a potential remedy.” See id. (quoting Schuss v. Pennfield Partners, L.P., 2008 WL 2433842 (Del Ch. 2008)). Rejecting Plaintiffs’ position, the Court held that the fiduciary duty claims were duplicative of the breach of contract claim because the establishment of any fiduciary relationship among the Partners was created by the partnership agreement which was also the source of the breach of contract claim.

(b) Promissory estoppel: The Court denied Defendants’ motion to dismiss the promissory estoppel claims. First, the Court held that the Third Amendment to the merger agreement, which assigned the rights of the original Acquiring Entities to the Silva-controlled companies, did not preclude a claim for promissory estoppel. See id. at *8. The Court acknowledged that the existence of a valid contract between the parties may, in some instances, preclude promissory estoppel claims. In this case, the Court found that the Third Amendment did not bar promissory estoppel because it did not directly involve the parties, nor did it relate to the agreement at issue in the pending litigation. See id. Second, the Court held that Plaintiffs’ failure to plead lack of consideration was not fatal to their claim for promissory estoppel. See id. at *10. Although recognizing that promissory estoppel historically functioned as a consideration substitute, the Court instead focused on the Delaware courts unwillingness to “apply strict contractual interpretation on what is, at base, an equitable remedy.” See id.

Finally, the Court held that Plaintiffs adequately pleaded reasonable reliance. See id. at *11. Invoking New York law, Defendants argued that, as a matter of law, Plaintiffs cannot reasonably rely on oral promises that directly conflict the terms of a written agreement, in this case the Third Amendment to the merger agreement. See id. at *10. Examining the case law, the Court found reliance was not precluded as a matter of law in this instance because the rule only applies where the oral promises flatly contradict the contractual terms. See id. The Court also held that the sophistication of the parties does not necessarily preclude reasonable reliance on oral promises where the parties had a pre-existing working relationship and repeatedly affirmed their business relationship. See id. at 12.

(c) Fraud: Defendants argued that Plaintiffs were improperly bootstrapping a fraud claim to a breach of contract claim by asserting that Defendants never intended to honor their agreement. See id. The Court found that Plaintiffs’ complaint adequately established “an intentionally false representation on which the Plaintiffs relied to their detriment” and denied Defendants’ motion to dismiss. See id. at *13. The Court noted, however, that in order to prevail on this issue Plaintiffs would have to rebut facts that contradict their theory that Silva intended to breach their partnership agreement from its inception. See id.

(d) Negligent Misrepresentation: The court dismissed the negligent misrepresentation claim based upon Defendants’ repudiation of the partnership agreement because “the promise to honor an agreement is only a misrepresentation if the promisor knows at the time of the promise that he will ultimately breach; such a misrepresentation cannot occur unknowingly or negligently.” See id. at *14.

(e) Breach of Contract: Asserting the statute of frauds, Defendants moved to dismiss the breach of contract claims regarding an underwriting contract related to the partnership’s acquisition of the nursing home company. See id. at *15. The Court held that the Plaintiffs’ obligations under the contract, which was for underwriting services with option to lend funding, fell outside Delaware’s statute of frauds. Denying the motion to dismiss, the Court refused to consider whether statute of fraud deficiencies could be cured by part performance or existence of a related writing. See id.

(f) Tortious Interference: The Court dismissed the claim for tortious interference because the non-Silva Defendants (Silva-controlled entities) were protected by the affiliate privilege. See id. at *17. Delaware law recognizes that a party to a contract cannot tortiuously interfere with that same contract. This “interference privilege” protects affiliates or entities under the control of that party as well. See id. at *16. Even nonparties to a contract may be protected so long as they “share a commonality of economic interests with one of the parties and act in furtherance of their share legitimate business interests.” See id. at *16 (quoting Sherin v. E.F. Hutton Group, Inc., 652 A.2d 578, 591 n14 (Del. Ch. 1994) (internal quotes omitted). Accordingly, the Court found that certain non-Silva Defendants were agents of Silva with regard to the partnership agreement and therefore fell within the scope of the interference privilege. See id. at *17.

(g) Claims against non-Silva Defendants: Defendants moved to dismiss all counts against non-Silva Defendants arguing inter alia that companies creates after the alleged partnership agreement cannot be bound by that agreement. See id. at *18. The Court recognized, however, under Delaware law a subsequently-formed entity may be subject to a pre-formation agreement by accepting the benefits of the agreement with knowledge of its terms. See id. (citations omitted). Further, corporations may be found to have imputed knowledge and to have implicitly adopted its agents contract where the agent is for all intents and purposes the alter ego of the corporation. See id. (citation omitted). The Court found that the complaint sufficiently alleged that Defendant business entities had knowledge of the partnership agreement, through Silva, and reaped the benefits of that agreement; and therefore was bound by the agreement. The motion to dismiss was denied. See id.
 

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Phoenix Equity Group LLC v. BPG Justison P2 LLC, No. 5008-VCL (Del. Ch., Dec. 7, 2009), read letter ruling here.

In this one-page letter ruling, the Delaware Court of Chancery interpreted its own Rule 5(aa)   [yes, that is the correct citation], to require the Court's approval even when a stipulation is submitted for one counsel to substitute for another.

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Zurich American Insurance Company v. St. Paul Surplus Lines, Inc., No. 4095-VCP (Dec. 10, 2009, Del Ch.), read opinion here. This opinion addresses the limited scope of review that the Court of Chancery is restricted to when asked to alter a decision of an arbitrator made in a binding arbitration. The facts of this case are beyond the scope of this blog but the issue involved applies to corporate and commercial cases. The procedural posture of this case began with a binding arbitration in connection with a subrogation claim by one insurance company against another. The Superior Court dismissed the original complaint and told the parties to refile in the Court of Chancery.

Section 5715 of Title 10 of the Delaware Code describes the few instances when the Court is authorized to modify a binding arbitration award. Section 5714 circumscribes the limited circumstances when the Court may vacate an arbitration award.  See also Section 1514(a)(3). In sum, the Court reasoned that the arbitrator's decision that he did not have jurisdiction over the claim submitted to arbitration was still tantamount to a "decision" as defined in the statute, and even if the arbitrator's decision to decline jurisdiction was apparently contrary to the intent of the Delaware Legislature regarding mandatory arbitration between insurance companies, none of the statutory bases that would allow the Court to modify or vacate the award applied in this case.

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Dirienzo v. Steel Partners Holdings, L.P., No. 4507-CC ( Del. Ch., Dec. 8, 2009), read opinion here. This Court of Chancery decision addressed the requirement that a party seeking an appraisal pursuant to Section 262 of Title 8 of the Delaware Code be a "record holder". In this litigation, the Court determined that the party seeking appraisal was not a record holder as required by DGCL Section 262(a), nor was there an express or implied waiver by the company of this requirement. The Court also rejected an estoppel argument that the plaintiff made based in part on the company's silence because it was determined that the company had no duty to speak at the relevant times.

After limited discovery related only to the plaintiff's entitlement to proceed, as contemplated by Section 262(g), the parties filed cross motions for summary judgment. The Court explained that the record holder is the party who owns the shares as recorded on the company's books. The Court determined that not even the plaintiff's broker in this case was the record holder, rather Cede & Company, a central security depository was determined to be the record holder. The Court cited case law at footnotes 14 to 17 for the Delaware law that even if the record holder is known, appraisal demands by a beneficial owner are invalid. Thus the company's motion for summary judgment was granted based on the finding that the plaintiff did not satisfy the record holder requirement for an appraisal.

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Off v. Ross, No. 3468-VCP (Del. Ch., Dec. 10, 2009), read opinion here. The Court of Chancery's prior decision in this case was highlighted here. This short decision involves a renewed application for attorneys' fees in connection with the settlement of a derivative and class action. The first request for fees last year was denied (see link above) based on the Court's concern that such an award at that time might interfere with a related pending action in New York. Now that the related New York case has settled, a renewed application for fees was submitted. This time the Court granted the application, based on the familiar factors that are discussed by the Court, though the amount granted was substantially discounted compared to the requested amount of fees. The Court explained that it was using as a lodestar the number of hours recorded by counsel multiplied by a reasonable hourly rate, plus a modest "multiplier", as opposed to a percentage of a common fund because the monetary benefit achieved was not readily quantifiable.

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In Cephalon, Inc. v. Johns Hopkins University, et al., C.A. No. 3505-VCP (Del Ch., Dec. 4, 2009), read letter decision here, Cephalon asked the Delaware Court of Chancery to review in camera certain documents identified in the privilege log of defendant Johns Hopkins University (“JHU”) to determine whether these documents were privileged.

Kevin Brady, a highly regarded Delaware litigator, provided this synopsis.

In a prior order regarding Cephalon’s Motion to Compel, the Court allowed Cephalon to select up to fifteen documents identified in JHU’s Supplemental Privilege Log for in camera review to determine whether the documents were privileged and whether the representations made by JHU in the Privilege Log as to those documents were reasonable and accurate.

Cephalon identified documents where JHU claimed attorney-client privilege despite the absence of any attorney among the authors and recipients listed in the Privilege Log. JHU submitted those documents to the Court with a letter requesting permission to make an additional submission containing background and contextual information about the documents to assist the Court in its review. The Court denied JHU’s request in essence saying that the privilege log had to stand or fall on its own merits. The Court stated that a communication regarding legal advice (not business advice) can qualify for the attorney-client privilege even if no party to the communication is an attorney. Under D.R.E. 502(b):

A client has a privilege to refuse to disclose and to prevent any other person from disclosing confidential communications made for the purpose of facilitating the rendition of professional legal services to the client (1) between the client or the client’s representative and the client’s lawyer or the lawyer’s representative, (2) between the lawyer and the lawyer’s representative, (3) by the client or the client’s representative or the client’s lawyer or a representative of the lawyer to a lawyer or a representative of a lawyer representing another in a matter of common interest, (4) between representatives of the client or between the client and a representative of the client, or (5) among lawyers and their representatives representing the same client.

In this case, given that the documents under review included e-mail which often contain a mix of business and legal matters, the Court discussed what should be done where the communication refers to both legal and business matters. The Court said:

If the legal-related aspects of the communication easily can be separated from the business-related aspects, the document must be produced with the legal-related portions redacted. If a communication contains an inseparable combination of business and legal advice, however, the communication may be protected by the attorney-client privilege. Where it is a close call, the party asserting the privilege will be given the benefit of the doubt.

The Court then discussed its decision as to the claim of privilege on the fifteen documents at issue. The results of the review are not relevant for discussion purposes here other than to say that the Court did discuss its basis for analyzing privilege asserted within email chains. Having reviewed in camera the fifteen documents, the Court concluded that JHU’s representations in the privilege log were reasonable and accurate and the privilege was sustained.

As a side note, this is an area of the law and practice that has become very complicated and very expensive for companies with the volume of electronic mail and the susceptibility to post-transmission modification within email chains. Indeed, surveys indicate that privilege review and the preparation of privilege logs are the most expensive components of e-discovery.

For anyone interested in the latest discussion about these topics and some very good suggestions about alternative non-traditional ways to handle privilege review and large privilege logs, I recommend a very recent article by Judge John M. Facciola and Jonathan M. Redgrave entitled “Asserting and Challenging Privilege Claims in Modern Litigation: The Facciola-Redgrave Framework" , Vol. 4, Issue No. 1, The Federal Courts Law Review, Nov. 2009. A pdf of the article is available here.
 

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In an opinion spanning over 120 pages (and 299 footnotes), the Court of Chancery in CA Inc. v. Ingres Corp., No. 4300-VCS (Del. Ch. Dec. 7, 2009), read opinion here, applied California and New York law to resolve a complicated contract dispute between two large software companies, CA, Inc. (“CA”) and Ingres Corp. (“Ingres”), which CA spun off several years ago. Given the length and the detailed analysis pertaining to California and New York law (and not Delaware law), the following summary very briefly touches upon the highlights of the decision.

Kevin Brady, a highly regarded Delaware litigator, prepared this synopsis.

Background

CA and Ingres are in the enterprise information technology software industry. Enterprise software is employed by large complex organizations to serve as the infrastructure of its business operation. Given the importance and complexity underlying these systems, it is costly to switch software and, as a result, companies tend to develop long term relationships with their providers. However, these long term relationships can cause problems in divestitures as contractual obligations tend to survive divested units or product lines.

In this case, CA negotiated the obligations that Ingres would have to continue to provide CA’s customers with access, support, and improvements to the Ingres products they had been using when those products were owned by CA. In fact, CA’s divestiture negotiations with Ingres required Ingres to provide updates to CA’s database software and other products that were divested to Ingres.

Not surprisingly, economic interests between CA and Ingres diverged after the divestiture. Disputes arose about what Ingres’ obligations to CA were for maintenance and support. In an attempt to resolve certain disagreements over Ingres’ obligations, the parties entered into an additional contract (the “Reseller Agreement”) that allowed CA to purchase licenses for the latest Ingres products, which CA could then pass on to its customers. Unfortunately, this contract only added to the complexity of the contractual disputes between the parties.

Ingres’ Obligations Under the Contracts

The first key dispute between the parties centered around the relatedness of the various contracts in question. The Court addressed three issues. First, pursuant to the divestiture agreement, was Ingres obligated to provide software, maintenance, and support to CA free of charge? The Court held that Ingres was in fact obligated to provide CA’s legacy customers with the latest version of its software for free as part of its maintenance and support obligations. Second, did the Reseller Agreement supersede the divestiture agreement? The Court held that the Reseller Agreement superseded the divestiture agreement as to the terms under which Ingres must provide the latest version of its software. Third, can Ingress enforce the Reseller Agreement despite a breach in a separate agreement? The Court held that Ingres cannot hold CA responsible in damages for the brief period a third party used the new version of the software because that entity’s use of the software directly resulted from breaches by Ingres.

CA’s Alleged Improper Use of Software

The second key dispute involved Ingres’ allegations that CA was improperly using Ingres’ software in CA’s own software product. The Court held that CA had a contractual right to use Ingres’ software as it did. Accordingly, CA did not need to compensate Ingres for CA’s use.

Attorneys’ Fees and Forum Selection Clause

In addition, with respect to a dispute regarding one third-party’s order for certain software, the Court found that CA was entitled to attorneys’ fees related to that dispute. However, with respect to a claim regarding another third-party’s use of the software, the Court declined to award attorneys’ fees to either party because each party prevailed on some of the substantive issues underlying that claim. Finally, with respect to a parallel California action, the Court enjoined that action in order to enforce the parties’ forum selection choice to adjudicate disputes relating to certain agreements either in Delaware or New York.
 

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The Delaware Court of Chancery is considering a new procedure for new cases to be filed with the Court for the purpose of being arbitrated by a member of the Court. The draft rules are only preliminary proposals subject to change. Chancellor William Chandler, III discussed the draft rules in a presentation to members of the Delaware Bar today. Here  is a copy of the current version of the draft proposed Arbitration Rules for the Delaware Court of Chancery. A few of the highlights of the embryonic concept include:

• As a prerequisite for cases seeking money damages, the amount in controversy must exceed one million dollars.
• The arbitrator will be a permanent sitting member of the Court.
• A preliminary conference will be scheduled within 10 days of the commencement of the case to address procedural and substantive aspects of the case.
• The statutory authority for the parties to consent to this procedure is 10 Del. C. Section 349.
• The arbitration hearing will generally "occur no later than 90 days following receipt of the petition". See Proposed Del. Ch. Ct. R. 97(c).
• The arbitration proceedings will be confidential.
• Discovery and motion practice are expected to be limited.
• Appeals will be directly to the Delaware Supreme Court
• Estimated fees are expected to be $12,000 for filing the petition, and $6,000 for each day of arbitration (to be shared by the parties).

Compare generally: 10 Del. C. Section 346 (regarding mediation of technology disputes) and 10 Del. C. Section 347 (mediation of business disputes).

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Kurtz v. Holbrook, No. 5019-VCL (Del. Ch. Dec. 1, 2009), read letter decision here.

This relatively short letter decision from the Delaware Court of Chancery addresses two motions to compel and explains why both were denied.

This is an expedited case that was filed on October 26, 2009 and seeks a preliminary injunction  that was scheduled to be heard on December 4, 2009. Because the Court indicated that it expected to issue a written opinion on the preliminary injunction application, this letter ruling only summarized briefly the factual background. The Court noted that it relied heavily on its discretion as provided in Rule 26(d)(1) to narrow discovery to ensure that it is “properly related to the issues presented in the litigation.”

Moreover the Court relied on that part of Rule 26 which allows the Court to limit discovery that is “unduly burdensome or expensive, taking into account the needs of the case, the amount in controversy, limitations on the parties’ resources, and the importance of the issues at stake in the litigation.” Ct. Ch. R. 26(b)(1)(iii).

The Court noted what it referred to as a “bit of ‘tit-for-tat’ at work” because the pending motion was likely motivated by a prior motion to compel that the other party had filed. The Court also emphasized the standards in Rule 5(d)(3) which requires that in lieu of filing discovery requests and responses with the Court, counsel who serves the discovery is treated as its custodian--but when discovery requests and responses are to be used at trial or are necessary to a pretrial or post-trial motion, “the verbatim portions thereof considered pertinent by the parties shall be filed with the Court when relied upon.” The Court denied the motion to compel in this case due to the failure of the moving party to comply with that requirement in Rule 5(d)(3).

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Mangano v. Pericor Therapeutics, Inc., No. 3777-VCN (Del. Ch. December 1, 2009),  read opinion here.

This 23-page opinion of the Delaware Court of Chancery explains in great detail the factual basis of the legal issues in this case in the context of dueling motions for partial summary judgment and for partial judgment on the pleadings. The key issues addressed in this opinion are cursorily highlighted in the following bullet points:

• The definition of a “beneficial” interest in stock is analyzed. This was a key issue because when the percentage of the plaintiff's stock ownership in the involved company dipped below 45%,  it would trigger the termination of a voting trust. One of the parties argued that the 45% mark was triggered when shares were transferred by gift to a sister who was expected to vote consistent with the wishes of the transferor, although there was no written or oral agreement to support that assumption. The Court rejected the federal definition of beneficial ownership and determined that for purposes of this case and based on Delaware law, that there was no beneficial ownership of the stock involved, as defined by the Court.
• The Court made a point of noting that stock certificates are not a prerequisite to the ability of a person to possess or own stock or to vote that stock. See footnote 64.
• The Court also has a very helpful description of when a contract will be considered “unambiguous,” despite differing interpretations by the parties, for purposes of making it “ripe” for interpretation by the Court in a summary judgment motion. See footnotes 26 through 31 and accompanying text.

 

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eBay v. Craigslist  (eBay Domestic Holdings v. Newmark),  is a case scheduled to be tried in the Delaware Court of Chancery starting on Monday. The case involves important issues of corporate law and corporate litigation arising, among other things, from board membership on, and investments by, one competitor in another competitor, and the imbroglio that develops from those facts.  Prior decisions of the Court in this case have been highlighted on this blog here, here, here and here. (Sometimes the "c" at the beginning of  the name "craigslist" is not capitalized, such as in the text of the Court's opinions, but it otherwise looks like a typo when one cites the case caption without a capital "C").

For your viewing pleasure, from your computer, live video/audio of the trial is expected to be available here, courtesy of www.courtroomview.com. Meg Whitman, the former head of eBay and a current candidate for governor of California, is expected to testify at the trial. I expect to have one or more short clips of the trial linked on this page shortly after the trial starts.

UPDATE: Video/audio of cross-examination of Meg Whitman is available here.  Professor Bainbridge links to this post here. The Deal Professor provides an update here.

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Vichi v. Koninklijke Philips Electronics, No. 2578-VCP (Del. Ch. Dec. 1, 2009), read opinion here. This Chancery Court opinion of 55-pages in its original format, involves multiple non-U.S. residents and foreign companies engaged in international business transactions. A central fact on which the legal issues were based, was a loan of 250 million Euros by an Italian businessman to an "affiliated Delaware subsidiary" of the Dutch conglomerate Philips. The Court addresses the following issues that I will cursorily cover in a format of bullet points.

• Personal jurisdiction based on Sections 3104(c)(1) and 3104(c)(3) of Title 10 of the Delaware Code. As is required, the two-step analysis was performed to determine if personal jurisdiction exists over a nonresident defendant. This includes the statutory basis, as well an analysis of whether exercising personal jurisdiction over a nonresident comports with the Due Process Clause of the 14th Amendment. Of particular note is the reiteration of established Delaware law that “a single act of incorporation in Delaware [of an entity], if done as part of a wrongful scheme, will suffice to confirm personal jurisdiction over the nonresident defendants responsible for the scheme.” (citing Papendick v. Bosch, 410 A.2d 148, 152 (Del. 1979)).
• One interesting aspect of this case is that the Court denied a motion to dismiss a fiduciary duty claim based on Dutch law  against a Dutch company (over which the Court determined it has jurisdiction in Delaware). That claim will thus proceed in Delaware.
• The Court, however, did dismiss a claim by a creditor that was deemed to be a direct claim for a breach of fiduciary duty under Delaware law. In Gheewalla, the Delaware Supreme Court established that creditors are barred from asserting direct claims against directors (or in this case, against managers of an LLC.)
• The Court also discussed the well established parameters of the conspiracy theory of exercising jurisdiction as well as the “apparent agency test” which allowed Philips to be held directly responsible for the actions of its agents in relation to the wrongful incorporation of a company in Delaware as part of a larger scheme.
• Among the claims dismissed was one based on the Delaware Securities Act.  See 6 Del. C. Sections 7303 and 7323. The Court reasoned that there was an insufficient nexus to Delaware to apply the Act. The Delaware Supreme Court had ruled many years ago that the Delaware Securities Act would not be incorporated via the "internal affairs doctrine". See footnotes 138 to 140.  Moreover, the Chancery Court in this case determined that Section 7303 provided a remedy of restitution in a criminal proceeding--not in civil litigation. 

• The Court also addressed the three-year statute of limitations in Delaware for claims of unjust enrichment, fraud and breach of fiduciary duty based on 10 Del. C. Section 8106(a), and also discussed were the three tolling doctrines that can potentially forestall the applicable deadlines until one either discovers or "should have discovered" the cause of action. Moreover, the Court referred to the Delaware Borrowing Statute at 10 Del. C. Section 8121 which refers to situations where a cause of action arises outside of Delaware and the statute of limitations in that state is shorter than the statute of limitations in Delaware. In those situations, the cause of action may be barred by the shorter statute of limitations.           
• The Court also referred to the longer six year statute of limitations for actions on promissory notes but that statute of limitations must truly arise directly out of a breach of that promissory note and not ancillary claims (e.g., such as fraudulent inducement to enter into the note, to which the longer period would not apply). See 10 Del. C. Section 8109 and cases cited at footnotes 117 and 118.
• The Court also addressed the “overwhelming hardship” threshold and other factors applied for the very rarely granted motion to dismiss based on forum non conveniens. See footnotes 82 to 88.
• This opinion is replete with many detailed facts and extensive legal analysis throughout its 55-pages that could very easily warrant a much more extensive synopsis, but my intent here was to merely highlight the key legal issues addressed by the Court so that any interested readers can download the entire opinion at the above link.
   

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State Line Ventures, LLC v. RBS Citizens, No. 4705-VCL (Dec. 2, 2009), read letter decision here.

This letter decision of the Delaware Court of Chancery must be read by any Delaware lawyer serving as "local counsel", and more importantly, should be required reading for any non-Delaware lawyer (or any out of state attorney)  who requests a Delaware lawyer to be his or her "local counsel".

The Court, in a pithy and pointed summary of Delaware law, debunks any definition of "local counsel" in Delaware as being anything less than counsel of record fully responsible for every pleading filed, every discovery request or reply, and every argument made to the Court--regardless of the frequent and customary role of "forwarding counsel" being heavily involved in the prosecution of the case. This letter ruling is only two-pages long and to avoid this synopsis being longer than the Court's ruling, I commend it for your careful review--and suggest that it be kept handy for future reference. Nonetheless, a excerpted quote from the decision follows:

Because the letter uses the phrase “local counsel,” I believe it important to make clear that the Court of Chancery does not recognize the role. I am certainly familiar with the term, and I know well that it is often used colloquially as if it were synonymous with “Delaware counsel.” It is not. Our rules make clear that the Delaware lawyer who appears in an action always remains responsible to the Court for the case and its presentation. See Ct. Ch. R. 170(b) (“The admission of an attorney pro hac vice shall not relieve the moving attorney from responsibility to comply with any Rule or order of the Court.”). So do the Principles of Professionalism for Delaware Lawyers.

It is of course true that Delaware counsel and forwarding counsel necessarily allocate responsibility for work, and that in some cases, the allocation may be heavily weighted towards forwarding counsel. It is also true that forwarding counsel may have primary responsibility for a matter from the client’s prospective, particularly if the Delaware litigation is one part of a larger picture. This is perfectly understandable, efficient, and appropriate. But it does not alter the Delaware lawyer’s fundamental responsibility for the Delaware proceeding. A Delaware lawyer always appears as an officer of the Court and is responsible for the positions taken, the presentation of the case, and the conduct of the litigation.

If a Delaware lawyer signs a pleading, submits a brief, or signs a discovery request or response, it is the Delaware lawyer that takes the positions set forth therein. This is true regardless of who prepared the initial draft or how the underlying work was allocated. When a particularly questionable argument was made in the briefing, I have not hesitated to ask the Delaware lawyer at the hearing how the argument possibly could be advanced, regardless of whether forwarding counsel was designated to make the argument. (Emphasis in original). 

UPDATE: The AmLaw Daily highlights this post here with a headline that I paraphrase: "In Delaware, There is No Such Thing as "Local Counsel".

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In the Matter of Texas Eastern Overseas, Inc., No. 4326-VCN (Del Ch. Nov. 20, 2009),  read opinion here. This Chancery Court decision addressed the petition for the appointment of a receiver of a dissolved corporation.

The goal of the petition in this case was to allow a company called AmeriPride to sue Texas Eastern Overseas, Inc. ("TEO") in California to determine if TEO had insurance coverage for environmental clean-up costs incurred by AmeriPride but for which AmeriPride maintained that TEO is responsible. The insurance company for TEO provided counsel that filed a motion to dismiss the California suit based on the expiration of the three-year period in DGCL Section 278 during which a dissolved corporation may pursue or defend a suit. The California court stayed that case in order to allow AmeriPride an opportunity to petition the Chancery Court for the appointment of a receiver for TEO, which would allow TEO to participate in that suit, so that the California court could then determine the issue of insurance coverage for claims against TEO.

This decision provides the latest Delaware law on the interface between DGCL Sections 278 and 279. That is, the Court addresses those instances when good cause exists under Section 279 for a receiver to be appointed for a dissolved corporation to allow that corporation to participate in a lawsuit beyond the three-year period after dissolution provided in Section 278.

One of the key issues was whether the dissolved corporation had undistributed assets. In the context of a motion for judment on the pleadings pursuant to Rule 12(c), the Court determined that there was enough of a basis to suggest a likelihood that TEO had assets in the form of available insurance coverage for the claims made against it (without actually deciding that issue as a conclusive matter).

The Court  relied on a Delaware Supreme Court  decision at footnote 23 for the position that the two statutes should be read in tandem to ensure that a dissolved corporation maintains the ability to sue and be sued "incident to the winding up of its affairs". The Court distinguished cases at footnote 26 on a factual basis when the dissolved corporation sought a receiver but did not have any demonstrable assets.

The Court reasoned that the protection for former shareholders, officers and directors that animated the three-year cutoff period in Section  278 would not be disturbed here because the receiver would not have any authority to pursue claims against them. Moreover, AmeriPride confirmed that it was not seeking any claims againts those former constituents of the dissolved corporation.

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Airborne Health, Inc. v. Squid Soap, LP, C.A. No. 4410-VCL (Del. Ch., November 23, 2009), read opinion here . A prior decision of the Court in this case was highlighted here. 

This synopsis was prepared by Kevin Brady and Ryan Newell of the Connolly Bove firm.

In this Delaware Court of Chancery opinion, Vice Chancellor Laster granted defendants’ motion for judgment on the pleadings, dismissing numerous claims regarding an asset purchase agreement. Among other issues, the Court distinguished between an anti-reliance clause and an integration clause.

Background

Defendant Squid Soap, LP (“Squid Soap”) was created to fill a void in specialized child hand-washing products. When dispensed, Squid Soap would leave a small spot of ink on the skin that could only be removed by sufficient washing. John Lynn obtained three patents for the technology and soap dispenser (the “Patents”). In 2007, various investors, including Airborne Health, Inc. (“Airborne”), approached Lynn.

According to Squid Soap’s counterclaims, “[b]ased on Airbone’s representations about, among other things, its brand name, sterling reputation, marketing prowess, and in particular its promises to leverage the Airborne name and marketing platform to fully maximize Squid Soap’s potential, Squid Soap, relying on and induced by Airborne’s representations and promises, re-focused its acquisition talks to Airborne, to the exclusion of its other suitors.” Accordingly, on June 15, 2007, Airborne and Squid Scope entered into an Asset Purchase Agreement (the “APA”). Defendant Weil, Gotshal & Manges LLP (“Weil”) drafted and negotiated the APA on Airborne’s behalf. Through the APA, Airborne acquired all of Squid Soap’s assets.

APA and Four Unique Provisions

First, Squid Soap sold its assets for $1 million at closing with “the potential for earn-out payments of up to $26.5 million if certain targets were achieved.” The Court reasoned,

What an earn-out (and particularly a large one) typically reflects is disagreement over the value of the business that is bridged when the seller trades the certainty of less cash at closing for the prospect of more cash over time. In theory, the earn-out solves the disagreement over value by requiring the buyer to pay more only if the business proves that it is worth more. But since value is frequently debatable and the causes of underperformance equally so, an earn-out often converts today’s disagreement over price into tomorrow’s litigation over the outcome. Based on an earn-out of this magnitude (viewed in terms of the portion of total potential consideration), the plain inference is that
Squid Soap believed that its business had tremendous value and was willing to bet heavily on that proposition.

Second, “Airborne purchased Squid Soap’s brand name, goodwill, and intellectual property, including the Patents, but the APA required that Airborne return the assets to Squid Soap if certain business targets were not met.” These “Asset Return Provisions” provided Airborne an opportunity to successfully market Squid Soap, but an opportunity to return the assets in the event Squid Soap was not successful. Specifically, if Airborne had not spent $1 million on marketing and achieved $5 million in net sales within one year, then Airborne was required to return the assets to Squid Soap. As the Court reasoned, “[l]ike the earn-out, this structure indicates that Squid Soap believed its product was a winner, that it was in demand, and that if Airborne could not make a go of it, then Squid Soap would get the assets back and could pursue a relationship with someone else.”

Third, the APA did not include any specific commitments by Airborne such as a mandatory commitment to spend certain levels of money on Squid Soap.

Fourth, the APA did not include representations by Airborne regarding its “positive brand name and image, its marketing power, . . . Airborne’s intent and . . . ability to market Squid Soap and to leverage Airborne’s positive image.”

Airborne’s Business Problems

At the time of the APA, Squid Soap claimed to be unaware of a special investigation conducted by ABC News regarding Airborne. In addition, Squid Soap claims that it was unaware of “a class action pending against Airborne in California state court, filed in May 2006, which asserted various claims for false or misleading advertising, consumer fraud, deceptive or unfair business practices, concealment, omission, and unfair competition.” Nine months after the APA was signed, Airborne settled the California Action for $23.5 million. Squid Soap alleges that Airborne knew of the California Action and the potential regulatory actions at the time the APA was executed.

The settlement shined the media spotlight on Airborne’s problems. More litigation resulted as the Federal Trade Commission and thirty-two states sued Airborne for false marketing. As a result, Airborne agreed to a collective $37 million in settlement fees and escrowed another $6.5 million for additional claims. Having been rebranded as “Squid Soap by Airborne,” Squid Soap alleged that Airborne’s financial struggles “killed Squid Soap in its infancy.”

Airborne Fails to Meet Benchmarks -- Attempts to Return Assets

In light of its financial struggles, Airborne decided to shift its focus back to its traditional products, at the expense of promoting Squid Soap. Airborne, therefore, did not meet the financial thresholds of the Asset Return Provisions. Airborne attempted to return the assets, but Squid Soap refused to accept them.

Litigation Arises

Initially, Squid Soap sued Airborne in Texas, but that action was dismissed. Then, Airborne and Weil filed this action in the Court of Chancery seeking a declaratory judgment that they were not liable under the APA. Squid Soap counterclaimed against Airborne and Weil alleging 1) fraud and fraudulent inducement, 2) equitable fraud, 3) breach of contract, 4) breach of the implied covenant of good faith and fair dealing, and 5) as to Weil, aiding and abetting. Airborne and Weil moved for judgment on the pleadings. Squid Soap alleged that Airborne “fraudulently induced Squid Soap to enter into the APA by representing false statements as true, actively concealing facts, and/or failing to disclose material facts.”

Fraud Claim Based on Airborne’s Contractual Misrepresentation

Squid Soap alleges that Airborne committed fraud by making a contractual misrepresentation in that Airborne intentionally concealed and failed to disclose the various litigations and investigations involving Airborne. The Court reasoned that “[b]ecause of Delaware’s strong public policy against intentional fraud, a knowingly false contractual representation can form the basis for a fraud claim, regardless of the degree to which the agreement purports to disclaim or eliminate tort remedies.”

However, the Court noted that “[t]he plain language of Airborne’s representation obligated Airborne to disclose any ‘Legal Proceedings’ that were (1) ‘reasonably likely to prohibit or restrain the ability of [Airborne] to enter into this Agreement’ or (2) ‘reasonably likely to prohibit or restrain the ability of [Airborne] to . . . consummate the transactions contemplated hereby.’” The Court held that it was undisputed that there was no litigation threatened or pending as of the date of the APA that was “reasonably likely to prohibit or restrain the ability of [Airborne]” to close the deal. As a result, the Court found that Airborne’s representation was accurate and entered judgment on the pleadings in favor of Airborne on Squid Soap’s contract-based fraud claim.

Fraud Based on Airborne’s Extra-Contractual Misrepresentations

In addition, “Squid Soap contends that Airborne committed fraud by making extra-contractual representations, actively concealing facts, and failing to disclose material facts.” The Court’s analysis hinged on “whether the APA bars Squid Soap’s right to assert fraud claims based on extra-contractual representations.” As the Court reasoned,

An anti-reliance provision must be explicit, and a standard integration clause is not enough. . . . [F]or a contract to bar a fraud in the inducement claim, the contract must contain language that, when read together, can be said to add up to a clear antireliance clause by which the plaintiff has contractually promised that it did not rely upon statements outside the contract’s four corners in deciding to sign the contract. The presence of a standard integration clause alone, which does not contain explicit anti-reliance representations and which is not accompanied by other contractual provisions demonstrating with clarity that the plaintiff had agreed that it was not relying on facts outside the contract, will not suffice to bar fraud claims.

The Court found that the APA did not contain any anti-reliance language or any other provision that would limit Squid Soap’s ability to assert a common law fraud claim or fraud-in-the-inducement claim. Instead of disclaiming reliance, the APA defined the parties’ contract. “When drafters specifically preserve the right to assert fraud claims, they must say so if they intend to limit that right to claims based on written representations in the contract. [The Court] will not imply that limitation.”

As to the substance of the claim, the Court defined the “core test’ as “whether the claim has been pled ‘with detail sufficient to apprise the defendant of the basis for the claim.’” Lacking that detail, Squid Soap’s “generalized and non-specific” allegations did not “identify any specific fact that was misrepresented and they do not mention any person or the time, place, or contents of the misrepresentation.” While Squid Soap claimed that without discovery it could not provide more detail, the Court disagreed. A party who alleges fraud “should be able to say when he was lied to, or what specifically was said to him that was materially misleading by the omission. The lack of prior discovery poses no impediment to a plaintiff’s ability to plead ‘the circumstances constituting fraud.’ After all, the plaintiff was there.” Accordingly, Airborne’s motion for judgment on the pleadings was granted in favor of Airborne on Squid Soap’s claim of extra-contractual fraud and fraudulent inducement.

Equitable Fraud

As an alternative to common law fraud, Squid Soap alleged that it should recover under equitable fraud. As the Court reasoned, equitable fraud is both separate and broader than common law fraud. The Court stated that “[f]raud in equity includes all willful or intentional acts, omissions, and concealments which involve a breach in either legal or equitable duty, trust, or confidence, and are injurious to another, or by which an undue or
unconscientious advantage over another is obtained.”

However, equitable fraud “requires special equities, typically the existence of some form of fiduciary relationship . . . .” Because the parties lacked such a relationship, and instead contracted at arms length, judgment was entered in Airborne’s favor.

Breach of Contract

Next, “Squid Soap contends that Airborne breached the APA “by making false representations about its marketing abilities and prowess, by failing to disclose the [California] Action and other litigation, and by failing to market and promote Squid Soap’s products as promised and required by the APA.” As to the false representations, the Court held that there were no representations in the APA about Airborne’s “marketing abilities and prowess.” As to the failed disclosures, this was akin to the contractual fraud claim that was previously dismissed. As to the failed marketing and promotional efforts, the Court reasoned that the APA did not contain any requirements that Airborne spend certain amounts or take certain actions. Accordingly, the motion was entered in Airborne’s favor on the breach of contract claim.

Implied Covenant of Good Faith and Fair Dealing

The Court also granted Airborne’s motion for judgment on the pleadings as to Squid Soap’s claim for breach of the implied covenant of good faith and fair dealing. The Court stated that “[t]he test for the implied covenant depends on whether it is ‘clear from what was expressly agreed upon that the parties who negotiated the express terms of the contract would have agreed to proscribe the act later complained of as a breach of the implied covenant of good faith—had they thought to negotiate with respect to that matter.’” Because the APA provides a specific representation for Airborne with respect to litigation disclosure, the implied covenant claim failed. While Squid Soap should have negotiated for broader representations, it did not and “the implied covenant is not a means to re-write agreements.”

Aiding and Abetting Against Weil

As the Court found no underlying wrong, judgment was entered in Weil’s favor.

Airborne and Weil’s Claims

In summary fashion, the Court addressed Plaintiffs’ claims and found that two issues were not suitable for disposition on the present record -- a claim for specific performance under the Asset Return Provision and a claim for damages for breach of the APA.

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In Levinhar v. MDG Medical, Inc., No. 4301-VCS (Del. Ch., Nov. 24, 2009), read opinion here, the Delaware Court of Chancery explains the expansive scope of claims allowable in a summary proceeding pursuant to Section 225 of the Delaware General Corporation Law (DGCL). Section 225 proceedings are summary in nature and are designed primarily to address the proper composition of a board. Typically, such actions address, for example, whether a particular director is a proper board member or was properly elected or removed. In this case, the penalty imposed by the Court for not including related claims in a prior Section 225 suit was to bar those claims in the present suit based on the doctrine of res judicata.

Section 225 Suits Must Now Include Related Claims to Avoid Later Bar of Res Judicata

This opinion includes an important explanation of the policy reasons behind res judicata, and the elements that must be established for its application. However, more importantly, this opinion is must reading for anyone who would file suit in Delaware based on DGCL Section 225. This is so because the Court's opinion in this case "serves notice" loud and clear to all who may have considered Section 225 suits to be limited by the nature of a Section 225 action as a summary proceeding, to the specific issue of proper board composition only. Whether or not one was laboring under that misconception, this opinion removes any doubt that failure to raise related issues creates the risk that those related issues may be barred by res judicata in later suits.

Companion Case Alternative

After providing copious citations to precedential Delaware decisions, the Court explains that an alternative to including related claims that are part of the same operative facts or transaction that forms the basis of the Section 225 dispute, one has the alternative of filing a contemporaneous companion case and then asking the Court to consolidate the companion case with the Section 225 case. See, e.g., footnotes 47 to 52 and accompanying text. The reasoning used by the Court includes the following: "Although Section 225 actions are summary proceedings, claims that bear on the appropriate composition of the board of directors many be brought in connection with a Section 225 action." Slip op. at 28. Moreover, the Court added that:  "... it is common in Section 225 cases for this court to address the consequences that stockholder voting agreements have on the outcome of director elections or removal efforts." Id. at 29.

Related Valuation Issues

The Court did not bar, and did allow to proceed, an appraisal claim that was also pursued in this matter. In footnote 54 (that is almost 2 pages long), the Court describes the differences between the valuation method in a claim for damages resulting from the breach of a stockholders' agreement, that may subject a stockholder in a closely-held company to a marketability discount, and the separate standard applied in an appraisal case in which Delaware law does not ordinarily apply either marketability or minority discounts. See, e.g., Cavalier Oil Corp. v. Harnett, 564 A.2d 1137, 1144-45 (Del. 1989). Compare Shannon Pratt, The Lawyers' Business Valuation Handbook: Understanding Financial Statements, Appraisal Reports, and Expert Testimony, 208-211 (2000). [As an aside, I was asked to write a Foreword for the updated edition of this treatise by Shannon Pratt.]

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In Laborers Local 235 Benefit Funds v. Starent Networks, Corp., et al., C. A. No. 5002-CC (Del. Ch. Nov. 18, 2009), read letter decision here, the Court granted plaintiff’s motion to expedite this matter  based on the stock based compensation expense disclosure claim. 

Kevin Brady, a highly regarded Delaware litigator, provided the synopsis for this decision.

The Court noted that “[t]o achieve expedition in this Court, a movant must establish a ’sufficiently colorable claim and show[] a sufficient possibility of a threatened irreparable injury.’” (citing Giammargo v. Snapple Beverage Corp., 1994 Del. Ch. LEXIS 199, at *6 (Del. Ch. Nov. 15, 1994). “Under Delaware law, nearly all disclosure violations are per se irreparable harm because the harm arising from the un- or misinformed transaction is of a nature where the injury cannot be compensated adequately in damages. (citing Alpha Builders, Inc. v. Sullivan, 2004 Del. Ch. LEXIS 162, at *19 (Del. Ch. Oct. 5, 2004)).”  

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Lefkowitz v. HWF Holdings, LLC, No. 4381-VCP (Del. Ch. Nov. 13, 2009), read opinion here. This 30-page opinion is a helpful primer on the recurring topics of both procedural and substantive arbitrability. That is, it addresses when the applicability of an arbitration clause in an agreement can, or cannot, be decided in the first instance by a court, for example, where, as in this case, injunctive relief was sought to prevent one party from pursuing a claim in an arbitration proceeding. Many similar cases have been highlighted on these pages involving similar issues.

While I suggest a reading of the entire opinion is necessary for anyone interested in the latest iteration of Delaware law on this topic, for present purposes I will merely provide highlights of several points in this decision that I have arbitrarily determined to be especially noteworthy.

• Substantive arbitrability addresses whether the parties decided in the contract to submit a particular dispute to arbitration, and those issues historically have been decided by a judge. The Court referred to what it described as the "seminal Delaware Supreme Court opinion" on this topic, James and Jackson LLC v. Willie Gary LLC, highlighted on this blog here, which formulated a two-prong test to determine whether an arbitration clause demonstrates "clear and unmistakeable evidence" that the parties intended to "arbitrate arbitrability". That test is whether the arbitration clause: (i) generally refers all disputes to arbitration; and (ii) references a set of arbitrable rules that empowers arbitrators to decide arbitrability, such as the AAA rules. Willie Gary, 906 A.2d at 80.
• Procedural arbitrability by contrast covers, for example, issues such as whether the proper notice  of intent to arbitrate was given as required in the arbitration clause, and those issues are presumptively for the arbitrator to decide.
• The Delaware Uniform Arbitration Act was recently amended to make two provisions that are unique to Delaware (i.e., they depart from the Uniform Arbitration Act in other states), less ambiguous. For example, whether one has a statute of limitations defense to an arbitration proceeding was formerly  considered to be a matter of "substantive arbitrability" that would ostensibly allow one to seek injunctive relief in court  to stop arbitration in some circumstances.  See 10 Del. C. Sections 5702(c); 5703 and 5714(a)(5) (1974).
• Recent amendments to those sections however, have "converted" them to be presumptively matters of "procedural arbitrability" for the arbitrator to decide--not the court.
• This opinion also has a very useful discussion of the interplay between the Federal Arbitration Act, and Uniform Arbitration Act and the Delaware Uniform Arbitration Act, and when one applies to the exclusion of the other.

There is much more to this opinion than I have only covered cursorily in this short post, but one concluding comment that I am impelled to make is that this case is a not uncommon example of why arbitration is not always the faster and less expensive alternative it is often touted to be. There are many instances of expensive litigation like this matter that incur substantial costs before the arbitration even begins. In addition there are other examples of post-arbitration litigation that contests the arbitrator's decision and asks the court to set aside what was supposed to be "final and binding arbitration".

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Amirsaleh v. NY Board of Trade.  A short video clip of the trial in this case that is ongoing this week in the Delaware Court of Chancery is available here, courtesy of  www.courtroomview.com  Prior decisions of the Court of Chancery in this case highlighted on this blog are available here and here.

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Amirsaleh v. Board of Trade of the City of New York, Inc., C.A. No. 2822-CC (Del. Ch. Nov. 9, 2009), read opinion here. See summaries of prior decisions of the Chancery Court in this case here and here. A video clip of the recent trial in this case is available here.

Kevin Brady, a highly respected Delaware litigator, provides the synopsis for this case.

In this Chancery Court decision, the defendant, the Board of Trade of the City of New York, Inc. (“NYBOT”), is the resulting entity of a December 2006 merger between NYBOT’s predecessor and IntercontinentalExchange, Inc. (“ICE”). Plaintiff, who owned two membership interests (which included a right to trade on the NYBOT exchange) in NYBOT’s predecessor, moved for summary judgment.

Pursuant to a merger agreement, each NYBOT interest would be converted into either newly issued shares of ICE common stock, cash, or some combination of cash and stock. Members were permitted to elect the form of consideration by January 5, 2007. However because the amount of merger consideration was fixed, the ability to elect was limited to the extent the stock or cash option was over- or undersubscribed.

Plaintiff never received the election form that was mailed to him until after the January 5 deadline, so he failed to make a timely election. By January 19, 2007, plaintiff had submitted his election form and pledge agreement, but defendants rejected the election as untimely. At the same time however, defendants accepted the elections of 25 other NYBOT members whose elections were submitted as late as January 18, 2007.

The Court noted that there existed a factual dispute as to why defendants accepted some forms after the January 5 deadline, but failed to accept plaintiff’s form. Plaintiff contended that defendants’ decision was driven by a desire to appease “connected” NYBOT members. In fact, plaintiff alleged that defendants closed the elections immediately after the last “connected” member submitted his form on January 18, 2007. On the other hand, “Defendants contended that the decision to accept late submissions was made in good faith and driven solely by valid business considerations,” and the election window remained open as long as possible so as to appease as many late filers as possible, but had to close when it did so that it had sufficient time to prepare the merger consideration payout that was due January 29, 2007. Because the stock consideration was oversubscribed, the result of defendants’ decision was that members (like plaintiff) who did not make a timely election were automatically cashed out at an amount “substantially lower than the value of the stock and cash combination received by those with timely elections.” Moreover, such late filers risked losing their NYBOT trading rights.

Plaintiff filed suit alleging that defendants had breached the merger agreement and the implied covenant of good faith and fair dealing by deeming plaintiff’s election untimely. Plaintiff sought a remedy of “shares of ICE in the same amount, and on the same terms and conditions, as issued to other members of NYBOT who had made an election to receive Stock Consideration” and also seeking reinstatement of his two trading memberships. Defendants previously moved for summary judgment on all claims, and prevailed on the breach of contract claim. See Amirsaleh v. Bd. of Trade of City of N.Y., Inc., 2008 WL 4182998 (Del. Ch. Sept. 11, 2008). Remaining for the Court was whether “defendants’ initial decision to accept late elections and the subsequent decision to stop accepting elections was a good faith effort to further the goals of the Merger Agreement.”

Court Finds No Difference Between Absence of Good Faith and Bad Faith

As the Court noted initially, “the implied covenant of good faith and fair dealing inheres in every contract.” It is a judicial tool to imply terms into a contract to protect the reasonable expectations of the parties. “It is triggered when the defendant’s conduct does not violate the express terms of the agreement but nevertheless deprives the plaintiff of the fruits of the bargain. . . . To prove a breach of the implied covenant, then, the plaintiff must allege an implied contractual obligation not to engage in certain conduct, a breach of that obligation by the defendant, and resulting damage to the plaintiff.”

The Court then engaged in an interesting analysis of whether all that is required is an absence of good faith or, on the contrary, if a showing of bad faith is necessary. After discussing the Supreme Court’s decisions in Dunlap v. State Farm Fire and Casualty Insurance Co., 878 A.2d 434 (Del. 2005) and 25 Massachusetts Avenue Property L.L.C. v. Liberty Property Ltd. Partnership, C.A. No. 3027-VCS, 2008 Del. LEXIS 611 (Del. Nov. 25, 2008), Chancellor Chandler concluded that “there is no meaningful difference between ‘a lack of good faith’ and ‘bad faith.’” To prove bad faith, “a plaintiff must demonstrate that the defendant’s conduct was motivated by a culpable mental state . . . [or] an improper purpose.”

Summary Judgment Denied Due to Disputed Material Fact

Having previously held that defendants’ decision regarding the late elections was not a breach of the merger agreement, the Court was left to decide whether the manner in which Defendants exercised that discretion “conflicted with the reasonable expectations of the pre-merger NYBOT and the pre-merger ICE (the ‘Merger Agreement Parties’). To determine those expectations, the Court must inquire what conduct the Merger Agreement Parties would have clearly agreed to proscribe had they foreseen it.”

The Court held that a material fact existed and thus denied plaintiff’s motion for summary judgment. “Plaintiff has a claim for breach of the implied covenant if he can demonstrate that defendants breached [the] implied obligation [not to give connected members special treatment in submitting late elections, including holding open the election window just long enough to ensure that all connected members had submitted their late elections].” However, the question remained whether defendants lacked the requisite intent in the event “defendants’ decision to accept late submissions was driven by considerations of customer satisfaction balanced against leaving enough time to calculate and distribute merger consideration – and reasonable efforts were made to give all late filers the same or substantially similar assistance turning in their late forms . . . .”
 

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Lola Cars Int'l Limited v. Krohn Racing, LLC, No. 3379-VCN (Del. Ch. Nov. 12, 2009), read 31-page letter decision here. This decision of the Delaware Court of Chancery is chock full of substantive Delaware LLC law that is of practical usefulness for business lawyers and litigators.

Key Issues Addressed

• Dissolution requested by one member of an LLC pursuant to  Section 18-802 of the Delaware LLC Act;
• Breach of fiduciary duty of an LLC manager and whether pre-suit demand was excused (i.e., was a majority of the LLC's governing body disinterested and independent);
• Breach of the implied duty of good faith and fair dealing;
• Rule 15 (aaa) regarding allowance of an amendment to a complaint despite filing of an Answering Brief to a Motion to Dismiss (yes, though unusual, Rule 15 (aaa) is the correct citation.)

Holding

The Court denied a motion to dismiss the claims for dissolution and appointment of a liquidating receiver, and also denied a motion to dismiss the claims for breach of fiduciary duty and the implied covenant of good faith and fair dealing. The Court's analysis and reasoning in support of these conclusions makes this decision "must reading" for anyone who wants to know the latest in Delaware LLC law on these key issues.  In addition, the Court exercised its rarely used option to allow, in the interests of justice, an amendment of a complaint despite an Answering Brief having been filed in response to a motion to dismiss.

Background Facts

The Court carefully describes the copious background factual details, but I will only cursorily mention them here in order to focus on the legal analysis. The LLC in this case was formed by Lola Cars International, which owned 51% and Krohn Racing, which owned 49%. However, the governing structure they created allowed for only 2 directors, with each appointing one, despite Lola's majority ownership. The deadlock that such an arrangement exposed the parties to, eventually came to pass. The LLC Agreement also provided for Krohn to provide the CEO. The provision about replacement of that CEO was one of the hotly contested issues in the case.

The parties' LLC Agreement provided very specific descriptions of the responsibilities of each party in terms of monthly reports, operational duties, capital requirements and the like. There were two separate complaints filed in this case. The first sought dissolution and the appointment of a liquidating receiver based on a litany of reasons, including: (i)  the insolvency of the company; (ii) the failure so far, and inability going forward, of the company to achieve its objectives as stated in the LLC Agreement; (iii) and deadlock of the two person board, among other reasons. (The second complaint was dismissed without prejudice and was not a major part of the decision.)

The factual basis for the fiduciary duty claims was explained expansively, and included, for example, specific dollar amounts that were alleged to have represented lost profits because Krohn Racing and its appointed CEO were engaging in transactions with the LLC that did not provide for "market rates" for the benefit of the LLC--but which involved discounted rates that only benefited Krohn Racing (i.e., Krohn benefitted by "sweetheart transactions" at the expense of the LLC.)

The Second Complaint sought injunctive relief based in part on an alleged violation of the LLC Agreement that leads to termination of the agreement, and Section 18-402 of the Delaware LLC Act  which by default (unless otherwise agreed), gives control of an LLC to its members in proportion to their respective equity interests. Although a TRO and request for a receiver pendente lite was denied, the Court did enter a status quo order on the first complaint.

Legal Analysis

A.  Dissolution

 The Court provides a classic discussion of the prerequisites under Section 18-802 for a member of an LLC to seek judicial dissolution of an LLC based on an argument that it is no longer reasonably practicable to carry on the business of the LLC. The Court relied heavily of the prior Chancery Court decision in Fisk Ventures, LLC v. Segal, (Fisk I), reviewed on this blog here, and a separate decision that the Court referred to as Fisk II, summarized on this blog here.

In Fisk I, the Court gave three examples of situations that should be considered in determining if the "reasonably practicable" standard had been met (which is not an impossibility standard):

1. Whether the members' vote is deadlocked at the board level;
2. Whether the operating agreement provides a procedure to break the deadlock;
3. Whether there is still a business to operate based on the company's financial condition.

Moreover, Fisk I emphasized that none of these factors is individually determinative, "nor must each be found for a court to order dissolution. Rather they provide guidance to the ultimate inquiry of whether the company can continue to pursue its stated business purpose with reasonable practicability." See Fisk I, 2009 WL 73957, at *4.

The Court  found that all three above factors were present in this case. There was a deadlock; the procedure in the agreement could not break the deadlock (e.g., about replacing the CEO); and the company was allegedly insolvent. The Court also recited several additional factors that supported dissolution and that related to the fiduciary duty claims of mismanagement, self-dealing and failure or inability of the company to achieve its stated purposes.

B.  Derivative Fiduciary Duty Claims and Demand Excusal

 The exemplary pre-suit demand analysis is notable for its application to the LLC context. See, e.g., footnote 33 for case supportinig application by analogy of the pre-suit demand analysis under Court of Chancery Rule 23.1 to the similar requirements of Section 18-1003 concerning whether demand is properly excused. The Court determined that it did not need to resolve whether both prongs of Aronson v. Lewis applied, or whether the second prong was eliminated based on the application of Rales v. Blasband. This was based on the Court's conclusion that under the first prong of Aronson, one of the two directors was not disinterested. That is, the Court reasoned that there was a particularized showing that the director against whom the allegations were made, faces a "substantial likelihood of personal liability, and not simply the mere risk of damages." (citing Rales, 634 A.2d at 936.)

That finding made it unnecessary to determine if he was independent. The Court cited to a Court of Chancery decision from the year 2000 for the now well-settled principle that if one member of a two member board fails the test of disinterestedness or independence, then demand is excused due to a lack of a majority of disinterested, independent directors. See footnote 35.

For the convenience of the minority of readers who don't have the seminal two-prong Aronson test committed to memory, it follows: Demand is considered futile and thus excused when particularized facts in the complaint create a reason to doubt that: (i) "the directors are disinterested and independent [or that] (ii) the challenged transaction was otherwise the product of a valid exercise of business judgment." (citing Wood v. Baum, 953 A.2d 136,140 (Del. 2008)(citing Aronson v. Lewis, 473 A.2d 805, 814 (Del. 1984)).

C. Implied Duty of Good Faith and Fair Dealing

This decision features the relatively rare case in which there is a finding that the elements of this somewhat amorphous cause of action survive a motion to dismiss. That distinction makes this opinion "must reading" for any litigator who  wants to understand the latest nuances of Delaware law on this non-waivable obligation implied in every Delaware contract. The Court relies on Fisk II, supra, for its discussion of the various aspects of this obligation that is imposed on every Delaware agreement but is not susceptible to mathematical precision in its definition or application. Among the many descriptions of its contours in this case, the Court observed that: "... it restrains a party from engaging in arbitrary or unreasonable conduct that has the effect of frustrating the contract's overarching purpose and denying the other party the benefit of its bargain." (citing Fisk II, 2008 WL 1961156, at *10).

Many Delaware decisions have emphasized that they will not provide an "addendum" to the contract terms negotiated by sophisticated parties who "forgot to include a provision" that at least one party now wishes, in retrospect, was included, but that principle is balanced with the principle that: when the contract is silent on a topic, the court will imposed this obligation where "it is clear from the contract that the parties would have agreed to that term had they thought to negotiate the matter." (citing Fisk II, supra, at *10). Even if the agreement gave Krohn sole discretion to replace the CEO, or not,  and the parties could have included a provision to limit that discretion, the  Court was permitted on a motion to dismiss to make the reasonable inference that Krohn acted in bad faith by failing to consider Lola's request to meet to discuss the CEO' removal. Thus the claim survived a motion to dismiss.

D. Rule 15 (aaa) amendment

This is a rather technical, though important, procedural point that I will conclude with by simply saying that it is possible, though rare, that the Court of Chancery will allow an amendment to a complaint, or dismiss a complaint without prejudice to refile, even if contrary to the presumption in Rule 15 (aaa) that if one files an Answering Brief in reply to a motion to dismiss--instead of filing an amended complaint in reply to a motion to dismiss, that there will not be another opportunity to amend. This finding only applied to a separate, related second complaint that was filed by Lola against Krohn but did not impact the prior rulings mentioned in this synopsis.

UPDATE: Professor Ribstein provides scholarly insights on this case here.

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In Brandt v. CNS Response, Inc., Nos. 4867 and 4688-CC (Del. Ch. Nov. 12, 2009), read letter decision here, the Court of Chancery denied a motion for protective order that was filed in an effort to prevent depositions of two witnesses in this expedited matter seeking injunctive relief that is scheduled for a trial on December 1. The Court relied on Court of Chancery Rule 26(b)(1) regarding the general scope of allowable discovery, where:  "... it relates to the claim or defense of the party seeking discovery...."

The Court was not persuaded by the arguments that depositions were already scheduled "all over the country" as most were already planned to be taken in Irvine, California, nor was the Court convinced that other depositions would be sufficient to cover the issues sought from the prospective deponents. The Court described the factual details on which its decision was based, and also warned the party taking the depositions that it would be expected to adhere to the representations made to the Court that the depositions of the deponents involved would be short and narrowly focused on the issues for which the depositions were requested.

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eBay Domestic Holdings, Inc. v. Newmark, et al., No. 3705-CC (Del. Ch. Nov. 9, 2009), read letter decision here. See summaries of multiple prior decisions by the Chancery Court in this case here.

In this short letter ruling, the Court of Chancery ruled on motions in limine regarding the admissibility of evidence to support the "unclean hands" defense and expert testimony. Evidence that related to the equitable defense of unclean hands was allowed to the extent that the actions of eBay's representatives on the board of craigslist may have been inappropriate, and beyond the bounds of fair competition, which might bar their request for equitable relief. The claims of eBay relate to actions taken by craigslist to prevent eBay from exerting influence over the composition of craiglist's board of directors. The Court did not determine whether the Unocal standard or the entire fairness standard applied to the actions of craigslist (spelled without a capital c.)

As for the expert testimony issue, the Court relied on a Delaware Supreme Court decision that gives it more flexibility than the criteria in Daubert  to determine the admissibility of expert testimony. See Bowen v. E.I. duPont de Nemours & Co., 906 A.2d 787 (Del. 2006). The Court allowed for eBay to present objections at trial, but preliminarily determined to admit the testimony and give it whatever weight it deserved based on the applicable factors.

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Airborne Health Inc. v. Squid Soap, LP., No. 4410-VCL (Del. Ch., Oct. 28, 2009), read letter ruling here.

In this two-page letter decision, the Court of Chancery cited to several cases to support its position that whether or not to stay discovery is a discretionary matter for the Court, and reasoned that a potentially case-dispositive motion at the beginning of the case is a "frequent and logical predicate for the Court to consider granting a stay." In addition to listing the various factors taken into consideration when ruling on such a motion, the Court observed that it expects to rule shortly on the motion for judgment on the pleadings--as an added justification for granting the motion to stay discovery. In closing, the Court reminded the parties of their obligation to preserve documents and evidence pending the stay.

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New Castle Shopping, LLC v. Penn Mart Discount Liquors, Ltd., et al., No. 4257-VCL (Del. Ch., Oct. 27, 2009), read letter decision here.

[This ruling is among the first written decisions from the newest member of the Court, within the same month of his investiture. Here is an interview on this blog with the Court's newest member.]  A prior decision several years ago by the Court of Chancery, involving the same landlord but a different tenant in the same shopping center, was highlighted here.

Three issues were decided in this four-page letter ruling: (i) The Court allowed the complaint to be amended pursuant to Chancery Court Rule 15(a), and cited to copious cases to support the preference in Delaware to permit amendments in order to decide matters on the merits; (ii) The Court denied a motion for default judgment under Rule 55(b). Apparently the motion was based on no reply being filed to the motion to amend complaint by a deadline set by the Court, and no briefing schedule on the motion having been stipulated to by the defendants. Ample citations to authority were cited by the court for its decision on this point. (iii) Although the basis for the request was not clear, the plaintiff also requested sanctions, in addition to a default judgment, as some type of penalty for the defendants not replying promptly to the motion to amend. The Court made quick work of this request and expressed its displeasure that sanctions were even sought under the circumstances, when there was no legal support for imposing them under the facts of this case.

In a concluding admonition to the parties, the Court referred to the Principles of Professionalism for Delaware Lawyers, particularly Principle A.4, entitled: Civility, which includes the provision that the lack of civility "may be detrimental to a client's interests and contrary to the administration of justice."

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Dutiel v. Tween Brands, Inc., No. 4743-CC and No. 484-CC (Oct. 28, 2009), read letter decision here. Read prior Chancery Court decision in this case highlighted on this blog here. In this most recent ruling, the Chancellor denied a motion for reconsideration of the Court's selection of lead counsel in a consolidated class action.

Overview

This letter decision denies a motion for reargument based on the familiar standards for such a motion. In addition to reciting the high hurdle to satisfy the prerequisites in this procedural setting, citing cases at footnotes 5 through 10, the Court summarized its reasoning by saying that relief pursuant to a motion for reconsideration is available “to prevent injustice” and there was no injustice in this situation. Instead, the Court explained that the motion was based on arguments that were themselves erroneous and, the Court added, also appeared to be based on “Dutiel’s misunderstandings and misapplications of settled Delaware law.”

As explained in more detail in the prior case summary linked above, the primary focus of  the Court's initial decision was the Court’s appointment of Ohio counsel as the lead counsel in this consolidated class action.

The Court used some “Halloween humor” to explain why it disagreed with the characterization by the movant of the Court's prior opinion in connection with describing the level of cooperation among the plaintiffs in this consolidated class action. In footnote 14 the Court explained as follows:

This Court appreciates holiday festiveness and cheer, but even at this time of year, it is best not to dress up or disguise a Court’s legal reasoning.”

Analysis

The Court addressed with a robust analysis the argument that the Court “misapplied a legal precedent” to the extent that it allegedly based its decision on the appointment of lead counsel on the fact that counsel chosen represented plaintiffs that “had a greater economic interest.” The Court addressed the cited cases that referred to “relative economic stakes” as compared to “simply economic stakes.”

The Court referred to other Chancery Court opinions that relied on a determination of economic interest of a plaintiff in “absolute terms not relative ones” and did not favor the plaintiff with the higher economic interest. See Wiehl v. Eon Labs, 2005 WL 696764 at * 3 (Del. Ch. Mar. 22, 2005).

Moreover, the Court noted that it was “baffling” and not understandable why Dutiel would demand an analysis of “relative economic stakes,” when in relative terms the interest of the plaintiffs whose counsel was chosen, was 1100% larger than the interest of Dutiel. The Court also explained that the Wiehl Court did not compare the sizes of the stakes of the different shareholders relative to one another, but noted how similar the stakes were in absolute terms (that is, as a percentage of the overall company). Such an analysis is mislabeled as relative, the Court explained.

The Court, in footnote 27, provided an explanation of the meaning of the word "relative" by the “Father of Relativity himself, Albert Einstein, who is said to have explained: “Put your hand on a hot stove for a minute, and it seems like an hour, sit with a pretty girl for an hour, and it seems like a minute. THAT''s relativity.”

Clarification of Reasoning

The Court went to great lengths to emphasize that it was not advocating a bright-line rule with regard to the factors to apply in determining lead-plaintiff status. For example, the Court explained that it was not basing its decision on the plaintiff with the highest absolute economic stake. It was not setting a specific dollar amount on the stake that a plaintiff must have in order for the Court to be confident that the plaintiff will take an active interest in the outcome of the litigation. Rather, the Court underscored that it considers several factors when deciding which plaintiff the Court will appoint as lead plaintiff. For several of the factors, the race between potential lead plaintiffs was too close to call, but in no way do such close races mean the plaintiffs never even had the opportunity to “lace up their shoes.”

On Incentives and Ethics

The movant argued that the Court’s decision would “invite abuse” to encourage plaintiffs “who routinely file elsewhere to game the system and seek a second bite at the apple when they  are shut out in a competing jurisdiction.” The Court described that argument thusly: "the movant simply created a straw man - - accusing the Court of incentivizing bad behavior - - and then purports to knock it down.”

Rather, the Court emphasized that its decision merely declined to penalize a litigant because his or her counsel filed in another jurisdiction. The Court reasoned that the “initial location of filing cannot be a principled basis for this Court to resolve lead counsel disputes.” The Court also rejected the argument that it gave any weight to the lawyers who “invoke this Court’s name in a ‘fishing’ press release and then file elsewhere, only to return here after determining that their action is going to be stayed or dismissed.”

The Court underscored that the referenced online press release did not bear upon its decision. It also explained that the role of the Court is not to serve as a “professionalism policeman.” The Court concluded with a suggestion to the movant that if the movant believed that “the issuance of online press releases poses an ethical problem, her counsel should report the conduct to the appropriate disciplinary counsel.”

UPDATE: Alison Frankel of The AmLaw Litigation Daily  also reviews this case and links to our summary here.
 

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eBay Domestic Holdings, Inc. v. Newmark, No. 3705-CC (Del. Ch. Oct. 29, 2009), read opinion here. See prior Chancery Court decisions in this case summarized here and here.  This letter decision rules on a Motion to Compel discovery responses and continuations of depositions.

Background and Prior Order

There were six separate aspects of the Motion to Compel, only a few of which will be highlighted. The first involved the request by the defendants to order plaintiff to produce complete, unredacted versions of all board minutes and related materials for the years 2004 through 2008. Previously, on September 16, 2009, the Court ruled that eBay was required to produce unredacted versions of its board minutes, and although it produced board minutes that referred to craigslist as required, eBay redacted information that was not related to craigslist. Defendants contend that the redacted versions are relevant because they relate to eBay’s strategy regarding classified ads and were improperly redacted.

The parties disputed the scope and meaning of the prior Order of the Court on this issue. The Court emphasized that the plaintiff’s competitive conduct in the classifieds business is “conditionally relevant to this case” and therefore the "discovery of board minutes and materials dealing with that conduct is appropriate.” However, the Court also underscored that it would not be appropriate to order all board minutes as discoverable without regard to their content, citing the parameters that are contained in Chancery Court Rule 26, which limits discoverability in connection with claims or defenses in a particular case. Thus, board minutes or materials that contain “absolutely no mention of plaintiff’s classified business are not relevant to a claim or a defense and are not discoverable.”

The Court ordered in camera review of four specific documents in order to determine whether those documents are covered under the prior Order of September 16, 2009 that compelled the production of certain minutes.

Required Continuation of Certain Depositions

Defendants argued that because certain passages of board minutes were redacted at the time that particular individuals were deposed, they did not have a fair opportunity to question those individuals about the discussions in the board meetings that were redacted, and therefore should be permitted to continue those depositions. Plaintiff argued that the additional redacted portions do not reveal any information that the defendants were not already aware of when they conducted the depositions.

Nonetheless, the Court ruled that the defendants should be permitted to continue the depositions of certain board members. However, the defendants were limited in the scope of the depositions to that which relates to the business discussions that were identified by the defendants upon review of the unredacted board minutes. The Court reasoned that the defendants may have been “generally aware” of the information in the board minutes but they did not have the opportunity to explore the specific discussions involved.

Deposition of CFO Compelled and Order to Produce Relevant, Non-Privileged Materials from the Files of the CFO

In addition to compelling the deposition of the CFO, the Court required a search of the files of the CFO for all relevant, responsive, non-privileged materials because the defendants were not previously aware of his role in the board meetings that were redacted. The defendants were generally aware of the CFO attending board meetings, but did not previously know that his files were likely to contain information about relevant issues in the case. They only came to know when they read previously unavailable minutes.

Court Rejects Request for Attorneys' Fees Incurred in Motion to Compel

The Court denied the request for fees and expenses incurred in connection with the Motion to Compel filed on May 21 (the current Motion to Compel), and with respect to any additional depositions ordered by the Court.

The Chancery Court firmly rejected the request for shifting of  the fees in connection with both Motions to Compel, and similarly denied the request for fees associated with the additional depositions that were ordered by the Court in response to the latest Motion to Compel. The Court relied on Chancery Court Rule 37(a)(4) which, despite some mandatory language, still allows the Court discretion to deny a request for fees regarding a Motion to Compel when “other circumstances make an award of expenses unjust.” The Court also agreed with the reasoning of the plaintiff that an award of fees would be unjust because the redaction of the minutes was an “inadvertent oversight” and not the result of “grossly negligent conduct.” (See footnote 7, citing Dow Chem. Canada, Inc. v. HRD Corp., 2009 WL 2355742, at * 6-7 (D.Del. July 30, 2009)).

The Court reasoned that the defendants were not entitled to be reimbursed for fees or expenses associated with the motions because the redactions determined to be wrongly made were not intentional. The further reasoning of the Court is eminently quotable, as follows:

This Court has never required perfection in document production. Absent clear evidence that the failure to produce relevant documents was something other than an mistake, it would be unjust to require plaintiff to pay the fees associated with the motion. It is not clear from the evidence that plaintiff intentionally concealed information from defendants.

In modern litigation mistakes and oversights in document production often occur. Parties face significant challenges in their attempts to comply with appropriate discovery requests. They often sift through large quantities of documentation for relevant and responsive material, all-the-while screening out irrelevant, privileged or otherwise undiscoverable information. In such an environment mistakes are inevitable and fees should not be awarded unless it is clear information was intentionally withheld.

Regrettably, motions to compel are a subjective enterprise and depending on the jurist reviewing the matter, the exercise of predicting the outcome of such motions is rarely easy. However, it is helpful to know for future reference that the author of this decision demonstrates understanding in terms of not being Draconian or Procrustean in ruling on requests for fee-shifting in connection with motions to compel.

Regarding the requests for fees in connection with the additional continued depositions that were ordered, the Court reasoned that Rule 37 deals with costs in connection with “obtaining the Order” on a motion to compel, and does not provide for costs relating to additional discovery that is later taken as a result of the Order.

Lastly, the Court rejected a request that an attorney be present during the in camera review because at that point the review would no longer be “in camera,” and moreover the Court observed (in an understatement) that it was “competent enough to evaluate the relevance of the eight presentations [submitted for review] on its own.”

This eight-page letter decision is of substantial practical value, and one that should be considered for inclusion in the “toolbox of every Delaware litigator"--at least those that practice in the Court of Chancery.
 

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In re John Q. Hammons Hotels Inc. Shareholder Litigation,  No. 758-CC (Del. Ch. Oct. 2, 2009), read opinion here. A prior decision in this case by the Court of Chancery  was highlighted here.

Kevin Brady, a highly respected Delaware litigator, prepared this synopsis.

This dispute arose out of the merger involving John Q. Hammons Hotels (“JQH”) pursuant to which the holders of Class A common stock received $24 per share in cash. Plaintiffs’ alleged that: (i) the controlling shareholder breached his fiduciary duty by negotiating benefits for himself that the minority stockholders did not receive; (ii) the directors breached their fiduciary duties by permitting a deficient process and subsequent approval of the merger; (iii) the acquisition vehicle aided and abetted the breaches of fiduciary duties: and (iv) the company’s proxy statement contained misstatements and omissions regarding the activities of the special committee process and certain conflicts with the company’s financial advisors.

On cross-motions for summary judgment, the Court concluded that Kahn v. Lynch Communications Systems did not mandate the application of entire fairness standard of review in this transaction notwithstanding procedural protections like a special committee or a minority of the majority vote requirement. Tthe use of sufficient procedural protections for the minority stockholders could have resulted in the application of the business judgment standard, but the procedures used here were insufficient. As a result, the Court determined that the applicable standard of review would be “entire fairness.”

Background

JQH was a Delaware corporation that owned and managed a multitude of hotels. John Q. Hammons (“Hammons”), JQH’s Chairman, CEO and controlling shareholder (he owned 5% of the Company’s Class A common stock and all of the Class B common stock) with over 75% of the total vote in JQH, which in turn controlled John Q. Hammons Hotels, LP (“JQHLP”). Defendants JQH Acquisition, LLC (“Acquisition”) and JQH Merger Corporation (“Merger Sub”) were formed for purposes of the merger described below. Jonathan Eilian (“Eilian”), not a defendant, was the principal of Acquisition, which wholly owned Merger Sub. Plaintiffs were owners of Class A stock of JQH, which was publicly traded (as opposed to Class B stock).

Potential Transactions with Barceló and Eilian

In 2004, Hammons entered into discussions with third parties regarding a sale of JQH or at least his interest in JQH. By October, Barceló Crestline Corporation (“Barceló”) entered into an agreement with Hammons for $13 per share for all outstanding Class A common stock. The deal was structured in a way that benefited Hammons’ in a number of ways, most especially from a tax standpoint.

The Board recognized that Hammons’ interests may not have been identical to those of the other JQH shareholders, so the Board formed appointed three independent directors to a special committee to evaluate and negotiate a proposed transaction on behalf of the unaffiliated stockholders and make a recommendation to the Board. Katten Muchin Rosenman, LL” (“Katten Muchin”) was the special committee’s legal advisor, and Lehman Brothers (“Lehman”) was its financial advisor.

After Barceló’s public announcement, Eilian told the special committee that he was interested in entering into a possible transaction with JQH. In December 2004, Eilian submitted a proposal to the special committee whereby he would acquire Hammons’ interest in JQH and to make a tender offer for the remaining shareholders at a price to be determined later. After some back and forth with escalating offers from both Barceló and Eilian, exclusivity with Barceló was not renewed and negotiations proceeded with Eilian.

Eilian’s Offer

In January 2005, Eilian made an offer whereby he would acquire all outstanding Class A stock for $24 per share. Hammons then informed the special committee that he wanted to negotiate with Eilian. On June 3, 2005, Eilian confirmed his offer of $24 per share of outstanding Class A stock. Lehman advised that the $24 per share offer was fair to the minority shareholders from a financial point of view and that “the allocation of the consideration between Hammons and the unaffiliated stockholders was reasonable.” The Special Committee approved the merger agreement and the Board voted to approve the merger and the transaction agreements.

The merger was contingent upon approval of a majority of Class A stockholders voting on the transaction unless the special committee waived that requirement. The Merger Agreement included a $20 million termination fee and a “no shop” clause. Along with the merger agreement, Hammons and Acquisition entered into a number of other agreements “designed to provide Hammons financing to continue his hotel development activities without triggering the tax liability associated with an equity or asset sale. . . . In order to achieve his tax goals, Hammons had to have an ownership interest in the surviving LP and continue to have capital at risk.”

Hammons was allocated a 2% interest in the cash flow distributions, preferred equity interest in the surviving LP and other rights and obligations. In addition, Hammons received $300 million in credit lines, as well as “(1) the Company’s Chateau Lake property in exchange for transferring certain assets and related liabilities to an Acquisition affiliate, (2) a right of first refusal to acquire hotels sold post-merger, and (3) an indemnification agreement for any tax liability from the surviving LP’s sale of any of its hotels during Hammons’s lifetime.”

At a special meeting of the shareholders on September 15, 2005, over 72% of Class A shareholders voted to approve the Merger. More than 89% of the Class A stockholders voted in favor of the transaction.

Allegations Regarding the Negotiation Process

Plaintiffs, Class A stockholders, raised various issues regarding the negotiation process, including:

• Hammons’ Ability to Block Transaction: Plaintiffs alleged that Hammons could threaten to walk away from any deal thereby leaving the plaintiffs with illiquid and undervalued stock. The result of Hammons’ power, as plaintiffs allege, was that “this threat relegated the special committee to a passive, tag-along role and forced them to be ‘friends of the deal’ in an effort to prevent Hammons from backing out of the deal.”

• Conflicts of Interest: Plaintiffs allege that because Katten Muchin advised the special committee and represented Eilian’s financing entity, iStar Financial Inc. (“iStar”), Katten Muchin had an incentive for the deal with Eilian to close. Likewise, Lehman sought from Eilian, but did not receive, the job of refinancing JQH’s debt. Further conflicts were alleged with the interactions between iStar and Lehman in the negotiations and those conflicts were not disclosed in the proxy materials.

The Litigation Starts

The action was filed in October of 2004. After discovery and an unsuccessful attempt at mediation, three sets of motions for summary judgment were filed:

• Director Defendants’ Motion for Summary Judgment: The directors basis for their motion was that “(1) plaintiffs cannot satisfy their burden to rebut the presumption of the business judgment rule, (2) the special committee members and the director defendants are shielded from monetary liability pursuant to the Company’s 8 Del. C. § 102(b)(7) exculpatory provision, and (3) there is no evidence to support the aiding and abetting claim.”

• Hammons’ Motion for Summary Judgment: Hammons’ alleged that “he took no part in the negotiations for the purchase of the minority’s shares and argues that he is entitled to summary judgment because plaintiffs cannot rebut the presumption of the business judgment rule and because even if entire fairness applies, Hammons acted fairly.”

• Plaintiffs’ Motion for Summary Judgment: Plaintiffs’ allege that “(1) entire fairness is the applicable standard of review, (2) the special committee process and stockholder vote were ineffective and the burden of persuasion at trial remains with defendants, (3) the challenged transactions were the result of unfair dealing, (4) certain defendants are liable for aiding and abetting Hammons’s breach, and (5) the only issue for trial is therefore fair price.”

Standard of Review – Entire Fairness or Business Judgment Rule

The Court noted that the threshold issue was whether the Court should apply the entire fairness standard or the business judgment rule in reviewing the merger. Alleging the merger to be a “minority squeeze-out transaction,” plaintiffs contended that Kahn v. Lynch Communication Systems Inc., 638 A.2d 1110 (Del. 1994), mandates that the Court apply the entire fairness standard of review. Defendants countered, alleging the business judgment standard of review was appropriate.

The Court rejected the plaintiffs’ argument stating that under Lynch, “‘the exclusive standard of judicial review in examining the propriety of an interested cash-out merger transaction by a controlling or dominating shareholder is entire fairness’ and that ‘[t]he initial burden of establishing entire fairness rests upon the party who stands on both sides of the transaction.’ Additionally, ‘approval of the transaction by an independent committee of directors or an informed majority of minority shareholders’ would shift the burden of proof on the issue of fairness to the plaintiff, but would not change that entire fairness was the standard of review.”

Hammons however, did not stand “on both sides of the transaction” and Hammons did not make the offer to the minority stockholders – an unrelated party, Elian, made the offer. Eilian negotiated separately with the minority shareholders, who were represented by the “disinterested and independent special committee,” and Hammons, “who had a right to sell (or refuse to sell) his shares . . . .” Thus, regardless of any procedural protections in place for the minority shareholders, “Lynch does not mandate that the entire fairness standard of review apply notwithstanding any procedural protections that were used [i.e., the special committee or the approval of the majority of the minority shares voting.].”

The Court stated that the business judgment “would be the applicable standard of review if the transaction were (1) recommended by a disinterested and independent special committee, and (2) approved by stockholders in a non-waivable vote of the majority of all the minority stockholders.” However, in order to invoke the business judgment standard, “it is paramount – indeed, necessary . . . – that there be robust procedural protections in place to ensure that the minority stockholders have sufficient bargaining power and the ability to make an informed choice of whether to accept the third-party’s offer for their shares.”

Here the Court found that the procedure in place (where the special committee could waive the vote of the minority stockholders and required the approval of only the majority of the voting minority shareholders), were not sufficient. Importantly, the Court stated that the minority vote serves as a complement to, and a check on, the special committee. It also noted that “[a]n effective special committee, unlike disaggregate stockholders who face a collective action problem, has bargaining power to extract the highest price available for the minority stockholders. The majority of the minority vote, however, provides the stockholders an important opportunity to approve or disapprove of the work of the special committee and to stop a transaction they believe is not in their best interests. Thus, to provide sufficient protection to the minority stockholders, the majority of the minority vote must be nonwaivable, even by the special committee.”

Application of the Entire Fairness Standard: Fair Dealing and Fair Price

In determining the entire fairness “based on all aspects of the entire transaction,” the Court considers both fair dealing and fair price. While neither prong is considered in isolation, “[f]air dealing involves ‘questions of when the transaction was timed, how it was initiated, structured, negotiated, disclosed to the directors, and how the approvals of the directors and the stockholders were obtained. . . .’” and “[f]air price involves questions of ‘the economic and financial considerations of the proposed merger, including all relevant factors: assets, market value, earnings, future prospects, and any other elements that affect the intrinsic or inherent value of a company’s stock.’” The Court did note that while the special committee approval and the majority of the minority vote were not sufficient to invoke the business judgment standard of review that did not mean that the defendants per se would not be able to prevail on the issue of fair dealing.

Finding material factual issues as to the fairness of the price, including the actual value Hammons received and Lehman’s valuation thereof, the court denied the defendants’ motion for summary judgment. Likewise, there were material factual issues as to the fairness of the deal as there were questions about whether the special committee was coerced by Hammons or whether Hammons’ self-dealing negotiations depressed the value of the shares. Accordingly, the Court found that neither plaintiffs nor defendants were entitled to summary judgment on the issue of fair dealing.

Disclosure Claims

Plaintiffs alleged four breaches of the duty of disclosure. First, plaintiffs allege that the proxy statement mischaracterized the special committee process by failing to disclose that it was a “subservient, deferential approach.” Under existing case law, directors are not required to engage in “self-flaggelation,” so the Court granted summary judgment in favor of defendants on this claim.

Second, plaintiffs alleged that the proxy failed to disclose the potential conflict that Lehman had with Eilian. Defendants’ motion was denied because the Court “has stressed the importance of disclosure of potential conflicts of interest of financial advisors.”

Third, plaintiffs asserted that Katten Muchin’s representation if iStar should have been disclosed. Even though this was disclosed to the special committee and measures were made to use different lawyers within Katten Muchin for iStar’s representation, the Court nonetheless held that this type of conflict must be disclosed to the shareholders. As the Court reasoned, “[t]his is particularly true, where, as here, the minority stockholders are relying on the special committee to negotiate on their behalf in a transaction where they will receive cash for their minority shares.” Thus the Court found that the defendants were not entitled to summary judgment on this claim.

Finally, plaintiffs alleged that it was a breach to not disclose a presentation to the special committee that Eilian made in 2004. In the presentation, Eilian provided a valuation of JQH’s shares under what defendants alleged was a hypothetical scenario. Because the Court could not conclude whether the scenario was hypothetical or tied to the merger and thus potentially material to a shareholder’s decision, the Court denied the defendants’ motion for summary judgment on this claim.

Aiding and Abetting Claim Survived

As to the acquisition vehicles, defendants’ motion for summary judgment on plaintiffs’ aiding and abetting a breach of fiduciary duty claim was denied. There were questions as to whether there was knowing participation by Eilian and whether Hammons’ conduct depressed the value of the stock. As a result, the Court found that the defendants were not entitled to summary judgment on this claim.

Postscript:  The DealProfessor has provided an insightful review of this case here. The Harvard Law School Corporate Governance Blog provides an overview of the case here.

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Third Avenue Trust v. MBIA Insurance Corp., No. 4486-VCS (Del. Ch. Oct. 28, 2009), read opinion here. This Court of Chancery case involves the rather uncommon result in which the Court declined to exercise jurisdiction over a dispute.

Although it may be admittedly simplistic to highlight this case in such a manner, the opinion by the Court of Chancery in this matter can be characterized, on a rudimentary level, merely as relinquishing jurisdiction over a case that is based on New York law between "New York-centered parties"  and does not present a sufficient policy justification for the Delaware Courts to adjudicate a dispute between entities regulated by the New York Insurance Department. The Court actually explains in quasi-metaphysical fashion the political philosophy that would justify its decision to decline to rule on this dispute involving insurance companies that operate in New York, and that the State of New York has a greater interest adjudicating. A taste of the flavor of the Court’s analysis is exemplified in its opening paragraph which provides as follows:

The United States is a federal republic that depends on comity among the states for the peaceful and efficient conduct not only of public regulation, but also of private commerce . . . . This case presents a clear example of a dispute where this Court ought to refuse to make a determination of another state’s law and refer the matter, by abstention and appropriate enforcement of a forum selection clause, to the Courts of the state whose law and public policy is affected by the resolution of the key question.

This is one of a series of recent cases where for different policy reasons and legal rationales, the Chancery Court was presented with cases involving arguments that the Delaware Court should refrain from ruling on a case involving competing litigation between the parties in another jurisdiction. Compare  two recent cases summarized here and here, one of which declined to adjudicate in Delaware a dispute involving litigation between the same parties in another jurisdiction, and another recent case summarized here that reached a contrary result based on contrary factors and facts.

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 Xu  v. Heckmann Corporation,  No. 4673-CC (Del. Ch. October 26, 2009), read opinion here.

The Chancellor of the Delaware Court of Chancery in this opinion decides a Motion to Dismiss Counterclaims involving issues related to fraud allegations against a director. The founder of a selling company, based in China, became a director of a U.S. corporate buyer as part of the deal. It was in this context that claims against the director were made post-closing by the purchaser. Similarly, the purchaser claimed that the fraud of the seller should relieve it of any duty to fulfill the payment obligations of the deal.

(The Court of Chancery Courthouse in Georgetown, Delaware, is featured in the photo).

Background
The factual background involved a purchase via merger by the Heckmann Corporation of a bottled water producer and distributor in China, founded by Xu Hong Bin, a citizen of the People’s Republic of China. The purchase price included $15 million in cash, the right to contingent payments of an additional $15 million, as well as restricted shares in the Heckmann Corporation. The merger also included Xu continuing as the president of China Water and also becoming a director of Heckmann. As a result of post-closing issues that developed, the parties entered into an Escrow Resolution and Transition Agreement (“ERTA”) which required the restricted shares that were part of the Merger Agreement to be returned to Heckmann at a substantially discounted price. The ERTA included a broadly worded mutual release of claims between Xu and Heckmann, as well as an integration clause.

Overview of Claims and Counterclaims
Xu sued for specific performance of the ERTA. Heckmann filed counterclaims claiming that Xu breached fiduciary duties he owed to Heckmann as a director and that he also breached the ERTA. Heckmann also asserted that Xu is not entitled to certain payments already made to him. The Court noted that Heckmann asserted that it was fraudulently induced into signing the ERTA by Xu’s failure to disclose fraudulent conduct, which was technically not a counterclaim, but rather was an affirmative defense to enforcement of the ERTA.

There are many detailed factual allegations that are beyond the scope of this short blog overview, but in essence, they involve what Heckmann alleges to be substantial fraud that it only discovered after the closing. The broad release language in the ERTA (which was entered into after the merger agreement), was the principle basis for the Plaintiffs’ Motion to Dismiss the Counterclaims filed by Heckmann. The choice of law provision in the ERTA provided that “except to the extent that the corporate laws of the State of Delaware apply to a party, this Agreement shall be governed by the laws of the State of New York." Thus the fiduciary duties owed by Xu to Heckmann were governed by Delaware law while general contract duties were governed by New York law.

Discussion of Scope and Validity of Release

The general release language in the ERTA covered claims being released between Xu and Heckmann and also included those  claims: “whether known to Heckmann or China Water at the time of execution of this Agreement or not . . ..”

Heckmann argued that the general release language was not valid because the transaction was “self interested” to the extent that it would purport to protect Xu from claims by Heckmann after Heckmann discovered the fraudulent conduct of Xu. See cases cited in footnotes 15 through 18.
The Court agreed that if Heckmann was unaware of the fraud committed by Xu when he negotiated the ERTA, while Xu was a director, then Xu “clearly had a fiduciary duty to inform Heckmann that the release would cover his alleged fraudulent conduct because the information would have been material to Heckmann’s decision to enter into the ERTA.” See footnote 20. The Court reasoned that such a rule:

“simply follows general principles of Delaware law that require a director to make full disclosure of his interest in the transaction before engaging in that transaction with the corporation. If the corporation is unaware that it is releasing a director of potentially fraudulent conduct then it is unaware of the director’s existing personal interest in the release.”

However, the Court highlighted an important distinction in a situation where a director negotiates a general release with his corporation made amidst corporate “suspicions or allegations that the director committed fraud” and where the mutual release is intended to settle those fraud claims, "even if the full scope of those claims is unknown when the release is signed.”

In such circumstances, the director accused of fraud does not have a fiduciary duty to disclose all his wrongful acts prior to signing a release. In such a situation, if the corporation already suspects fraud has occurred, and it settles the claims against the director with a general release, it cannot be said that the corporation was deprived of material information it needed to evaluate the settling of its claims. This is so because the corporation would be aware that a director has an existing personal interest in the transaction (i.e., the release agreement), and is aware that fraud may be greater than it suspects. See footnotes 21 through 24.

The Court recognized that the distinction makes sense because requiring a director accused of fraud by his corporation to disclose all prior wrongdoing before negotiating a settlement would make the settlement of fiduciary claims arising out of fraudulent conduct impossible. Requiring a full confession, especially as to disputed claims, would remove any incentive to settle and would remove any assurance that upon hearing of additional wrongdoing, that the corporation would still settle.

There was a factual issue here about whether Heckmann was aware of fraud or of potential fraud committed by Xu when it entered into the release and that factual issue could not be resolved at this early procedural stage.

The Court related the foregoing analysis to the fraudulent inducement arguments which were considered as an affirmative defense and not regarded by the Court as a counterclaim. That affirmative defense to the formation of a contract was controlled by agreement pursuant to New York law.

Breach of Contract Claim Dismissed

There was an issue about whether Xu had the authority to enter into the ERTA. The Court observed that

“all contracts include the inherent representation that the party entering into the contract has the authority to do so. This inherent representation is important because, if it is false, the contract may fail or be unenforceable as a matter of law. Thus, if a person signing a contract misrepresents that he has the necessary authority to do so, the legal questions that are triggered have to do with contract formation or enforceability, not breach of contract.”

The Court explained why this makes sense as a matter of logic. In this case, Heckmann wanted to prove that Xu lacked authority to enter the ERTA. If Xu lacked the authority to enter into the ERTA, then that lack of authority was not a breach of contract, because the contract would not exist or would not be enforceable by virtue of that lack of authority. Thus, the Motion to Dismiss the Counterclaim for Breach of Contract was granted.

Claim for Conversion Rejected

In Delaware, “an action in conversion will not lie to enforce a claim for the payment of money.” See footnote 44. No exception to that rule applied here because Heckmann was suing for a return of money pursuant to a disputed contract and those claims would be based on contract principles. Thus, the Motion to Dismiss the Counterclaim for Conversion was granted. See also footnote 47. (In order to assert a tort claim along with a contract claim, the plaintiff must generally allege that defendant violated an independent legal duty, apart from the duty imposed by contract.)

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Retirement Board of Allegheny County v. Rothblatt, et al., No. 4946-CC  (Del. Ch., Oct. 13, 2009), read opinion here.

Kevin Brady, a distinguished Delaware litigator, provides this case synopsis.

 Plaintiffs asked for expedited treatment in a preliminary injunction action brought to enjoin the exercise of options issued under an option exchange plan. On October 13, 2009, the Court denied Plaintiff’s request to expedite the matter on the grounds that plaintiff failed to show good cause to expedite the action -- a sufficient threat of irreparable harm.

By way of background, In November 2008 the defendants approved an option exchange plan regarding United Therapeutics (“UTC”) stock, wherein the plan allowed UTC directors and employees to exchange their existing options for new options with an exercise price of $61.50. This plan was approved shortly after UTC experienced a substantial decline in its stock price.
Plaintiff alleged that not only did the share exchange violate UTC’s existing stock option plan, it violated CEO Martine Rothblatt’s employment agreement with UTC. Moreover, the plaintiff alleged that the board violated their fiduciary duties by approving the “repricing” plan. Rothblatt exchanged 582,607 options pursuant to the exchange plan; the shares were received in December 2007 as compensation under an employment agreement with UTC.

The Court noted that because expedited proceedings impose a substantial burden on the Court and the parties, good cause must be shown, i.e., a showing of irreparable injury. Here the plaintiff wanted the Court to preliminarily enjoin defendants and UTC employees from (1) exercising any UTC stock options issued pursuant to the option exchange, (2) issuing or selling the UTC stock necessary to fulfill the exercise of options issued in the option exchange, and (3) issuing UTC stock options to Rothblatt in December 2009.

Plaintiff argued that without an injunction it would be irreparably injured in that: (i) the cash inflows from option exercises at the lower strike price of the exchanged options would be less than inflows at the original strike price; (ii) approximately 150 employees were given “repriced” options in the exchange and plaintiff will not be able to recover from those employees once they have exercised their options and sold their shares into the market; and (iii) the number of shares underlying the “repriced” options amounts to approximately 5.5% of UTC’s public float and that exercise of the options and resale of the underlying shares will flood the market, thereby diluting the value of existing UTC shares. The Court however, was unpersuaded.

As to plaintiff’s first assertion, the Court noted that while it was true that the cash inflows from the lower strike price on the “repriced” options would be less than cash inflows would have been if the options were exercised at their original price, if the option exchange was invalidated, plaintiff’s damages are easily calculable and hence no irreparable harm. Even if it is determined later that Rothblatt is not entitled to any shares she might receive in December 2009, the damages UTC would suffer would be easy to calculate (disgorged profits).

As to plaintiff’s second assertion, plaintiff sued the UTC directors in their individual capacities for breach of fiduciary duty in approving the option exchange so the directors would be liable for the damages of the “repriced” options they personally received as well as those given to the employees. Moreover, as noted above, damages to UTC caused by the exercise of employee-held options are also easy to calculate.

Finally, as to plaintiff’s third assertion, the Court found that it did not demonstrate the type of irreparable injury for which a preliminary injunction could be granted because the options that plaintiff challenges are not additional options, but rather replacement options -- “the challenged option exchange and the resale of shares acquired via that exchange will not create any greater dilution in the market than the exercise of the original options and resale of those shares would have.”

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In LeCroy Corp. v. Hallberg, No. 4328-VCP (Del. Ch. Oct. 7, 2009), read opinion here, the Court of Chancery granted Defendants' motion to dismiss an individual defendant from the action due to a lack of personal jurisdiction but denied defendants’ motion to dismiss based on forum non conveniens. For other cases involving forum non conveniens summarized on this blog, see here.

Kevin Brady, an highly respected Delaware litigator, prepared this revised synopsis.

By way of background, this case involves a dispute between two corporate competitors and a former employee who left one company to join the other. Plaintiff LeCroy Corporation is a Delaware corporation with no operations or connections to Delaware. Its operations, like those of Defendant SerialTek, LLC (“SerialTek”), are based in California. Likewise, SerialTek’s sole connection to Delaware is its status as a Delaware business entity. Defendant Matthew Hallberg, who has no connection to Delaware, previously worked for LeCroy in marketing and now has similar employment responsibilities at SerialTek.

SerialTek is owned by Paul Mutschler, Rand Kriech, and Dale Smith. Mutschler was Halberg’s supervisor, mentor and friend when they worked for LeCroy in California. Kriech and Smith were never employees of LeCroy, although Kriech was a LeCroy sales representative and he signed a version of an employment agreement. LeCroy employees had confidentiality and non-compete provisions in their employment agreements that extended one year after any potential departure from LeCroy. On August 14, 2007, while Mutschler was still employed at LeCroy, he and Smith created a SerialTek predecessor in Colorado, which was later dissolved in favor of the formation of a new Delaware entity, allegedly in an attempt to hide Mustchler’s involvement. SerialTek was originally conceived as a new start-up company that would compete directly with LeCroy in the protocol analyzer market.

Mutschler left LeCroy in November 2007 but following his departure from LeCroy, Mutschler remained in contact with Hallberg. Through this relationship, Hallberg allegedly transmitted confidential LeCroy information to Mutschler. In November 2008 during a period when Hallberg had been given the responsibility by LeCroy to determine how LeCroy could best compete with a new SerialTek product, Hallberg began actively seeking employment with SerialTek. Ultimately, Hallberg took a position at SerialTek which was essentially identical to his position at LeCroy.

Soon thereafter, LeCroy brought suit against SerialTek and Hallberg alleging breach of contract, tortious interference with contract, misappropriation of trade secrets, and unfair competition. The Defendants filed a motion to dismiss alleging lack of personal jurisdiction and forum non conveniens.

Plaintiff Fails Conspiracy Theory Test to Get Jurisdiction Over Former Employee

In opposition to Defendants’ motion, LeCroy alleged that it had personal jurisdiction over the Defendants under the Delaware long arm statute (10 Del. C. § 3104)(c)(3)) and under the conspiracy theory, where “the acts of one conspirator that satisfy the long-arm statute can be attributed to the other conspirators.” Even under the conspiracy theory, a plaintiff must still establish first that “there [is] a statutory basis for personal jurisdiction under Delaware’s long arm statute. . . .” and second, that “the court’s exercise of personal jurisdiction over a nonresident defendant must comport with the Due Process Clause of the Fourteenth Amendment.” Where the acts of a conspirator satisfy the long arm statute, such acts can be attributed to other conspirators as they are agents of each other.

Since Hallberg was a nonresident with no contacts to Delaware, personal jurisdiction over him would exist only if the acts of SerialTek, Mutschler, or some other alleged co-conspirator could be attributed to Hallberg. The Court noted that a plaintiff alleging personal jurisdiction under the conspiracy theory must satisfy a “very narrowly construed” five-part test from Istituto Bancario Italiano SpA v. Hunter Eng’g Co., 449 A.2d 210 (Del. 1982) where:

(1) a conspiracy [to defraud] existed; (2) the defendant was a member of that conspiracy; (3) a substantial act or substantial effect in furtherance of the conspiracy occurred in the forum state; (4) the defendant knew or had reason to know of the act in the forum state or that acts outside the forum state would have an effect in the forum state; and (5) the act in, or effect on, the forum state was a direct and foreseeable result of the conduct in furtherance of the conspiracy.

To satisfy the above, there must be specific factual evidence asserted; conclusory allegations are not sufficient. While the Court noted that elements 1, 2, 3, and 5 represented “close calls,” it held that LeCroy had failed to allege specific facts in support of the fourth element – that Hallberg had reason to know of SerialTek’s formation in Delaware. The failure of such a reason to know would “by necessity [mean that Hallberg] would not have reason to know of either the Delaware act or effect.” Hallberg was a marketing person, with no need to know of SerialTek’s legal situs. LeCroy’s arguments that Hallberg would have reason to know of the Delaware connection were unconvincing.

Plaintiff Fails to Show Act Causing Tortious Injury in Delaware Under § 3104

In addition to failing to satisfy the five-part test, LeCroy was also unable to satisfy the long arm statute’s requirement of an act that “[c]auses tortious injury in the State by an act or omission in this State.” The Court noted that had the Defendants’ alleged conspiracy been a breach of fiduciary duty that harmed LeCroy, then under the holding of Sample v. Morgan, 935 A.2d 1046 (Del. Ch. 2007), the injury against the non-resident Delaware company would have been deemed to have occurred in Delaware. However, because the alleged harm was not that of a breach of fiduciary duties, the controlling authority of Iotex Communications, Inc. v. Defries, 1998 WL 914265, at *8 (Del. Ch. Dec. 21, 1998), applied. Under Ioetex:

[A]s a general rule, in the case of Delaware corporations having no substantial physical presence in this State, an allegation that a civil conspiracy caused injury to the corporation by actions wholly outside this States [sic] will not satisfy the requirement . . . of a substantial effect . . . in the forum state.

Thus, LeCroy failed to satisfy the showing of a tortious injury in Delaware, as required by the long arm statute.

Defendants Fail Forum Non Conveniens Test to Show “Overwhelming Hardship”

In setting forth the Cryo-Maid factors for forum non conveniens analysis, the Court reiterated that “[t]he issue is whether any or all of the Cryo-Maid factors establish that the defendant will suffer overwhelming hardship and inconvenience if forced to litigate in Delaware.” SerialTek’s suggestion that California was the more appropriate and convenient forum “[did] not drive the Cryo-Maid analysis, [because] the central goal . . . is to determine if the defendant faces overwhelming hardship and inconvenience.” The Court noted that under Delaware law, “considerations of convenience do not drive the Cryo-Maid analysis.”

The Court’s discussion of the Cryo-Maid factors provided two interesting take-away points. First, the Court held that the lack of another pending litigation between the parties “decisively favors respecting Plaintiff’s choice of a Delaware forum.” The Court stated that it was “aware of no case where this Court has upheld a forum non conveniens dismissal under similar facts [i.e., involving litigation at an early, pre-discovery stage that is pending only in Delaware].”

Second, the Court discussed at great length SerialTek’s argument that the catchall factor of Cryo-Maid [i.e., “all other practical problems that would make the trial of the case easy, expeditious, and inexpensive”] disfavors Delaware because SerialTek is a start-up company. SerialTek argued that the expenses of litigating in Delaware would hamstring the young start-up and diminish its limited resources. The Court held that Defendants failed to demonstrate the overwhelming hardship having “not provided any firm numbers relating to SerialTek’s size, its operating budgets, capitalization, or actual or projected revenues, or regarding the added expenses of litigating in Delaware.”

As a result, the Court concluded that SerialTek had not established overwhelming hardship and inconvenience if forced to litigate in Delaware, so LeCroy’s choice of forum would be respected and SerialTek’s motion to dismiss on forum non conveniens grounds was denied.

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In two actions involving challenges to a consummated acquisition, the Court of Chancery in In re Nymex Shareholder Litigation, Nos. 3621-VCN, 3835-VCN and Greene v. New York Mercantile Exchange, Inc., et al., No. 3835-VCN (Del. Ch. Sept. 30, 2009), read opinion here, dismissed a multitude of conclusory allegations regarding breaches of fiduciary duties of loyalty, due care and candor in the sale of NYMEX to CME. In doing so, the Court reaffirmed the considerable deference Delaware law provides to an independent Board facing a change of control situation post-Lyondell.

Kevin Brady, a highly respected Delaware litigator, prepared this synopsis.

The Merger

NYMEX “was the largest commodity futures exchange in the world.” The defendants were all members of the Board of Directors of NYMEX including Richard Schaeffer (chairman of NYMEX) and James Newsome (President and Chief Executive Officer). The Plaintiffs consisted of common stock owners (the “NYMEX Plaintiffs”) and Shelby Greene who brought an action on behalf of the Class A Members of the NYMEX Exchange.

In the middle of 2007, the NYMEX Board established a Strategic Initiatives Committee (“SIC”) in order to “consider, negotiate and recommend any significant transaction involving NYMEX.” At about the same time, New York Stock Exchange (“NYSE”) Chairman John Thain spoke with Schaeffer about NYSE purchasing NYMEX for $142 per share, which represented a large premium above NYMEX’s then trading price. However, NYSE never made a formal offer allegedly because “Schaeffer personally demanded a senior executive position for himself as a pre-condition of the deal.”

Prior to Thain’s expression of interest, Schaeffer and Newsome had initiated negotiations between NYMEX and CME and at the beginning of 2008, a confidentiality agreement was entered into between the two companies. After the confidentiality agreement was announced, the NYMEX Board approved a change of control severance plan “which provided more than $97 million in change of control payments to senior management.”

Three weeks later, NYMEX announced that “CME had offered to buy NYMEX for approximately $119 per share, which represented a 2.1% premium over the closing price of NYMEX shares on that day and an 11% premium above the closing price of NYMEX shares on the last trading day prior to the announcement. . . . [and that a] substantial portion of the merger consideration was payable in CME stock.” NYMEX also announced that it had entered into a 30-day exclusive negotiating period with CME which was later extended to March 15, 2008.

No Collar Negotiated; No Protection Against Drop in Share Price

Prior to the announcement, CME stock was trading at $635.14 per share, but within a week of the announcement it fell to $485.25 per share. Notably, the CME offer did not contain a collar, which would have provided protection against fluctuations in stock price. As a result of the lack of a collar and because much of the merger consideration was in CME stock, the decline in stock price resulted in a substantial decline in the merger consideration. According to the Complaint, CME offered to “collar” the stock portion of the merger consideration but that offer was rejected by Schaeffer and Newsome (although they supposedly never mentioned the offer of a collar to the rest of the Board).

On March 17, 2008, CME and NYMEX announced the merger agreement, consistent with the original offer in January 2008, by which CME agreed “to acquire all of NYMEX’s common stock in exchange for $36 per share in cash and 0.1323 shares of CME common stock per NYMEX share.” By this date, the merger consideration had fallen to $100.30 per share. Nonetheless, J.P. Morgan and Merrill Lynch provided fairness opinions in favor of the deal. The Board unanimously approved the merger and more than 95% of the shares were voted in favor of the deal. The merger closed on August 22, 2008.

Plaintiffs’ Allegations

Plaintiffs in the NYMEX action brought numerous allegations of breaches fiduciary duties of loyalty, due care and candor arising out of the sale of NYMEX to CME. Plaintiffs also alleged that the Board was controlled by Schaeffer, and that the Board agreed to sell NYMEX through an unfair process at an inadequate price in order for Schaeffer and Newsome to obtain nearly $60 million in severance payments. Further, the shareholder class alleged that the directors breached their fiduciary duties by, among other things:

• omitting or misstating necessary information in NYMEX’s proxy materials with respect to the CME deal;

• agreeing to CME’s first and only offer;

• failing to inquire into other potential transactions;

• agreeing to a 30-day exclusive negotiating period with CME;

• causing investment bankers to allegedly understate the value of NYMEX shares in fairness opinions supporting the transaction;

• agreeing to a $50 million breakup fee; and

• agreeing to the $97 million change in control plan with an acquisition agreement imminent.

Plaintiffs also asserted that the CME Defendants aided and abetted the NYMEX Defendants in the breach of the above duties.

Does Revlon “Change of Control” Scrutiny Apply to Mixed Cash/Stock Deals?

The parties disputed whether this case should be evaluated under Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., as involving a fundamental change of corporate control or whether it should be evaluated under the business judgment rule. While “Revlon scrutiny applies only to transactions ‘in which a fundamental change of corporate control occurs or is contemplated,’ such ‘change of control’ does not occur for purposes of Revlon where control of the corporation remains, post-merger, in a large, fluid market.”

“In transactions . . . that involve merger consideration that is a mix of cash and stock,” the Court noted that “[t]he [Delaware] Supreme Court has not set out a black line rule explaining what percentage of the consideration can be cash without triggering Revlon.” Indeed, the Court contrasted In re Santa Fe Pacific Corp. Shareholder Litigation (merger transaction involving consideration of 33% cash and 67% stock did not trigger Revlon) with In re Lukens Inc. Shareholders Litigation, (merger transaction involving consideration of 60% cash and 40% stock likely triggered Revlon).

The mixed cash/stock deal (44% cash and 56% CME stock) before the Court in NYMEX provided an opportunity for the Court to further narrow the 33%-60% range noted above and give guidance as to when Revlon would be triggered.

However, the Court decided that it did not need to address the threshold Revlon applicability issue because NYMEX’s Certificate of Incorporation contained an exculpatory clause authorized by 8 Del. C. § 102(b)(7) that protects the NYMEX directors from personal monetary liability for breaches of the duty of care. If the Plaintiffs failed to show that the either a majority of the directors were interested, lacked independence or failed to act in good faith, then their only remaining claim would be a breach of a duty of care which is addressed by §102(b)(7). Thus, even if Revlon applied, application of the §102(b)(7) exculpatory clause would lead to dismissal “unless the Plaintiffs have successfully pleaded a failure to act loyally (or in good faith), which would preclude reliance on the Section 102(b)(7) provision.”

Post-Lyondell Duty of Loyalty Discussed

As to the breach of the fiduciary duty of loyalty, the Plaintiffs alleged that the disinterested members of the Board were dominated and controlled by Schaeffer, and acted in bad faith. However, the Court held:

[t]hat directors acquiesce in, or endorse actions by, a chairman of the board—actions that from an outsider’s perspective might seem questionable—does not, without more, support an inference of domination by the chairman or the absence of directorial will. The NYMEX directors were otherwise unquestionably independent—this is not an instance where certain relationships raised some concern but not sufficient doubt to sustain a challenge to director independence. In short, the Complaint alleges nothing more than a board which relied upon, and sometimes deferred to, its chairman. It does not allege dominance such that the independence or good faith of the board may fairly be questioned.

Consequently, the claim for breach of the duty of loyalty failed as a matter of law and was dismissed.

“Because the Plaintiffs’ allegations were too conclusory to support an inference of domination,” the Court noted that for the Plaintiffs to succeed, they had to “convert into a loyalty claim their aversion to the process the Board employed in negotiating the merger” and the most the Plaintiffs could show was that “the Board’s process was not perfect.” Relying on the Delaware Supreme Court’s 2009 decision in Lyondell Chemical Co. v. Ryan, 970 A. 2d 2235 (Del. 2009) and the Court of Chancery’s decision in Wayne County Employees’ Retirement Systems. v. Corti, 2009 WL 2219260 (Del Ch. June 24, 2009), the Court explained :

The Delaware Courts have repeatedly held that “there is no single blueprint that a board must follow to fulfill its duties.” In any event, claims of flawed process are properly brought as duty of care, not loyalty, claims and, as discussed, those claims are barred by the exculpatory clause of NYMEX’s Certificate of Incorporation. Moreover, to the extent the Complaint alleges that the Board acted in bad faith, such allegations must fail because, based on the facts in the Complaint, it cannot be said that the Board intentionally failed to act in the face of a known duty to act, demonstrating a conscious disregard for its duties. More precisely, the Complaint has not alleged that the Board “utterly failed to obtain the best sale price.”

As a result, the Court granted the motion to dismiss the Complaint as to the breach of fiduciary duty claims.

Court Rejects Breach of Fiduciary Duty Claims Against Schaeffer
and Newsome as Sole Negotiators

Plaintiffs alleged that Schaeffer and Newsom breached fiduciary duties by “active participation in wrongdoing” in serving as the principal negotiators, specifically by:

[r]ejecting and keeping secret CME’s secret collar offer, ignoring the SIC, and withholding information regarding strategic opportunities and bids from fellow directors, as well as in ‘committing’ to CME that NYMEX would not attempt to renegotiate any of the economic terms of the proposed sale and failing to advise the Board of such a commitment, and in entering into an agreement with CME to vote their shares in favor of the proposed acquisition.

Moreover, Schaeffer was alleged to have breached his fiduciary duties by “rejecting NYSE’s interest in the Company due to NYSE’s failure to abide by his personal demands.” The Court dismissed these claims by holding that “[i]t is well within the business judgment of the Board to determine how merger negotiations will be conducted, and to delegate the task of negotiating to the Chairman and the Chief Executive Officer.” In addition, because the Board was “clearly independent,” there was no need for the utilization of the SIC.

Court Rejects Breach of Fiduciary Duty Claim Against Schaeffer and Newsome For Failure to Obtain a Collar

Characterizing Plaintiffs’ claim that Schaeffer and Newsome violated fiduciary duties by rejecting CME’s offer of a collar as speculative and conclusory, the Court held that

[t]he mere failure to secure deal protections that, in hindsight, would have been beneficial to shareholders does not amount to a breach of the duty of care. The presumption of deference to the judgment of management is only superseded by a showing of gross negligence, bad faith or conflicting personal interest. Plaintiffs have failed to plead the facts necessary to overcome this presumption.

The decision to omit a collar while negotiating merger terms was within the Board’s judgment. A post-facto analysis of the merits of a collar “is of no legal moment.” Accordingly, this claim was dismissed.

Direct v. Derivative Claims and the Parnes Exception

Returning to the NYSE offer, Plaintiffs alleged that Schaeffer stymied the potential bid (which Plaintiffs assert would have been greater than the ultimate deal with CME) by seeking a post-merger position for himself in the combined entity. The Court reasoned that these claims are not protected by the § 102(b)(7) clause because they pertain to breaches of a duty of loyalty. However, because claims pertain to a proposed NYSE acquisition and an entrenchment claim against Schaeffer, the claim was derivative. Following the merger, Plaintiffs’ standing to bring derivative claims was lost.

The general rule for determining “direct v. derivative” claims is set out in Tooley v. Donaldson, Lufkin & Jenrette, Inc., 845 A.2d 1031 (Del. 2004) as a two-part test: “(1) who suffered the alleged harm (the corporation or the suing stockholders, individually); and (2) who would receive the benefit of any recovery or other remedy (the corporation or the stockholders, individually).” The Court noted a very narrow exception to the general rule in Parnes v. Bally Entertainment Corp., 722 A.2d 1243 (Del. 1999). There, the Court held that “in order to state a direct claim with respect to a merger, a stockholder must challenge the validity of the merger itself, usually by charging the directors with breaches of fiduciary duty resulting in unfair dealing and/or unfair price.” A direct claim in such circumstances can be found only “[i]f the side transactions are alleged to have reduced the consideration offered to the target stockholders to a level that is unfair, then an attack is labeled as individual because it goes directly to the fairness of the merger.”

Here, the Court found that the “Plaintiffs’ allegations regarding the NYSE negotiations fell well outside the Parnes exception because the alleged breaches of fiduciary duty were far too attenuated from the ultimate CME transaction and the price that CME paid to establish a causal link.” As a result, the claim against Schaeffer was derivative and thus subject to dismissal. Moreover, because the confidentiality agreement with CME did not begin until months after NYSE’s interest waned, the Court noted that “it cannot be said that the failed negotiations with NYSE are in any way causally linked with the consideration ultimately offered in the CME transaction. . . . [and] there is no suggestion that the alleged breach occurred in order to benefit CME.”

Disclosure Claims

Plaintiffs claimed that the Board breached disclosure duties by failing to disclose:

• “more details concerning the NYSE’s then-potential offer of $142 per share;”

• “Schaeffer’s alleged self-interest in connection with an NYSE/NYMEX business combination;”

• “the fact that Schaeffer had been negotiating the terms of the transaction with CME;” and

• “additional information regarding the underlying assumptions of the fairness opinions, including an explanation for why J.P. Morgan and Merrill Lynch both used two transactions in their precedent transaction analysis that were never consummated.”

Plaintiffs also alleged that the bankers’ fairness opinions should have been updated in light of the reduced merger consideration relative to the time the opinions were initially made.

The Court started its analysis by noting that “the fiduciary duty of disclosure is a specific application of the duties of care and loyalty; it ‘requires that a board of directors ‘disclose fully and fairly all material information within the board’s control when it seeks shareholder action.’’” The Court then dismissed Plaintiffs’ disclosure claims for two reasons. First, to the extent the allegations were tied to the directors’ duty of care, they were barred because of the § 102(b)(7) charter provision. Second, to the extent they were tied to the duty of loyalty, they were dismissed because “[a] mere conclusory allegation that the alleged disclosure violations also constitute a violation of the duty of loyalty is not sufficient to survive a motion to dismiss, particularly in light of the holding that the Complaint fails to otherwise state a non-exculpated claim against the Director Defendants for breach of fiduciary duty.”

Dismissal of Aiding and Abetting Claims Against CME

Plaintiffs alleged that the CME Defendants aided and abetted the alleged breaches of fiduciary duty by the NYMEX Defendants. Because Plaintiffs were only able to muster conclusory allegations of the CME Defendants’ “knowing participation” in the alleged breach as non-fiduciaries, the Court found that their claims failed as a matter of law. The Court also noted that the complaint did not contain any allegation that the CME Defendants induced Schaeffer and Newsome to commit the alleged breaches.

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Last week the Delaware Court of Chancery heard arguments in the litigation involving the Bank of America and Merrill Lynch merger.

The Courtroom View Network  has made available a free video/audio clip here of that hearing, which they provide with the following introductory background description of the matter:

Hearing on defendant's motion to dismiss. Shareholders asserted breach of fiduciary duty and waste claims against Bank of America for consummating a merger with Merrill Lynch and for failing to disclose material financial information before shareholders voted on the merger.

The defendants asserted that the plaintiffs could not prevail without alleging bad faith because Merrill Lynch's accelerating deterioration, and the directors' considering invoking the Material Adverse Change (MAC) clause to void the deal, did not occur until after the shareholder vote, at which time disclosure would have had no effect. The defendant also asserted that the undisclosed $5.8B in negotiated bonuses was in line with reasonable shareholder expectations. According to the defendant, there was no credible allegation that the directors acted in their own self interest, and instead had credible, sound reasons for not exercising the MAC, even if the directors were also threatened with job loss if they declared a MAC.

The plaintiff alleged that the board had set up an information system that would have kept it informed of the $9B loss before the vote, and did in fact resolve to declare a MAC three weeks after the vote. Director knowledge of the $5.8B bonus provision could be inferred, according to the plaintiff, because 12% of the total deal, although only noted in a schedule, was so significant that it must have been considered by the Board.

The Court denied the motion. The plaintiff alleged that at the time the board recommended that shareholders approve the deal, there were senior people at the corporation discussing with outside counsel whether they should consider getting out of the deal. Further, the job threat to the board followed by the decision not to declare the MAC constituted facts pled from which an inference could reasonably be drawn that the directors and CEO put personal interests ahead of the interests of the shareholders, even though other inferences favorable to the defendants could also be drawn.
 

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Choice Hotels International, Inc. v. Columbus-Hunt Park Dr. Bnk Investors, L.L.C., No. 4353-VCP (Del. Ch. Oct. 15, 2009), read corrected opinion here (and letter accompanying corrected version here.) This Chancery Court decision involves a dispute pursuant to Section 18-110 of the Delaware LLC Act regarding who the proper manager of the LLC is (analogous to DGCL Section 225), but before the Court could address those substantive issues, it needed to address a procedural entanglement that arose due to the parties having other litigation pending among them in another jurisdiction.

Holding

This Chancery Court opinion granted a Motion to Stay this Delaware dispute regarding the governance of an LLC, in order to allow a previously filed Maryland lawsuit between the parties to proceed.

Compare this result with the very recent decision in another case by the Delaware Court of Chancery that denied a Motion to Dismiss or Stay a Delaware suit despite pending litigation between the parties elsewhere, in the matter styled: Total Holdings USA, Inc. v. Curran Composites, Inc., No. 4494-VCS (Del. Ch. Oct. 9, 2009), read opinion here. A very short overview of the Total Holdings case is available on this blog here.

Overview

In this Choice Hotels decision, the Court provides an extensive factual background and procedural history of the competing lawsuits in which the parties are involved in different states. Within the 34-page opinion, the Court provides a “mini-treatise" on the various rules and policy reasons, as well as court decisions and standards, that are applied in Delaware to determine whether a lawsuit in Delaware will be stayed in favor of litigation pending in other states between the parties, or whether the Delaware court will hear the case before it instead of favoring a similar case proceeding between the parties in another jurisdiction.

Discussion

This case and the Total Holdings case, supra, decided within a week of each other by two different members of the Court of Chancery, involving completely different factual and procedural circumstances, provide a juxtaposition of two different results reached by courts who had to decide which competing similar lawsuits would proceed. Admittedly, these two recent Chancery decisions involved much different sets of circumstances and the legal issues were not the same, but the common thread between them was that a decision had to be made about whether a Delaware case would be stayed or allowed to proceed in light of a related case pending elsewhere.

In Total Holdings, the Court of Chancery denied a Motion to Stay or Dismiss, but in the Choice Hotels case the Court granted it. This is an indication that there is no simple “bright line test” that would allow one to easily predict when a case will be stayed or dismissed in favor of similar or related litigation between similar or identical parties, pending simultaneously in more than one forum. In part this lack of predictability is due to the intensely factual nature of the analysis. In one sense, this Choice Hotels decision by the Court of Chancery can be simplistically summarized by saying that "the Court applied the 'first-filed rule' to allow the lawsuit between the parties that was filed first in another state to proceed and thus stayed the subsequently filed Delaware lawsuit.” However, that would not be a meaningful assessment of the somewhat complex factual and procedural history involved with the very nuanced legal principles that the Court wrestled with in this case.

This short blog overview assumes some familiarity with the first-filed rule--also known as the McWane doctrine.

Special Consideration Given To Summary Proceedings Even When Delaware is Second Suit.

The McWane doctrine and the forum non conveniens analysis are both tempered by the competing policy priority that is enjoyed by lawsuits that are given statutory status as “summary proceedings” such as actions filed under 8 Del. C. Section 225 or 6 Del.C. Section 18-110, both of which provide a procedure for a swift resolution of cases involving a contest for control to determine who the rightful directors of a corporation are, or who the valid managers are of an LLC.

Specifically, the Court recognized that :

“in cases where rapid resolution of a corporate governance dispute is needed and a non-Delaware court is not in a position to provide expedited adjudication and prompt justice, the courts typically will deny a Motion to Stay the Section 225 or Section 18-110 action in Delaware because the policies underlying those sections take precedence over the policies underlying McWane." (See footnote 41.)

However, the Court cited cases at footnotes 42 and 45 to acknowledge that the policies underlying Section 225 will not invariably compel the denial of a Motion to Stay in every situation, but rather when faced with a Motion to Stay a summary  action, the Court must balance the McWane policies of comity in promoting the efficient administration of justice against the policies underlying the summary nature of the Delaware action.

The Court applied the familiar McWane factors to this case and also discussed the applicability of the forum non conveniens standard which is triggered when it is unclear whether a related case was filed first. It also may be applicable when multiple actions are contemporaneously filed. 

Court Rejects Ad Hominem Attack

In footnote 27, the Court addresses a matter of interest far beyond this case. The Court rejected an ad hominem attack that Choice Hotels mounted against the principal of the defendant, based on prior criticism in another case by another member of the Court of Chancery who lambasted the party as not being trustworthy. This argument used up about one third of the plaintiff's brief according to the Court's estimate. Choice Hotels tried to use that prior expression of judicial disapproval, unsuccessfully, based on the maxim of falsus in uno, falsus in omnibus. The Court rejected the arguments because regardless of the condemnation in the prior case of his truthfulness, there were no specific facts averred that were relevant to the instant action that would support drawing such a negative reference from the past conduct of the defendant's principal.

Excerpts of Court's Reasoning

Among the McWane factors applied by the Court was whether "prompt and complete justice" was availabe in the Maryland courts where the other case(s) were pending.  Extensive review of the various Maryland case management options revealed that Maryland has a type of  "business court" that the Chancery Court found:  "...may not be as quick as a summary proceeding under Section 18-110, but it still appears capable of providing an efficient and reasonably prompt resolution of the business entity issues raised  by [the plaintiff'] in Delaware."

The Court's reasoning to support its grant of the motion to stay was buttressed by its observation that: "If I refuse to stay the Delaware Action, it seems quite possible that overlapping litigation will proceed on two fronts."

In its concluding rationale, the Court explained that the policy animating the McWane doctrine also applies to "a single party filing two or more actions in diverse forums and thereby forcing the nonfiling party to expand its efforts significantly."

Court Rejects Argument that Fraud Claims Are Waivable by Agreement

As an aside to its analysis, the Court also addressed a important issue that has broad application in many cases. The plaintiff in this Delaware case asserted that a waiver that the defendant in the Delaware case signed would prevent him from raising defenses to a certain agreement. However, the Court would not agree that Delaware law prevents an intentional fraud defense to enforcement of an agreement, relying on Abry Partners V, L.P v. F & W Acq. LLC, 891 A.2d 1032, 1035 (Del Ch. 2006). The Court quoted from Abry, a case that involved two sophisticated parties arguing over a stock purchase agreement, and which addressed whether public policy would allow enforcement of a provision that limited liability for misrepresentation of fact:

... when a seller intentionally misrepresents a fact embodied in a contract--that is, when a seller lies--public policy will not permit a contractual provision to limit the remedy of the buyer to a capped damage claim.

Id.

Postscript

On a more macroeconomic level beyond the concerns of this case, it is also noteworthy to mention in passing that at least one corporate law scholar has suggested that Delaware Courts should consider refraining from addressing certain cases that arise in connection with the threat of increasing federal jurisdiction over corporate law--issues which are in no way raised in this case, but some of the legitimate procedural and policy reasons on which a Delaware court may rely for refraining to consider a case before it, are referenced in this case. See footnote 28 citing In Re Bear Stearns Cos. S’holder Litig., 2008 WL 959992 (Del. Ch. April 9, 2008). See generally Professor Edward Rock's recent lecture, here, addressing the broader policy issues (not applicable to the facts of this case), regarding when it might be preferable for a Delaware court to refrain from hearing a case before it. Although the good professor referred in his recent presentation primarily to the federal government being an indispensable party (as a majority shareholder) under Rule 19, some of the reasons for abstaining in this opinion may be generally relevant to his conceptual discussion.

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Total Holdings USA, Inc. v. Curran Composites, Inc., No. 4494-VCS ( Del. Ch. Oct. 9, 2009), read opinion here.

Professor Larry Ribstein has already prepared a scholarly analysis of this case, primarily addressing the choice of law aspects of the opinion. Here is a link to his expert insights on his Ideoblog. Of particular interest to those who litigate in Delaware courts is Professor Ribstein’s discussion of his extensive scholarship on the issue of why Delaware is often chosen in agreements as the law that governs the agreement, as well as the frequent consent to Delaware as the choice of forum. (The good professor’s scholarship was cited no less than four times by the Court of Chancery in this opinion, at footnotes 4, 22, 29 and 37. No doubt this is due in part to the Court’s recognition of Ribstein as one of our country’s leading experts on alternative entities, such as partnerships and LLCs, as well as choice of law issues.) I could not hope to do better than his treatment of the case, so I will limit my overview of the case to bullet points as a way to highlight some aspects of the case that I think may be useful for the average person making his living as a litigator.

This case should be compared conceptually with the very recent Court of Chancery decision in Choice Hotels International, Inc. v. Columbus-Hunt Park Dr. Bnk Investors, L.L.C., No. 4353-VCP (Del. Ch., Oct. 15, 2009), which was summarized on this blog here. In that case, which involved a very different factual and legal context, another member of the nation’s business court explained in great detail why various principles of comity and procedural fairness required that Delaware lawsuit to be stayed in favor of another pending case between the parties in another state. By contrast, this opinion in Total Holdings explains the compelling policy and principles that support the decision to allow the plaintiff  to have its case heard in Delaware, and rejecting the attempt by the defendant to escape Delaware primarily on “personal jurisdiction” grounds, based on a statutory and contractual analysis in addition to policy grounds.

Now for the bullet points:

• Section 15-114 of Delaware’s Revised Uniform Partnership Act (DRUPA) is a consent provision that, in essence, provides that if one serves as a partner in a Delaware partnership, one is thereby consenting to personal jurisdiction in a dispute involving the meaning of the general partnership agreement—especially when the agreement specifically chooses Delaware law. This provision is analogous to DGCL Section 3114 which provides that directors and officers consent to the jurisdiction of Delaware courts by virtue of agreeing to serve in that capacity with Delaware corporations.
• Section 15-1206(b) of the DRUPA was passed in 1999 and gave notice to all the world that as of the year 2002 its provisions would govern ALL partnerships.
• An example of the Court “pulling out all the stops” to keep this case in Delaware by explaining its rationale based on policy, statutes and contract interpretation, is the following money quote: “The idea that a state’s interests are only implicated by physical contacts is outmoded in all sorts of ways: one just has to think of how many businesses sell services without any physical contact with customers or even any delivery of physical product.” Slip op. at 17.
• The Court reiterates longstanding Delaware law that recognizes choice of law provisions as long as the jurisdiction selected is reasonable in the context of the contract. (See footnote 32 for supporting case, and Section 2708 of Title 6 of the Delaware Code which expressly authorizes such agreements by statute.)
• The venerable “internal affairs doctrine” applies with equal force to partnerships as it does in the more familiar corporate context , and Delaware “has a compelling policy interest in adjudicating” such disputes.
• A closing quote from the last page of the opinion, is a final example of how “really, really much” the Court of Chancery wanted to keep this case in Delaware (and for good reason):

“Absent a willingness to adjudicate such disputes when parties like Curran have voluntarily agreed to jurisdiction here, Delaware courts would undercut the efficiency-generating predictability that comes from forming a Delaware entity because parties could not rely on having access to our courts.”

 

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Viking Pump, Inc. v. Century Indemnity Company, et al., No. 465-VCS (Del. Ch., Oct. 14, 2009), read opinion here

The Delaware Court of Chancery’s 90-page opinion in this case, involving esoteric issues of whether certain claims are covered by historic insurance policies, may qualify in some circles merely by virtue of its length only as a novella or a doctoral dissertation, but alas, it covers a topic that strays beyond the typical scope of this blog (and the court primarily applied New York law), so it will be relegated to “bullet point treatment” in order to highlight cursorily a few nuggets that are most likely to be of interest to the typical reader of these pages.

• Warren Pumps LLC and Viking Pump, Inc. bought businesses from Houdaille Industries, Inc. and they seek to use insurance coverage that Houdaille purchased, in connection with pump manufacturing businesses that Houdaille used to own.
• On cross-motions for summary judgment under Chancery Court Rule 56(h), the Court ruled that Viking Pump and Warren Pump could exercise the rights of the insured under the applicable policies. The Court also made related rulings. See also prior ruling at: Viking Pump, Inc. v. Liberty Mutual Ins. Co., 2007 WL 2752914 (Del Ch. Apr. 13, 2007)(“Viking Pump I”).
• The Court reminded us that Delaware employs the Restatement (Second) of Conflict of Laws, and recited the five factors in Section 188 of the Restatement that are reviewed to decide what law governs a contract that is silent on the issue.  See also Section 193 that specifically applies to insurance contracts and Section 6 that provides “general” choice of law considerations.
• For an extensive choice of law analysis in a different context, involving jurisdiction over partners of a Delaware partnership, see the very recent decision in the Total Holdings case, by the same author of this opinion, highlighted on this blog here.
  

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Beard Research, Inc., et al. v. Michael J. Kates, et al., No. 1316-VCP,(Del. Ch. Oct. 1, 2009), read opinion here.

Kevin Brady, a highly regarded Delaware litigator, and an e-discovery expert, provided this synopsis.

This Court of Chancery decision is a follow-up to the Court’s opinion dated May 29, 2009, which was summarized on this blog here. In this latest opinion, Vice Chancellor Parsons found Defendants jointly and severally liable for Plaintiffs’ attorneys’ fees and expenses (including expert fees and expenses) associated with Plaintiffs’ Motion for Sanctions for Spoliation of Evidence with respect to the inspection of the disputed laptop’s hard drive. Vice Chancellor Parsons granted Plaintiffs’ application for fees in the amount of $56,546.00 and expenses in the amount of $20,360.80, for a total of $76,906.80.

By way of brief background, Plaintiffs had repeatedly requested the production of Defendant Kates’ laptop since 2005, asserting that it might contain files, emails, and other data relevant to the merits of this case. Defendants failed to produce it which resulted in the Plaintiffs filing three motions to compel production of Kates’ computer. By the third motion, unbeknownst to Plaintiffs or the Court, Kates already had reformatted the hard drive in the requested computer several times, replaced the drive, and then lost or discarded it.

On July 24, 2008 Kates finally complied with the July 24 Order, but not before he ran a disk cleanup program on the new hard drive and deleted files in “flagrant disregard” of the discovery rules and a litigant’s obligation to preserve potentially relevant evidence. Plaintiffs gave Kates’ laptop to their forensic computer consultant for inspection which showed that several files had been deleted on the evening of July 23, 2008 and several deleted files might have been relevant to the pending litigation. Plaintiffs then moved for sanctions for spoliation of evidence.

Scope of the Fee Award

Following the May 29 Opinion, Plaintiffs’ counsel submitted an itemized affidavit seeking attorneys’ fees and expenses associated with the Motion totaling $104,340.80. On June 25, Defendant ASDI objected to Plaintiffs’ claim for fees and requested that the award be reduced to $60,096.55 because certain fee or expense items included in the Affidavit were for work done outside the scope of the awarded fees and expenses. In addition, Defendants argued that the fees requested by Plaintiffs were generally excessive.

The Court disagreed, awarding Plaintiffs their fees and expenses that pertained directly to Plaintiffs’ efforts to gain possession of and inspect Kates’ computer. The Court noted that:

Plaintiffs [were] entitled to such fees and expenses incurred between July and September 2008 because Defendants wasted Plaintiffs’ (and the Court’s) time and resources by forcing litigation of a third motion to compel, even though the original hard drive in Kates’ laptop already had been changed, reformatted, and ultimately lost well before the July 24, 2008 hearing…. [and] those expenditures could have been avoided if Plaintiffs and the Court had known that the evidence of interest was no longer available.

Reasonableness of the Claimed Fees

Defendants also objected on the grounds that the total amount of fees sought were excessive given the nature of the related dispute. In addressing this issue, the Court looked to the eight-factors identified in Rule 1.5(a) of the Delaware Lawyers’ Rules of Professional Conduct as a guide to determining whether an attorney’s fee is reasonable. In particular, the Court focused on the first factor “the time and labor required, the novelty and difficulty of the questions involved, and the skill requisite to perform the legal service properly.”

Plaintiffs claimed a total of $83,980.00 in attorneys’ fees which represented the time of four attorneys. The Court however found that the activity in question should only require the work of two attorneys, so two of the attorneys’ fees were disallowed. The Court also noted that:

[b]ecause the motion for sanctions sought extensive relief directed to the merits of this case as a whole, including dismissal or an adverse inference in favor of Plaintiffs, the time spent by attorneys with that level of experience may have been reasonable. Much of the requested relief was denied, however, and my award of attorneys’ fees and expenses represents a more narrow sanction directed to the prejudice caused by the spoliation of Kates’ hard drive and the procedural missteps related to it.

The Court agreed with the Defendants that the claim for attorneys’ fees should be reduced by thirty percent based on the nature of the dispute for which fees were awarded.

Defendants also sought a reduction of the expenses submitted, but the Court found that the lion’s share of those expenses were for the services of Plaintiffs’ forensic computer consultant, and that the Defendants had failed to present any persuasive reasons for the Court to question the reasonableness of those expenses. As a result, the Court awarded Plaintiffs the full amount of the expenses they requested.

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In a post-trial opinion in City of Westland Police & Fire Retirement System v. Axcelis Techs., Inc., C.A. No. 4473-VCN (Del. Ch. Sept. 28, 2009),  read opinion here, the Court of Chancery denied a stockholder’s request pursuant to § 220 to inspect the company’s books and records because the stockholder failed to prove a “proper purpose” for its request.

Kevin Brady, a highly respected Delaware lawyer, provides us with the following synopsis of this case.

The Court found that the plaintiff had not demonstrated any basis from which the Court might infer wrongdoing in the Board’s business decisions and that plaintiff’s allegations and reliance upon a precipitous stock price fall were insufficient to support a § 220 request. Because the plaintiff’s request was denied, the Court dismissed the action.

Background

Plaintiff City of Westland Police & Fire Retirement System (“Westland”) is a beneficial owner of shares of Defendant Axcelis Technologies, Inc. (“Axcelis”). In 1983, Axcelis and SHI entered into a joint venture, SEN. In February 2008, SHI offered to acquire Axcelis for $5.20 per share (shares closed at $4.18 the day of the offer). The board of Axcelis rejected SHI’s proposal finding that the “price failed to compensate shareholders adequately for synergistic value of the SEN joint venture and ignored the substantial business opportunity to take market share back from Axcelis competitors.”

In March, 2008, SHI raised its bid to $6 per share (shares closed at $5.45 the day of the offer). The board of Axcelis again rejected the bid finding that a transaction with SHI would not to be in the stockholders’ best interests and stating that there would need to be a confidential exchange of information for serious negotiations to occur.

Director Elections – Resignations Rejected

In May 2008, Axcelis held its annual shareholders’ meeting at which the terms for three Directors (the “Three Directors”) were expiring. While the Three Directors ran unopposed for reelection, they all received less than a majority of the votes in their reelection bids (Axcelis employs plurality voting). The Court noted that in reviewing the facts, it assumed that the plaintiff’s position was correct – that this failure “was the result of a concerted effort by at least some Axcelis shareholders to ‘send a message to the board, expressing their discontent with [Axcelis’] unresponsiveness to SHI’ by withholding support for each of the Three Directors. . . .”

As a result of the vote, an Axcelis corporate governance policy (the “Policy”) was triggered pursuant to which, directors who do not “receive a majority of the stockholder vote must submit their resignations to the Board’s Nominating and Corporate Governance Committee, which must then consider and recommend to the Board whether such resignations should be accepted or rejected. The Board then must then accept or reject resignations submitted by its directors under the Policy.”

Accordingly, the Three Directors submitted their resignations but the Board decided not to accept the resignations. The Board cited the knowledge and experience of the Three Directors, as well as their importance in furthering negotiations with SHI.

Negotiations Renewed Without Success; Share Price Drops

In June 2008, Axcelis and SHI entered into a confidentiality agreement and SHI then had access to a significant amount of Axcelis’ information. Axcelis also imposed a September 4, 2008 deadline for SHI to submit an acquisition proposal. While Axcelis anticipated that this process would result in a revised bid from Axcelis, the deadline passed without a proposal and SHI put its discussions on “hold.” By this point, Axcelis’s shares were trading at $1.43 per share.

Westland Section 220 Demand Rejected

In December 2008, Westland delivered to Axcelis a demand for the inspection of books and records, pursuant to 8 Del. C. § 220. While Westland sought various categories of documents pertaining to the negotiations with SHI, Axcelis rejected the demand claiming that Westland had failed to satisfy the standard of § 220 and the corresponding Delaware case law.

Westland Files Complaint

In the beginning of 2009, Axcelis was in need of capital so it agreed to sell its ownership in SEN to SHI. On March 30, 2009 when the deal closed, Axcelis’ shares were trading at $0.41 per share. Just days later, Westland filed a Complaint seeking to compel inspection of certain Axcelis’ books and records pursuant to § 220. Westland alleged that the Board had breached its fiduciary duties in its decision to retain the Three Directors and in its handling of SHI’s bids. In its Complaint, Westland alleged as its “proper purpose” that the Board had breached its fiduciary duties by:

(1) rebuffing the attempts by SHI to negotiate an acquisition of Axcelis for more than 18 months; (2) subsequently rejecting two above-market acquisition proposals from SHI as inadequate; (3) retaining three candidates for the Board after a majority of the shareholders refused to support them, allegedly for their failure to negotiate with SHI; and (4) selling one of Axcelis’s most important assets, its stake in SEN, to SHI.

Plaintiff Failed to Demonstrate ”Proper Purpose”

Under § 220, a stockholder has a limited right to inspect the books and records of the corporation as long as the stockholder demonstrates that there is “a purpose reasonably related to such person’s interest as a stockholder” for the inspection. To succeed, a stockholder must present ‘some evidence to suggest a credible basis from which [this Court] can infer that mismanagement, waste, or wrongdoing may have occurred.’ Mere suspicion is insufficient.

Here the Court addressed two aspects of the Board’s alleged breaches: (i) the Board’s retention of the Three Directors; and (ii) the Board’s handling of SHI’s bids. With respect to the retention of the Three Directors, Westland alleged that the Board made its decision “for the purpose of entrenching those directors and themselves in office.” However, the Court found that the plaintiff had failed to demonstrate “any credible basis from which the Court might infer the foundational assumptions upon which the Plaintiff’s theory rests….” The Court determined that Westland’s “mere accusations are insufficient.”

The Court noted that the Three Directors had been properly reelected to the Board under Delaware corporate law’s plurality voting provisions. It was the stockholder vote that also triggered the Policy which then placed the Three Directors’ retention at the discretion of the Board. The Court held that the Board’s actions did not rise to the level of wrongdoing by exercising its discretion under the Policy to retain the Three Directors. There was “no evidence that the Board identified, and then sought to thwart, the will of the shareholder franchise by refusing to accept the resignations of the Three Directors.” The Court noted that if Westland wanted to remove the Three Directors, it should have supported an alternative slate. As the Court concluded, “[a] poor strategic choice cannot be the basis of a Section 220 action.”

Westland Invokes Unocal

Westland also raised a unique argument that the Board’s retention of the Three Directors amounted to a defensive measure thereby requiring the heightened standard under Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985). The Court found this argument unavailing, reasoning that there was no threat to Axcelis’ corporate control at the time of the May election.

With respect to the Board’s handling of SHI’s acquisition proposals, the Court likewise held that there was no basis for the application of Unocal. The Court held that the rejection of an acquisition offer alone is not a defensive action that would warrant the application of enhanced scrutiny of Unocal. Moreover, the Court held that there is no basis from which to infer that the Board engaged in wrongdoing when rejecting the bids.

Recognizing that Westland was interested in learning more about the negotiations and the ultimate loss of share value, the Court nonetheless held that Westland was required to “point the Court to something other than a precipitous drop in stock price before Section 220 inspection rights may be granted. Otherwise, Delaware corporations would be universally subject to the very burdens Section 220 was carefully designed to protect against.” Accordingly, the § 220 request was denied and the action dismissed.

Postscript: For a critical view of this case, a blog called The Race to The Bottom has a review of this case here. See also, Professor Larry Hamermesh's analysis of the case here.

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Dutiel v. Tween Brands, Inc., No. 4743-CC (Del. Ch. Oct. 2, 2009), read letter decision here.

This letter decision of the Court of Chancery addresses the issue of who should be appointed as lead counsel in this consolidated class action.

The different plaintiffs in the two different cases sought the appointment of two different firms as lead counsel.

Procedural Background

Initially, three separate putative class actions were filed in the State of Ohio to challenge a proposed merger between Tween Brands Corporation and Dress Barn, Inc. The parties in those three Ohio cases agreed to consolidate them and have the combined cases filed in Delaware, which they did. However, several weeks before the Ohio plaintiffs filed their combined putative class action complaint in Delaware, but subsequent to the filing of the Ohio actions, a new putative class action challenging the merger was filed in Delaware by a fourth plaintiff.

Analysis

The parties agreed on the factors that the Court should consider when ruling on a motion to designate a lead plaintiff or to appoint lead counsel, which include but are not limited to the following:

“(1) The quality of the pleading that appears best able to represent the interests of the shareholder class and derivative plaintiffs; (2) Weight to the shareholder plaintiff that has the greatest economic stake in the outcome of the lawsuit; and (3) Weight to whether a particular litigant has prosecuted its lawsuit with greater energy, enthusiasm or vigor than have other similarly situated litigants.”  (citing TCW Tech. Ltd. P’ship v. Intermedia Comm’s, Inc., 2000 WL 1654504 at *4 (Del. Ch. Oct. 17, 2000)).

The Court rejected the argument that the first to file a lawsuit in Delaware “wins some advantage in the race to represent the shareholder class . . . .“ The Court also observed that the economic interest of the Ohio plaintiffs together was approximately $11,000 at stake, while the economic interest of the Delaware plaintiff was about $900.

Also rejected by the Court was the idea that “a firefighter who arrives second to a fire is any less committed to dousing the flames.” Nor did the Court regard idioms as appropriate, reasoning that: “While the early bird may get the worm, sometimes it is the second mouse that gets the cheese.” See footnote 11.

In conclusion, the Court held that the combined cases between the Ohio plaintiffs and the Delaware plaintiff should be consolidated, and that the Ohio plaintiffs would be the lead plaintiffs and their counsel would be appointed as the lead counsel.
 

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Vice Chancellor J. Travis Laster, the newest member of the Delaware Court of Chancery, is the first  member of the Court to be interviewed for this blog.

The Honorable J. Travis Laster was sworn in at an investiture ceremony at the Court today, October 9, 2009. His Honor took a few minutes to talk with Kevin F. Brady and Francis G.X. Pileggi to answer a few questions.

Blog: Why did you want to make the change from private practice to a member of the judiciary?

VCL: The call to public service is very important to me. My parents were models in this regard. They are both teachers. I always knew that I wanted to do some type of public service, and being on the Court of Chancery was my “dream job". It includes of course, a public service component.

Blog: Is there any "formal judicial training" scheduled after your investiture before you start hearing cases?

VCL: Although there is no formal training for new members of the Court of Chancery, my extensive experience in practicing before the Court is certainly a form of training. Also, I plan to attend a mediation course to help me serve as a mediator, although I certainly participated in mediations during my 13 years of practice before the Court.

Blog: Will you take over all the cases that had been assigned to former Vice Chancellor Lamb at the time his term ended?

VCL: The 88 cases that Vice Chancellor Lamb had on his docket when his term expired will be “inherited” by me. In addition, recently filed new cases have also been assigned to me. I jokingly wondered if I got the nod because the initials VCL will be used after the case number for cases assigned to me and those are the same letters used for former Vice Chancellor Lamb’s cases.

Blog: What will you look for when you consider candidates for being your law clerk?

VCL: The most important qualifications will be “mental horsepower” and an interest in the topics within the jurisdiction of the Court, as well as the capacity to address complex issues quickly. I am currently using two clerks who were hired for me by Vice Chancellors Parsons and Strine before I was sworn in. They are Matt Levy from Duke and Mike Sirkin from Temple.

Blog: Do you have a "judicial philosophy" in terms of how you plan to deal with your docket of cases?

VCL: The word “balanced” is the best way to describe my approach to cases. As a product of the Delaware Bar, my experience representing both shareholders as well as management over the years allows me to understand the issues from both of those perspectives. It is important to make clear to litigants that they will receive, and they deserve, a fair and respectful hearing, and thoughtful consideration regardless of whether they are a large company or an individual of modest means.

Blog:  What are you looking forward to the most in your new job and what do you think will be the most challenging part?

VCL: One of the things that I am looking forward to the most is not needing to fill out time sheets. The most challenging part of my position will be to fill the shoes of my predecessor and live up to the high expectations of the Court. I am following Steve Lamb who was a tremendous judge and known and respected all across the country and that’s a tough act to follow. I am coming onto a court that has been praised as one of the nation’s best and whose colleagues are known for their opinions, insights and scholarship. This Court has a docket where you are deciding very big questions and opinions that get read by corporate practitioners and corporate scholars all across the country. So, it’s an exciting challenge but I am very mindful of those responsibilities and it’s a little bit humbling, but that I think is the most challenging thing for me.

Blog: What do you think you will miss about private practice?

VCL: One thing that I may miss about private practice is the flexibility of having my own firm to decide what resources I will have available as opposed to the more limited resources of the state.

Blog: What changes, positive or otherwise, have you seen in the practice of law in the past ten years?

VCL: The positive changes that I have seen include the greater sophistication of the lawyers and the law. I also view as a positive development the greater democratization of the Delaware bar which now has a more diverse array of lawyers who are respected participants in the corporate litigation area. A negative development is some of the harsher, more aggressive litigation tactics that we have not seen in Delaware. I think it is really important to maintain the traditional professionalism, civility and collegiality that Delaware has traditionally fostered.

Blog: Given the nature of the business disputes that come before the Court of Chancery, what changes do you see in the next five or ten years?

VCL: Without expecting any drastic changes in the future, depending on what the federal arena brings, one likely trend is the increase in “alternative entity cases” that we are already seeing more of. As for potential federal changes, there has always been a symbiotic relationship between federal and Delaware jurisdiction, and that give and take will likely continue.

Blog: Finally, what would you like people to know about you that you don't think they already know?

VCL: I want to be known as being “open to feedback.” My grandfather used to say that one should get all of the advice that one can, because some day one might be able to use some of it.

Blog: Thank you very much Your Honor for taking time out of your schedule to talk to us. We wish you the best of luck for a long and healthy tenure on the Court of Chancery.

VCL: My pleasure. Thanks for inviting me.
 

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BabyAge.com, Inc. v. Weiss, No. 4576-CC (Del. Ch. Oct. 1, 2009),  read opinion here.

This Chancery Court decision addressed two issues: (1) a motion for leave to amend a complaint; and (2) a motion to overturn the decision of a Special Master regarding advancement issues.
Court of Chancery Rule 15(d) permits a supplemental pleading to set forth new claims, with leave of Court, provided that the new claims relate to the original claims. The motion should be denied only if the plaintiff inexcusably delayed in making the request and the defendant is prejudiced as a result. The defendant bears the burden of proving inexcusable delay and resulting prejudice. In this case the new claim was for the advancement of legal fees incurred in pursuit of counterclaims. The original complaint made a claim for advancement of legal fees incurred in defending a declaratory judgment that was properly terminated. The new claim sufficiently related to the original claim and there was not a sufficient showing that prejudice would result from the amendment. The Court also reasoned that there was no need to engage in extensive new discovery.

Determination of Special Master

The Court made quick work of a request to reverse or overturn a determination by a Special Master about advancement of fees during May and June 2009. The Court denied that request and determined that the fees awarded by the Special Master should be paid immediately.

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eBay Domestic Holdings, Inc. v. Newmark, No. 3705-CC (Del. Ch. Oct. 2, 2009),  read letter decision here. See prior decision by the Court of Chancery in this case summarized on this blog here.

The procedural context of this letter opinion was a Motion to Dismiss, alleging that the issues presented were not ripe for judicial determination. The Motion to Dismiss eBay's requested relief was granted.

The key issue was whether there was a fiduciary duty claim and a waste claim that could be pursued based on the approval by the directors of Craigslist of a new indemnification agreement which had not been signed by the current directors and which they stated under oath would not be signed. The Court granted the Motion to Dismiss, reasoning that the fiduciary duty and waste claims were not ripe for judicial determination, because the indemnification agreements at issue were not entered into and there was no basis to establish that they would ever be entered into in the future. Moreover, no funds had been spent for the new indemnification agreement. Thus, the issues were not ripe for adjudication. 

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In West Willow-Bay Court, LLC v. Robino-Bay Court Plaza, LLC, No. 2742-VCN (Del. Ch. Oct. 6, 2009), read opinion here, the Delaware Chancery Court discussed the theories of mutual mistake and unilateral mistake as a basis to reform a contract. After applying the facts and analyzing the issues, the Court, in a 16-page opinion,  rejected the reformation arguments based on the circumstances in this case that involved a contract for the sale of a pad site and the issue of who had the obligation to obtain consents needed by third-parties for a proposed development.

Several prior decisions by the Court of Chancery in this case have been summarized on this blog here.

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Concord Steel, Inc. v. Wilmington Steel Processing Co., Inc., No. 3369-VCP (Del. Ch. Sept. 30, 2009), read opinion here. See prior decision of Chancery Court in this case summarized here.

In this Chancery Court opinion, Concord sought a permanent injunction and money damages for breach of a restrictive covenant. A preliminary injunction was granted in April 2008. After a three-day trial, post-trial briefing and oral argument, the Court granted a permanent injunction barring the defendants from breaching the covenant-not-to-compete until September 2011 and found liability for more than $500,000 in damages as well as “reasonable attorneys’ fees and expenses.”

This opinion provides a 44-page description of the Delaware law on covenants-not-to-compete, sometimes referred to as restrictive covenants or non-competition agreements.  Bottom line: the general rule is that they will be strictly enforced if they comply with the minimal prerequisites applicable, despite what can be extreme hardship--even  bankruptcy for the party against whom enforcement is obtained (which can be a business or an individual, or both.)

The Non-Competition Covenant in this matter was contained in an Asset Purchase Agreement (“APA”) between Concord Steel and Wilmington Steel Processing Co. (“WSP”). The Non-Competition Covenant provided that for a period of four (4) years, WSP (and its CEO) would not engage in or have an interest, “anywhere in the world” in any “competitive business” as was defined in the agreement. The litigation focused on the definition of “competitive business” in the agreement.

Procedural Background

The complaint in this case was filed in November of 2007, at which time a preliminary injunction was also sought. After oral argument in March 2008, the Court granted a preliminary injunction in April 2008. The trial took place in October 2008 and post-trial oral arguments took place in April 2009. The prior decision on the preliminary injunction is sighted as Concord Steel, Inc. v. Wilmington Steel Processing Co., 2008 WL 902406 (Del. Ch. April 3, 2008), and linked above

Summary of Claims

Concord argued that WSP violated the proscription against engaging in a “competitive business” as defined by the APA by accepting and performing a very specific type of work that was described in detail in the opinion.  Defendants deny any breach and argue that the Non-Competition Covenant did not prevent them from performing the work at issue. Also, Defendants urged as a defense to the imposition of a permanent injunction that it would be an “invalid restraint on competition” and that it would not advance any legitimate economic interest of Concord. They also object to the request for lost profits as being based on gross, rather than net, profits.

Analysis

The Court reviewed the elements of a breach of contract claim which needs to be proven by a preponderance of the evidence. See footnotes 55 and 56. The Chancery Court reiterated the well settled Delaware law on contracts which is a “objective theory of contracts” and that a determination about whether a contract is ambiguous is a question for the Court to resolve as a matter of law. See footnotes 58 through 69.

The Court engaged in an extensive factual and legal analysis of the intent of the parties, including extrinsic evidence in the form of testimony by experts in the steel industry. After a careful deductive process, the Court concluded that the Non-Competition Covenant was breached. The Court also rejected a laches defense, in light of the finding that Concord sued within one month of becoming aware of the claim.

The Court reviewed the prerequisites for obtaining permanent injunctive relief. See footnote 110. For specific performance of a Covenant-Not-To-Compete, the Court also recognized the well established requirements that it must be demonstrated by “clear and convincing evidence that the Non-Competition Covenant is reasonable in geographic scope and temporal duration, and advances Concord’s legitimate economic interest.” (See footnote 111.)

In reviewing the balancing of equities aspect of the elements of injunctive relief, the Court was not persuaded that enforcement of the covenant “would be fatal to WSP.” The Court’s reasoning was based on its finding that WSP would still be able to do some work that was outside of the restricted behavior. Rather, the Court explained that an injunction would merely put the parties in the position that they agreed to be in under the APA. [Sidebar note: The author of this blog post can attest from experience that bankruptcy can result from enforcement of these covenants but that is a risk of the party who enters into these agreements, and one should not expect to be saved via the "balancing of the equities test.".]

Money Damages and Lost Profits

The Court determined that the proper measure of damages would be gross profits of WSP and not the net profits because under Delaware law, “fixed costs generally are not deducted from lost profits.” See footnote 121.

In addition, the Court relied on a provision in the APA that awarded attorneys’ fees to the prevailing party in the event of a breach. In closing, the Court ordered that counsel for plaintiffs submit a stipulated or proposed form of judgment in accordance with the opinion and in accordance with Section 4734 of Title 10 of the Delaware Code. (Ouch.)

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ZRII, LLC v. Wellness Acquisition Group, Inc., (Del. Ch., Sept. 21, 2009), read opinion here. This 43-page Chancery Court decision addresses issues common to business litigation matters. Key employees leave to compete with their former employer, which was based in Utah. The Court applied Delaware law to determine that the prerequisites for a preliminary injunction were satisfied, as well as whether the fiduciary duties of officers were breached. Utah law applied, however, to the substantive claims of civil conspiracy and tortious interference with business relations; misappropriation of confidential information and trade secrets; and breach of company contracts. It  light of only a portion of the opinion applying Delaware law, and despite the extensive factual background in the Court's opinion, this will be a relatively short synopsis.

Bottom line: This opinion is noteworthy, for purposes of this blog, primarily due to its imposition of fiduciary duties on officers of an LLC in the procedural setting of a preliminary injunction motion based on Delaware law. The fiduciary duty claim is analyzed in the unusual context of a discussion about whether the elements of civil conspiracy under Utah law are satisfied.

The familiar elements that must be satisfied for a preliminary injunction are recited at page 21 of the opinion. (See, e.g., footnote 93. See also footnotes 130 and 134). For the probability of success on the merits factor, the Court focused on the application of that element to the civil conspiracy claims under Utah law. The Court describes in extensive detail the somewhat sordid details, such as spoliation of evidence, but in the end they do not relate directly to the analysis of Delaware legal issues, so I will not cover them here.

The parties did not disagree with the application of Delaware law for the imposition of fiduciary duties on the officers of the Delaware LLC. (See footnote 115). The Court found that there was a likelihood of success on the claims that the officers conspired in furtherance of their own interests--rather than the best interests of the company, to take over the company (or later take its employees to compete against it). In sum, the Court granted a preliminary injunction, but limited its duration to three months due to other proceedings among the parties where the remainder of the claims would apparently be addressed.

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The Washington Legal Foundation published an article here last week that is an overview I did of the recent Delaware Chancery Court decision in Wayne County Employees’  Retirement System v. Corti, 2009 Del. Ch. LEXIS 126 (Del. Ch. 2009). The Court's opinion describes the duties of directors in the context of a contested transaction and also recites the Revlon duties of directors.

UPDATE: Professor Stephen Bainbridge, whose corporate law scholarship is often cited in Chancery Court opinions, refers to this decision here.

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Business litigation fans, or those interested in the latest developments occurring in Delaware corporate and commercial litigation in general, may be interested in a trial slated to begin soon in Delaware Chancery Court between two online titans, Craigslist and eBay. An article about the imbroglio is described in a Bloomberg article here as follows:

Executives of EBay, the most-visited e-commerce site, obtained a seat on Craigslist’s board after buying 28 percent of the company’s shares and used that access for “data mining,” lawyers for Craigslist claimed in a filing in a Delaware lawsuit over the company’s decision to adopt corporate defense measures. 

Courtroomview.com is expected to have a live video/audio feed of the trial, available online in real time. Their website here describes the trial as including an issue about whether: "... actions by the popular online community's board of directors "unfairly diluted" Ebay's 28.4 percent stake in Craigslist."

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J. Travis Laster was confirmed today by the Delaware Senate to become the newest Vice Chancellor on the Court of Chancery for the State of Delaware. October 9 is expected to be the date of his investiture and swearing in ceremony when he takes his seat on the Court. Here is a prior post on this blog about the Governor's appointment last month. By all accounts, the newest member of the nation's premier business court will continue the tradition of intellectual rigor, fairness, promptness and expertise in handling corporate and commercial litigation. We wish him a long and healthy tenure as a member of the Delaware Judiciary. Hat tip and thanks to Kevin Brady for providing the update--and for giving us hope that we may have an interview of sorts with soon-to-be Vice Chancellor Laster in the near future to publish on these pages. (The image above is the Court of Chancery Courthouse in Georgetown from the Court's website.)

UPDATE: Professor Stephen Bainbridge, whose scholarship has been cited in Chancery Court opinions, adds his approval here.

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In R&R Capital, LLC v. Merritt, No. 3989-CC (Del. Ch. Sept. 3, 2009), read letter decision here, the Court: (i) granted plaintiffs’ motion for summary judgment on their claim that defendant Merritt was properly removed as the manager of the several limited liability companies (“LLC”); and (ii) entered an order appointing a receiver to wind up the business and affairs of those LLCs.

Kevin Brady, a highly regarded Delaware litigator, provides the synopsis for this case.

A prior opinion in this case by the Court of Chancery, highlighted on this blog here, discussed the contractual flexibility of the LLC Act and detailed the public policy analysis regarding the LLC Act. That opinion is recommended reading for the Court’s view of the “theoretical underpinnings” that set the parameters for drafting an LLC agreement.

Background

Defendant Linda Merritt was the manager of various Delaware limited liability companies (the “Entities”). Merritt was a member and the manager of the Entities since they were formed. Plaintiffs also are members of the Entities. Merritt was the only manager of the Pandora Entities and PDF Properties, LLC was its sole member. Plaintiffs had certain contractual rights under the operating agreements of the Pandora Entities. However, as characterized by the Court, “the working relationship of the Entities’ members is, to put it mildly, dysfunctional and beyond repair or reconciliation.”

In 2007, Merritt allegedly told plaintiffs that she was selling real estate for approximately $300K and that plaintiffs would receive approximately $130K and Merritt would get approximately $150K from that sale. Plaintiffs contested the distribution of the sale proceeds, but Merritt sold the property without plaintiffs’ consent and without making any distribution to plaintiffs. Although Merritt claimed that the sale proceeds were used to pay LLC expenses, Merritt did not provide an accounting to show these payments. In addition, the parties disagreed over Merritt’s management of Grays Ferry Properties, LLC and the Pandora Entities.

Plaintiffs claimed that:

(1) Merritt failed to timely pay city, state and/or federal taxes related to the Entities, (2) there are outstanding judgments and/or liens against the Entities as a result of Merritt’s conduct, and (3) many of the Entities have had their certificates of formation cancelled by the State of Delaware for failing to pay their required annual taxes or for failing to maintain a registered agent for service of process.

In turn, Merritt brought a number of grievances with respect to plaintiffs’ conduct.

Notice of Removal Sent

In August 2008, Plaintiffs sent Merritt a notice of removal as manager of the Entities under the “for Cause” section of the Entities’ operating agreements, which permitted removal for cause where the manager “(a) engaged in fraud or embezzlement, (b) committed an act of dishonesty, gross negligence, willful misconduct, or malfeasance that has had a material adverse effect on the Company or any other Member, or (c) been convicted of any felony.”

The notice of removal was sent because of allegations that Merritt had committed fraud in a transaction involving the sale of thoroughbred horses to R&R Capital, LLC (“R&R”). At the time, this alleged fraud was the basis of a lawsuit in the Eastern District of Pennsylvania brought by R&R. At the time of the notice, Merritt was not immediately removed, but was allowed to remain as the manager pending the decision of the Eastern District, which ultimately held that Merritt had committed fraud.

Court Rejects Merritt’s Defenses

In granting Plaintiffs’ motion for summary judgment, the Court rejected Merritt’s three arguments. First, the Court disagreed that the Plaintiffs were estopped by res judicata, collateral estoppel, or judicial estoppel. While the Plaintiffs had raised fraud allegations in another matter in New York, that issue was not decided and thus the finality requirement for these three defenses was not satisfied.

Second, the Court held that in the straightforward unambiguous reading of the operating agreements, the material adverse effect clause represented an individual basis for removal, separate from the fraud basis. Merritt alleged that for cause removal was permissible only if the fraud was accompanied by a material adverse effect. However, the Court disagreed in favor of the plain language of the Operating Agreements.

Finally, the Court discarded Merritt’s “last ditch effort” to claim that “the August 2008 notice was not immediately effective because there was never a judicial finding of ‘cause’ when the notice was sent to her. . . .” The Court held that the notice was proper and effective because Merritt was not removed immediately but rather remained as manager pending a finding of fraud by the Eastern District.

Summary Judgment Granted and Receiver Appointed.

The Court noted that the removal of Merritt as the manager would not be the end of the problem. The Court stated that because Merritt was still a member of the Entities and given the lack of any relationship among the members, the Court required the parties to submit the name of a potential receiver to wind up the Entities.
 

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Martinez v. Regions Financial Corp., No. 4128-VCP (Del. Ch. Sept. 9, 2009), read letter decision here. Also, an implementing Order accompanying the decision that provides for a procedure to address reasonableness of advanced fees, is available here. 

Kevin Brady, a highly regarded Delaware litigator, provides the synopsis of this case.

The Court of Chancery in this September 9 ruling issued a follow-up opinion to its August 6, 2009 decision regarding a dispute between plaintiff, Susan A. Martinez, and defendant, Regions Financial Corporation, wherein plaintiff sought to enforce a change of control agreement. In its August 6 decision, the Court had directed the parties to submit an appropriate form of order reflecting the Court’s rulings. See Martinez v. Regions Fin’l Corp., No. 4128-VCP, 2009 WL 2413858, at *15 (Del. Ch. Aug. 6, 2009), summarized on this blog here. The parties, unfortunately, could not reach agreement so they went back to the Court for guidance on two issues: (i) whether a claim voluntarily withdrawn by plaintiff after defendant moved for summary judgment and filed its opening brief should be dismissed with or without prejudice; and (ii) what procedure should be followed for submission and payment of the plaintiff’s invoices for advancement and to the extent there are disputes about those invoices, how the dispute should be resolved.

Dismissal of Purportedly Withdrawn Claim

After the Complaint was filed, there were cross motions for summary judgment. The
August 6 decision addressed defendants’ summary judgment motion as to the Counts I – IV, but did not discuss Count V, because plaintiff voluntarily withdrew that claim in a footnote in her answering brief. Plaintiff claims that “because [defendant] neither opposed withdrawal of Count V nor suggested that the withdrawal should result in dismissal with prejudice of that claim, [plaintiff] should not be barred from raising Count V in the future.” In response, defendant claims that the plaintiff “cannot voluntarily withdraw a claim in the face of a motion for summary judgment without consequence.”

The Court noted that dismissal of a claim may be treated as an attempt to amend the complaint and that the Court, as a matter of discretion, typically grants such a motion to amend “‘if justice so requires,’ unless the moving party has been guilty of undue delay, bad faith, or dilatory conduct.” The plaintiff neither sought leave of Court nor the consent of defendant before withdrawing the claim after defendant moved for summary judgment on all claims. Moreover, plaintiff failed to explain any reason for withdrawing the claim or show good cause as to why that claim should be dismissed without prejudice. As a result, the Court dismissed Count V with prejudice.

Procedure for Payment of Attorneys’ Fees and Expenses Pursuant to Advancement Ruling

Since the parties could not come to any agreement as to a form of order, the Court determined that the plaintiff must submit copies of invoices for fees and expenses incurred by plaintiff to defendant and file a notice of such submission with the Court. Defendant then has thirty days to make payment. If defendant disputes the reasonableness of any of the submitted invoices, defendant “shall (i) remit the undisputed amount plus prejudgment interest within thirty days of submission of the invoices to [defendant], (ii) advise [plaintiff] in writing with specificity of any and all disputes respecting the reasonableness of the invoices (“Objections”) within twenty days after the date the invoices were submitted to it, and (iii) simultaneously file those Objections with the Court” and the Court will schedule a telephone conference to resolve them
 

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For any readers interested in watching and listening to a video/audio clip of Delaware Chancery Court proceedings from the convenience of your computer, you are in luck. Last Friday in the case of PPF Safeguard v. BCR Safeguard Holding, Del. Ch., No. 4594, a hearing was held on a motion to intervene by various insurers in a suit related to Hurricane Katrina damage and litigation in Louisiana. Courtesy of www.courtroomview.com,  here is a link to a few minutes for free. In general, www.courtroomview.com  provides this service for a fee to broadcast live the proceedings for selected cases. This clip covers part of the referenced hearing before Vice Chancellor Strine.

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eBay Domestic Holdings, Inc. v. Newmark, Inc., No.3705-CC  (Del. Ch., Sept. 16, 2009), read letter decision here.

The Chancery Court addressed three issues of practical importance in most corporate and commercial litigation matters in Delaware and elsewhere.

1. Should certain documents be designated as merely "confidential" as compared to "highly confidential", the latter designation requiring that the documents may be viewed by outside counsel only and not their clients;
2. Whether specific documents that were produced should be treated as privileged--thus resulting in a waiver of the privilege for the subject matter covered by those documents; and
3. Whether a party should be entitled to a clawback of certain documents that were inadvertently produced.

The Court's 4-page letter ruling is pithy and full of practical analysis that deserves a place in every business litigator's toolbox.

First, the argument made to change the designation to merely confidential was based on the lack of technical expertise by outside counsel to understand the import or nuances of the documents in question. The reply to that argument is that the documents were produced on the condition that they be restricted to viewing by outside counsel. The Court  ordered eBay to review 1,900 selected documents and make a good faith determination about whether they warranted the more limiting designation, and any document not designated in good faith as highly confidential must then be re-designated as merely confidential.

The second and third issues  were somewhat conflated. eBay initially produced the documents in dispute, but after defendants argued that the documents were privileged and therefore their production resulted in a waiver of subject matter privilege, eBay sought to clawback the disputed documents. The Court determined that the good faith production of reviewed documents did not result in a waiver of privileged communications between counsel.

The Court's rationale was to "avoid discouraging litigants from making a good faith effort to produce non-privileged documents while withholding documents that are privileged." The Court also held that if eBay inadvertently produced documents that were truly privileged, that they could recall those documents without waiving the privilege.

In sum, the Court concluded that there would be no waiver, and whether or not the documents should be withheld would be based on whether they were privileged. eBay thus far had not met its burden to establish that the documents at issue were privileged, but the Court gave eBay one  more week to prepare a privilege log to establish their status as privileged--after which the defendants could present their objections and then the Court would make a final ruling on whether the documents involved deserved to be designate as privileged.

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Julian v. Julian, No. 4137-VCP (Del. Ch. Sept. 9, 2009), read opinion here. Two of the prior opinions in this case by the Chancery Court were highlighted on this blog here and here.

The Court referred to other proceedings among these parties, including the following separate cases pending in the Delaware Chancery Court in what the Court described as this “unending tale of internecine strife”: Julian v. Eastern States Constr. Serv., Inc., No. 1892-VCP (Del. Ch. filed Jan. 18, 2006) and Julian v. Julian, No. 4099-VCP (Del. Ch. filed Oct. 16, 2008).

Issues Addressed

This opinion dealt with the following issues: (1) Aiding and abetting the breach of a LLC manager’s fiduciary duty by either not objecting to or enjoying the benefit of actions taken by the manager; (2) The statutory requirements under the Delaware LLC Act applicable to the resignation of an LLC member; (3) Issues of substantive arbitrability; and the standards applicable to a motion to dismiss and a motion to stay litigation.

Factual Background

The sum and substance of the factual background involved three brothers whose family controlled a multitude of companies. One of the brothers resigned from seven of the LLCs and alleged breaches of fiduciary duty at two other LLCs from which he did not resign. Some of the LLCs had arbitration clauses and some of them did not. Arbitration proceedings among the brothers have been instituted contemporaneously with the several pending cases in Chancery Court and among the issues addressed was which claims are subject to arbitration.

Right to Resign as LLC Member

Two different versions of 6 Del. C. Section 18-603 of the Delaware LLC Act applied to the seven LLCs from which one of the brothers purportedly resigned. The first version of Section 18-603 applied to those LLCs that filed a Certificate of Formation that was effective on or before July 31, 1996. That version allowed a member of an LLC the right to resign upon not less than six months prior written notice.

Those LLCs formed after July 31, 1996 were governed by the current version of Section 18-603 which “prohibits members from resigning prior to the dissolution and winding up of the company unless such resignation is allowed by the LLC Agreement.” See footnote 6. Generally, the right of a member to resign from an LLC is governed by the terms of the LLC Agreement unless, as here, the agreement is silent in which case the right is governed by Section 18-603.

Standards Applicable to Various Motions

The Court discussed the different standards applied to a motion to dismiss under both Rule 12(b)(1) for lack of subject matter jurisdiction when the claims involved are governed by an arbitration clause--as compared to a motion under Rule 12(c) [which is similar but not identical to a Rule 12(b)(6) motion], and is known as a motion for judgment on the pleadings.

In addition, the Court discussed the standards applicable to a motion to stay litigation, which is governed by the Court’s inherent power to manage its own docket. This power allows the Court to issue a stay pending the resolution of an arbitration, on the basis of comity, “efficiency or common sense.”  When considering a stay of claims that are not subject to arbitration, the Court “looks to the preclusive effects of a pending arbitration elsewhere on the action before the Court and vice-versa, as well as the burden imposed by litigating actions in different fora (citing Salzman v. Canaan Capital Partners, L.P., 1996 WL 422341, at * 4-5 (Del. Ch. July 23, 1996)). The Court found an insufficient basis to stay the litigation.

Substantive Arbitrability

A substantial portion of the 28-page opinion was devoted to the issue of substantive arbitrability. By contrast, procedural arbitrability addresses issues such as whether the proper notice was given to initiate the arbitration, and that ruling is generally made by the arbitrator. Substantive arbitrability is generally addressed in two parts, the first being whether the issue at hand comes within the scope of the arbitration clause. The second part of substantive arbitrability is whether the Court or the arbitrator shall decide whether the issue at hand is within the scope of the arbitration clause. The controlling Delaware law that decides that issue is based on the seminal Delaware Supreme Court decision in James & Jackson, LLC v. Willie Gary, LLC, 906 A.2d 76, 79 (Del. 2006). See a summary of that decision on this blog here.

Although a determination of the substantive arbitrability issue can be quite involved and the Court devotes many pages to the analysis as applied to the facts of this case, the general rule is that unless the parties unequivocally provide for the arbitrator to make that decision, such as referring to the American Arbitration Rules which so provide, the presumption is that the Court will determine whether the issue at hand is within the scope of the arbitration clause. See footnotes 35 to 38.

Aiding and Abetting Breach of Fiduciary Duty

The Court addressed a motion to dismiss for failure to state a claim for breach of fiduciary duty. In response, instead of establishing a breach of fiduciary duty, the plaintiff argued that there was a claim for aiding and abetting breach of fiduciary duty. Thus, analyzing that different claim, the Court described the necessary elements for a claim of aiding and abetting a breach of fiduciary duty as follows: (1) Knowledge of the breach of the duty; and (2) Participation in the wrongful conduct. The complaint alleged that the manager of the LLC increased management fees by 400% with the “consent of” the defendant charged with aiding and abetting the breach. The Court’s reasoning for allowing the claim to go forward deserves to be quoted. The Court explained that:

“Under the plaintiff-friendly motion to dismiss standard, the allegations that Richard [the member of the LLC alleged to have aided and abetted the breach] consented to the increase in fees, which benefited a company controlled by Richard and Francis [the manager of the LLC], are sufficient to support a reasonable inference that Richard participated in the alleged wrongdoing. The fact that Francis could have taken that action on his own as a manager does not negate a reasonable inference that Richard may have been involved in the decision. The evidence conceivably could show that Richard knew about the increase and supported it, even though he also knew that fee increase of 400% would have been suspect, especially in light of the family feud he and Francis had with Gene [the plaintiff brother] and the fact that he and Francis stood to benefit from the increased fees.”

In footnote 69, the Court addressed the argument that the LLC Agreement gave Francis “wide discretion to make decisions.” The Court cited to Section 18-1101(c) of the Delaware LLC Act for the provision that an LLC Agreement cannot eliminate the implied contractual covenant of good faith and fair dealing.

Concluding Remarks with Equitable Flavor

Finally, as an example of its exercise of equitable principles as opposed to strict compliance with procedural rules, the Court rejected an argument that the claim for aiding and abetting was not specifically pleaded in the complaint and should thus be dismissed based on Chancery Court Rule 15(aaa) [which provides for dismissal if a complaint is not amended in response to a motion to dismiss].  The Court reasoned in footnote 69 that “the argument lacks merit for the facts alleged in the Complaint suffice to support an aiding and abetting claim. To the extent a formal amendment to the Complaint in that regard might be considered necessary, I find that a dismissal with prejudice would not be just under all the circumstances. The most that would be warranted in terms of relief is a dismissal without prejudice, and I find that unnecessary.”

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Merrill Lynch Trust Company, FSB v. Campbell, No. 1803-VCN (Del. Ch. Sept. 2, 2009), read opinion here. Read summary of prior Chancery Court decision in this case here.

(Chancery Court Courthouse--from Court's website)

Background

The Court’s own introduction to this 35-page opinion is best quoted:

“The financial advisor (or sales representative) of a major brokerage firm improvidently advised an elderly woman to place most of her life savings in a charitable remainder unit trust with a 10% annual payout, lifetime gifts to her children and successor-beneficiaries, and the remainder to go to five charities, an event expected to occur almost half a century later - - objectors that all now seem to agree and understand were unrealistic and likely unattainable. In the spirit of cross-selling, a trust company sister entity of the brokerage firm was designated trustee. Legal advice was provided by an attorney selected by the brokerage firm; the attorney never even spoke with her client, the trustor.

In order to achieve the desired annual distribution and to maintain any hope of preserving principal for the benefit not only of the intervening life beneficiaries but also of the charities, the trust company invested the assets almost exclusively in equities. When the financial markets experienced a downturn, this investment strategy, which arguably suffered from a lack of diversification, resulted in a drastic drop in the asset value of the trust.”

The original challenge by the trustor to the wisdom of the advice that lead her to establish a unit trust in the first instance was barred by the Court as untimely. In this post-trial memorandum opinion, the Court found that the trust company “generally acted within the broad discretion accorded it under the controlling trust document, as well as the laws of Delaware governing the actions of fiduciaries and trustees. Certain payments from the trust related to the arbitration between the trustor and the brokerage firm, however will be disallowed.” The arbitration proceeding in which the trustor first asserted claims against a brokerage firm based on the investment mix was not successful for the trustor. Moreover, the trust company refused to be replaced as the trustee.

This decision shows how exceedingly difficult it is to remove a trustee even based on what appears on the surface to be a compelling factual situation.

The decision is notable for its discussion of the applicable “prudent investor standard” that governs the investment strategy of a trustee. See footnotes 54 to 58. Also noteworthy is the Court’s reference to the obligation of a trustee to consider the interest of all beneficiaries (see footnote 66), and the Court's observation that the discretion of a trustee is only subject to review by the Court on a “abusive discretion standard” (see footnote 70).

In footnote 76 the Court observed that there was “something unsettling about allowing MLTC [an affiliate of Merrill Lynch] to evade liability . . . It no doubt seems unfair to Campbell.” However, the Court also noted that the “fatal flaw of this unhappy tale is found in the Trust Agreement itself. Fiduciary duties, always contextual,” did not allow the Court to second guess the investment decisions, and in light of the formation date making certain claims time barred, no breach of the prudent investment standard could be found.

Attorneys’ Fees

To add insult to injury, the Court recognized that it was constrained by the traditional Delaware law that the payment of fees for attorneys out of the trust corpus has been considered to be generally proper where the: (i) attorney’s services are necessary for the proper administration of the trust or (ii) the services otherwise result in a benefit of the trust. This is true regardless of whether litigation is successful or not.

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Smith v. Horizon Lines, Inc., No. 4573-CC (Del. Ch., August 31, 2009),  read letter decision here. ( A separate complaint involving Horizon in a class action suit pending in federal court in Delaware can be read here.)

Holding

This letter decision found a lack of strict compliance by the plaintiff with the section of the Delaware General Corporation Law (“DGCL”) that allows a shareholder to demand books and records from a corporation. In particular, Section 220(b) of the DGCL imposes certain prerequisites that must be satisfied in order for the stockholder to obtain  certain corporate books and records.

Summary of Court's Reasoning

DGCL Section 220(b) provides that where a stockholder is other than a record holder of stock, the demand under oath for books and records shall state the status of the person as a stockholder, and also must be “accompanied by documentary evidence of beneficial ownership of the stock, and state that such documentary evidence is a true and correct copy of what it purports to be.” However, in this case the demand letter was accompanied merely by a heavily redacted account statement that showed simply that someone by the name of Smith owned “some type of Horizon security at some unknown time.” The Court relied on a prior decision in which a complaint under Section 220 was dismissed for failure to strictly comply with the statute.  See Mattes v. Checkers Drive-In Rests., Inc., 2000 WL 1800126 (Del. Ch. Nov. 15, 2000).

In the present case, the Court reasoned that the “heavily redacted page that lacked the full name of the owner and the date of ownership does not satisfy the ‘documentary evidence’ requirement of the statute and therefore supported dismissal.”

There were two primary bases for the Court’s reasoning. First, the Court determined that the requirement in Section 220 for both “documentary evidence of beneficial ownership of the stock” and that the beneficial owner “state that such documentary evidence is a true and correct copy of what it purports to be”  must both be satisfied. The sworn statement of the stockholder is an independent requirement under Section 220 and the Court emphasized that such a statement was not a substitute for the separate requirement of “documentary evidence of beneficial ownership.”

The second pillar on which the Court’s reasoning relied, was explained by the Court in terms of the intent of the General Assembly which wanted any stockholder who was not a “record owner” (i.e., that the company could independently confirm as a shareholder), to prove her beneficial ownership. This purpose of Section 220 could not be served if the shareholder supplies a document that does not actually evidence that she is the beneficial owner of the stock on the relevant date.

Conclusion

In sum, although the Court found that the failure to comply strictly with the statute required that the Motion to Dismiss be granted, without prejudice, the Court also allowed for the complaint to be amended within 30 days with a new demand letter that attached unambiguous documentation to evidence beneficial ownership of Horizon stock.

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In re Countrywide Corp. S’holders Litig., 2009 WL 2595739 (Del. Ch., Aug. 24, 2009), read letter decision here.  The Chancery Court's separate letter decision of August 28, 2009 approving legal fees relating to the settlement in this case can be read here.

Prior Decisions

The prior decision of the Chancery Court in which the court refused to approve the class action settlement in this case,  In re Countrywide Corp. S’holders Litig., 2009 WL 846019 (Del. Ch., Mar. 31, 2009), was reviewed by Kevin Brady here. Other posts on this blog involving Countrywide cases can be found here.

Background

The background facts were described in the synopsis of the March 2009 opinion by Kevin Brady at the above link. Familiarity with that opinion is presumed and a summary of the facts will not be repeated. In sum, a class action suit was filed shortly after Countrywide announced that it was merging with Bank of America in January 2008. In exchange for supplementatl disclosures prior to the vote, but no additional monetary consideration, the parties negotiated a settlement. In the March 2009 opinion, the Chancery Court refused to approve the settlement based on an objection by one shareholder that the release should not cover certain common law fraud claims that could be brought in light of a speech by the CEO of BOA, Kenneth Lewis, to the Delaware State Chamber of Commerce on January 14, 2008, in which he dismissed rumors of Countrywide's bankruptcy and asserted that Countrywide had a "very impressive liquidity plan...." After the March 2009 opinion, the release was amended accordingly.

Now, the same shareholder objects to the release of potential federal securities laws violations based on the same statements of Lewis.

Overview of August 24, 2009  Decision

• The Court  explained its duty to apply various factors to make an independent determination about whether the proposed settlement was fair and reasonable
• Rule 23(a)  and  Rule 23(b) must also be satisfied before the Court will conclude that this case should be certified as a class action--which must precede the Court's approval of the proposed class action settlement.
• In certifying this case as a class action, the Court did not require an opt-out right for class members
• The  Court rejected the objections to the settlement and approved the settlement  based on the following rulings and reasoning:

• The absence of a monetary benefit "is not fatal to a settlement which, almost by definition, confers only a therapeutic benefit." The Court found the merger price fair and that there were no other potential buyers--and that the shareholders would have done worse without the merger.

• The Court reviewed the elements that must be established for a successful fraud action based on the federal securities laws (which the objector arged should not be released), and found that those claims "possess no obvious value" (based on the unlikely success in pursuing them on the facts of this case.) Thus, the Court reasoned it was fair and reasonable to release them.

• The federal securities laws claims based on the Lewis statements did not predominate over the equitable claims.

• The release provision in the settlement proposal is not overbroad. In reaching this conclusion, the court evaluated not only the claims in the complaint but also those that might be barred due to the release. See Raskin v. Birmingham Steel Corp., 1990 WL 193326 at *6 (Del. Ch. Dec. 4, 1990). See also In Re Philadelphia Stock Exchange, 945 A.2d at 1145-46 (Del Ch. 2008)(a settlement can release claims not specifically asserted in a settled action only if those claims are "based on the same factual predicate or the same set of operative facts as the underlying action".)

• There is no requirment that a specific claim be included in a lawsuit in order for it to be released. Id., 945 A.2d at 1137

•  An objector is not required to present its common law fraud claims (that it wants carved out of the settlement) with the same specificity as would be needed when pleading in a complaint.

• Approval of a class action settlement by the Court of Chancery only requires a cursory scrutiny of the issues presented, but the Court's consideration must be the product of a logical and deductive process. 

 The Court thus concluded that the class treatment was proper, the case was certified as a class action and the proposed settlement was approved.

Attorneys' Fees

In its letter decision of August 28, 2009 approving attorneys' fees (linked above), the Court  recited the familar factors it must consider in reviewing an application for fees, as announced in the seminal Supreme Court opinion of Sugarland Indus., Inc. v. Thomas, 420 A.2d 142 (Del. 1980). There was no specific objection, other than a general complaint that the fees sought were too high. The Court addressed the following factors:

1. Benefit Achieved. Although the benefit achieved in this case was not monetary, the supplemental disclosures benefitted the shareholders by providing them a better understanding of the transaction, and thus a fee award is warranted. The disclosures were material and beneficial to the class.
2. Benefits Attributable to Plaintiffs' Counsel. This factor was clearly satisfied.
3. Contingent Fee Arrangement. The plaintiffs' counsel took this case on a fully contingent basis.
4. Time and Effort Spent. The Court observed that this was an expedited matter that included a preliminary injunction motion and depositions in several states as well as "extensive document review". Consultation with experts was also among the tasks done by plaintiff's counsel.The time spent by plaintiffs' counsel was about 4,000 hours. Though not part of the analysis, the Court noted that if an hourly rate were computed, it would not be excessive.
5. Difficulty and Complexity of the Litigation. The Court emphasized that this was expedited litigation that "involved difficult issues" and plaintiffs' counsel was confronted with numerous challenging issues.
6. Standing and Ability of Counsel. The Court found that plaintiff's counsel are "experienced and skilled in complex Delaware corporate class action litigation".

In sum, the Court found that $750,000 would be a fair and reasonable award for combined fees and expenses under the circumstances of this case. (Though the amount sought was initially in excess of $1.4 million, the parties later reached an agreement on an application for a combined award of fees and expensed in the amount of $750,000.)

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ACS State Healthcare, LLC v. Wipro, Inc. and Wipro, Ltd., No. 4385-VCP (Del Ch., July 23, 2009), read Order here; and

In Re: Waddell & Reed Financial, Inc., No. 4602-CC (Del. Ch., June 12, 2009), read Order here.

The two above Orders of the Delaware Court of Chancery, in unrelated cases, are noteworthy enough to highlight. Rulings of the Chancery Court in the form of Orders, and some transcripts of oral bench rulings, are cited in briefs by Delaware lawyers if they address a sufficiently important  issue. Though of arguable precedential value, if they are on point and there are no closer well-established cases controlling the issue, they are not uncommonly viewed by the Delaware Bench and Bar as at least worthwhile to refer to in briefs.

Leslie Spoltore, an esteemed litigation partner in our Delaware office, has prepared the following summaries of the two referenced short Orders.

ACS State Healthcare, LLC v. Wipro, Inc. and Wipro, Ltd., No. 4385-VCP ( Del. Ch., July 23, 2009).

The ever evolving world of electronic discovery has created uncounted changes in the practice of law. The shear volume of electronically stored information (ESI) can have significant impact on the cost, scope and length of the discovery process. As technology evolves so too does the discovery process, sometimes referred to as EDD or electronic data discovery. The case of ACS State Health Care, LLC v. Wipro Inc. and Wipro Ltd. is a recent example of how the Delaware Chancery Court is developing the law in this evolving field.

On July 23, 2009, the Court of Chancery signed a “clawback” Stipulation and Order in this case, one of the first such rulings in Chancery Court. [But see, here for a recent decision in the Hexion case that interpreted a somewhat related stipulated order, and here for a September 2009 Chancery Court decision that allowed for "clawback" of inadvertently produced documents.] The Stipulation permits the parties to the action to produce documents, without first engaging in a page-by-page review and without risk that such production would constitute a waiver of attorney client privilege. Noting that the voluminous number of documents that were likely to be relevant and/or responsive in the case, the parties determined that a document-by-document review prior to production would cause “substantial delay” and would be unduly burdensome. In an effort to alleviate the cost and time of discovery, the Stipulation sets forth the protocols for the search for responsive documents (e.g., key word searches, analytical software tools, and other reasonable means to locate privileged materials). If the protocols are followed, and if privileged material was inadvertently disclosed, the disclosure of such material will not be considered a waiver of any attorney-client, work product and/or other applicable privilege or immunity. ( As an aside, one of the counsel involved recognized, off the record, that it was akin to an experiment to address the new challenges presented by EDD of ESI.)
-------------------------------------------------------------

In Re: Waddell & Reed Financial, Inc.,  No. 4602-CC (Del. Ch., June 12, 2009).

In the case of In Re: Waddell & Reed Financial, Inc. (“Waddell”) the Court of Chancery was asked to address the issue of reopening a shareholder vote to include approximately 3.2 million shares of common stock which were previously uncounted. The disputed shares were provided by the shareholders to RiskMetrix Group, Inc., a proxy advisory firm. Due to a technical error with the transmission from RiskMetrix Group, Inc., the votes of these shareholders were not counted.
Waddell and Daniel C. Schulte (“Schulte”) sought relief in the Court of Chancery to redress this error. The Verified Petition filed by Waddell and Schulte was supported by affidavits and other documents which outlined the technical nature of the failure to remit the proxies. Finding that it was equitable to allow the votes to be counted, Chancellor Chandler entered an Order on June 12, 2009 permitting the inspector to reopen the vote and to accept the previously omitted votes.
 

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PharmAthene, Inc. v. SIGA Technologies, Inc., No. 2627-VCP, (Del. Ch., July 10, 2009), read letter decision here.  Read summary of prior opinion of the Chancery Court in this case here.

Issues Addressed

This ruling addressed two issues: (i) under what circumstances is an attorney/client relationship created; and (ii) whether the attorney/client privilege applies to in-house counsel whose communications might include business advice in addition to legal advice.

Analysis

The first issue focused on whether communications between in-house counsel for MacAndrews & Forbes Holdings, Inc. (MAF) and the defendant, SIGA, were privileged. In making its initial analysis, the Court discussed the factors considered to determine when an attorney/client relationship exists. The money quote follows:

... in determining whether an attorney-client relationship exists, “courts look at the contacts between the potential client and its potential lawyers to determine whether it would have been reasonable for the ‘client’ to believe that the attorney was acting on its behalf as counsel.” (citing 3Benchmark Capital Partners IV, L.P. v. Vague, 2002 WL 31057462, at *3 (Del. Ch. Sept. 3, 2002)).
 

Regarding the first issue, the Court concluded that:

... communications between attorneys employed by MAF and representatives of SIGA may qualify as privileged. Under Rule 502(b)(3) of the Delaware Rules of Evidence:

A client has a privilege to refuse to disclose and to prevent any other person from disclosing confidential communications made for the purpose of facilitating the rendition of professional legal services to the client . . . by the client or the client’s representative or the client’s lawyer or a representative of the lawyer to a lawyer or a representative of a lawyer representing another in a matter of common interest.  

The Court observed the MAF was a substantial but not controlling shareholder of SIGA, thought they had a "common interest" in the success of SIGA, and MAF attorneys often provided legal advice to SIGA. Thus the ruling was that the communications between MAF attorneys and SIGA representatives on matters of common interest would be privileged.

The second issue focused on the standard for determining what types of communications should be protected by the attorney/client privilege. The Court emphasized that the attorney/client privilege protects legal advice as opposed to business or personal advice. (see case cited at footnote 4). Therefore, a communicaiton by an attorney that included business advice would not be privileged. (fn 5). To the extent a communication is inseparably inclusive of different categories of advice, it "may" be privileged. (fns 6-8).

The Court reviewed in camera certain documents identified in a privilege log because it was asked to determine if they included discoverable facts about business advice involving a transaction at issue in the case. After reviewing the documents in issue, one by one, the Court made a ruling on each document's "status".

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The plaintiffs in Sokol Holdings, Inc. v. Dorsey & Whitney, LLP, No. 3874-VCS (Del. Ch. Aug. 5, 2009), read opinion here, brought suit in the Delaware Court of Chancery against the law firm of Dorsey & Whitney LLP (“Dorsey”) alleging professional negligence and breach of fiduciary duties based on claims of overbilling, improper billing of contract attorneys, and unnecessary costs due to ineffective work. The plaintiffs had retained Dorsey to assist in various international litigations. Plaintiffs sought “money damages, a declaration that Dorsey’s fees are unreasonable, an accounting, and attorneys’ fees.”

Kevin Brady, a highly regarded Delaware litigator, provided this synopsis.

In an unusual twist of events, the plaintiffs, following a failed mediation, raised the question of whether the Court of Chancery has jurisdiction to hear the suit and argued, in the event jurisdiction rests with the Delaware Superior Court, that they would seek a jury trial. In response, Dorsey filed a motion to maintain jurisdiction, seeking an order keeping jurisdiction in Chancery or alternatively an order of a bench trial if the case was transferred to Superior Court.

Court Discusses Attorney-Client Relationship and Breach of Fiduciary Duty

The Court of Chancery noted that while Delaware courts have referred to attorneys as fiduciaries, the attorney-client relationship does not raise the same concerns as the fiduciary relationship cases that the Court of Chancery traditionally has jurisdiction over. “The hallmark of a fiduciary relationship is that one person has the power to exercise control over the property of another as if it were her own.” Contrary to that category of relationships, Court of Chancery cases involving attorneys as fiduciaries generally involve allegations of professional negligence.

In concluding that it did not have jurisdiction, the Court stated,

clients with malpractice claims should not be able to bootstrap their way into Chancery simply because the conduct of attorneys can at times and in certain factual circumstances raise fiduciary concerns. Rather, equitable jurisdiction should only be available when an attorney’s conduct implicates traditionally and uniquely equitable concerns. . . . our Superior Court has long heard such claims, and the loose language of cases referring to lawyers as fiduciaries does not transmogrify legal malpractice or legal billing disputes into an equitable claim for breach of fiduciary duty. 

Filing in Court of Chancery Waived the Right to a Jury Trial

In transferring the case to the Superior Court, the Court held that “[t]he decision to bring an action in Chancery . . . serves as an effective waiver of the right to a jury trial. Accordingly, this court is generally not solicitous of plaintiffs who file suit in Chancery only to belatedly decide they want to have a jury hear their case.”  Having deliberately chosen to file in Chancery and having waited nearly a year to decide that it wanted to pursue a jury trial, the Court in fairness to Dorsey ordered a bench trial in the Superior Court.

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Case Financial, Inc. v. Alden, No. 1184-VCP (Del. Ch., Aug. 21, 2009),  read opinion here.

Two prior decisions by the Delaware Chancery Court in this case were previously reviewed on this blog and are available here.

Background

This Chancery Court opinion contains the findings of fact and conclusions of law based on a trial held in March 2009. The factual setting involves the sale of a company that provided financing for plaintiffs and plaintiffs’ attorneys through advances or high interest loans. The CEO of the old company remained in place at the new company for a period of time. At some point, the new company, Case Financial, formed a wholly-owned subsidiary called Case Capital. Eventually, individuals at the new company began to suspect that the CEO had committed fraud in the course of selling the old company and that he also committed various breaches of fiduciary duty after the acquisition.

Main Issues

The Court addressed three primary issues, only one of which was controlled by Delaware law. The main issue based on Delaware law was whether the new company had standing to assert claims in light of some of the wrongful conduct alleged to have occurred at the subsidiary level. In this 33-page opinion, the Court determined that the parent corporation did have standing to assert claims for breach of fiduciary duty against its former director for conduct he engaged in that breached the fiduciary duty owed to the parent, including any such conduct that also impacted the wholly-owned subsidiary, for which he also served as a director. The two issues controlled by California law which will not be addressed in this synopsis, dealt with the scope of a “crime exception” in a release, as well as the applicability of representations in the asset purchase agreement regarding fraud claims occurring after the closing. These are all interesting corporate litigation issues, but we will only focus on those governed by Delaware law in this case.

Piercing the Corporate Veil

One argument that was considered and rejected by the Court was that the parent and subsidiary were, in essence, alter egos of each other, and thus the unusual argument was advanced that the parent company should not be distinguished from the parent's wholly-owned subsidiary for purposes of standing, and for purposes of allowing the parent to pursue claims against the CEO of the subsidiary. The court addressed the five customary factors to consider for an analysis of when the corporate veil can be pierced, in addition to fraud,  but the  Court concluded that the parent company in this case failed to carry its burden on these factors.

The Court emphasized that Delaware law takes the corporate form and corporate formalities very seriously, and will only disregard the corporate form in exceptional cases. See Sprint Nextel Corp. v. iPCS, Inc., 2008 WL 2737409, at * 11 (Del. Ch., July 14, 2008).

Direct  v. Derivative Claims

The Court then addressed the question about whether the claims for fraud and breach of fiduciary duty could be pursued directly by the parent corporation against the director of its subsidiary.
The Court discussed a procedural conundrum involved in this case, and explains the reasons why a parent corporation must still follow the "normal" requirements to sue a director of a subsidiary derivatively through its status as a shareholder of a subsidiary, and on behalf of a subsidiary. See, e.g., footnote 41. The Court , however, did not find it necessary to base its decision on those procedural distinctions, because the Court concluded that the parent corporation had standing to assert a fiduciary duty claim against Alden, who was also an officer and a director of the parent corporation, in addition to being an officer and director of the wholly-owned subsidiary.

Therefore, the Court reasoned that because Alden owed fiduciary duties directly to the parent as a director and officer, a direct claim could be pursued by the parent based on the duties that Alden owed to the parent as an officer and director of the parent corporation.  Nonetheless, as a director and officer of both entities, he obviously owed duties to both.

The Court reasoned that because Alden owed fiduciary duties to the parent corporation directly, the ability of the parent to pursue a suit against Alden directly would not depend on whether the entirety of the damage was sustained directly by the parent or derivatively through its wholly-owned subsidiary. Moreover, the Court demonstrated that the parent offered reasonable arguments why Alden may have violated his duties as a director of the parent by improperly misappropriating opportunities of the parent “by virtue of his actions” at the subsidiary.

Likewise, the parent alleged that it suffered a direct injury from the fraud caused by its former director which was not an injury suffered solely by virtue of the ownership stake of the parent in its subsidiary. Thus, the Court concluded that the parent corporation had direct claims against its former director for both fraud and fiduciary duty  breaches, and that it was not necessary that those claims be pursued on a derivative basis at the subsidiary level.  See generally  Anadarko Petroleum Corp. v. Panhandle E. Corp., 545 A.2d 1171, 1174 (Del. 1988) (cited at footnote 41 for the suggestion that shareholders of the parent corporation may have standing to sue the subsidiary “double derivatively” when the directors of a wholly-owned subsidiary do not fulfill their duty to maximize shareholder value in a wholly-owned subsidiary context.)
 

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 In Cephalon, Inc. v. Johns Hopkins University, No. 3505-VCP (Del. Ch. Aug. 18, 2009) read opinion here, while ruling on two motions to compel, Vice Chancellor Parsons addressed a couple of the most expensive and time consuming segments of discovery: (i) privilege review and the content and detail required in privilege logs for information withheld due to attorney-client privilege or work product immunity; and (ii) the scope of redactions and disclosure of underlying factual information.

Kevin Brady, a highly respected Delaware litigator, provided this synopsis.

Privilege Logs

In challenging the sufficiency of defendants’ privilege log, plaintiff Cephalon complained that “over 150 documents on [defendant’s] logs do not identify even one attorney as being involved with the document.” The Court noted that “[t]he fact that a written communication does not involve an attorney, however, does not mean the document cannot be privileged. Such a communication, for example, could recite legal advice received from a lawyer or reflect a confidential request made by an officer or other representative of a company for legal advice. In both those instances, the document could very well be privileged.”

After his review of the privilege log, Vice Chancellor Parsons granted in part the motion to compel and ordered the defendants to revise their privilege logs. For every privilege log entry where a document is being withheld on the basis of attorney-client privilege, if the log description contains no reference to an attorney, the Court ordered that the defendants must state, in addition to the basis for withholding (i.e. attorney-client privilege, work product immunity), that the document “contains confidential information made for the purpose of facilitating the rendition of professional legal services to the client or provide a similar basis for the claimed privilege.” Summary descriptions would not be acceptable. In addition, Vice Chancellor Parsons went the extra step and required that “an attorney sign the amended privilege log in accordance with Rule 11.”

Scope of Redactions and Disclosure of Underlying Facts

Another challenging area for practitioners is the decision as to what factual information in a privileged communication must be disclosed. Here Cephalon argued that the privilege does not protect underlying facts from disclosure and so those facts should be disclosed. While the Court agreed with Cephalon that “privilege is limited to confidential communications and does not protect the underlying facts from disclosure. . .” the Court went on to note that not all facts in a privileged document must be produced. “Rather, production may be required if the factual information easily can be segregated from other aspects of a document and produced without disclosing privileged communications.” 
 

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In re National City Corp. Shareholders Litigation, No. 4123-CC (Del. Ch. July 31, 2009),  read opinion here.

Kevin Brady, a highly respected Delaware litigator, provided this synopsis.

In this case, the Court of Chancery approved a settlement agreement, certified a class, and awarded attorneys fees and expenses in the amount of $400K instead of the $1.2 million amount initially requested by the plaintiffs and agreed to by the defendants.

Background

In the fall of 2008, National City Corporation (“NCC”), was in the same troubled situation that many large financial institutions were in at that time -- capital and liquidity issues as a result of the problems in the credit and housing markets. Indeed, the Office of the Comptroller of the Currency (“OCC”) told NCC that it was “very possible” that NCC would not receive government assistance under the Troubled Asset Relief Program/Capital Purchase Program which would have had a devastating effect on NCC’s financial outlook. As a result, in September 2008, NCC was considering strategic alternatives.

Proposed Merger Between NCC and PNC

In October 2008, NCC announced a proposed merger with PNC Financial Services Group, Inc. (“PNC”). The merger was a $5.58 billion all-stock deal that was to close by the end of 2008. Starting on October 27, 2008, lawsuits were filed by various shareholders of NCC that, among other things, sought to enjoin the merger alleging that the NCC directors had breached their fiduciary duties and that PNC had aided and abetted those breaches. At the core, each of the shareholders’ actions alleged that NCC had not secured “fair and maximum consideration” for the shareholders. The Court consolidated the various lawsuits and in November 2008, a consolidated class action complaint was filed, which alleged over thirty disclosure violations.

Case Settled Within Month of Filing Consolidated Complaint

Within days of filing the consolidated class action complaint, the parties engaged in settlement discussions and by December 12, 2008, the parties had agreed to settlement terms and a memorandum of understanding was prepared which stated that the plaintiffs would take additional discovery before the settlement was placed before the Court for approval. Following two depositions, the shareholders of both NCC and PNC voted to approve the merger and by February 2009, the parties had signed the memorandum of understanding which required additional disclosures and $1.2 million in attorneys’ fees and expenses for plaintiffs’ counsel.

Objections Filed

Numerous shareholders filed objections to the settlement. The objectors argued that “NCC’s management acted in its own self-interest in approving the merger because fourteen officers of the Company received change-in-control payments at the completion of the merger.” The Court however, dismissed these claims because as it noted:

NCC’s board, not its management, approved the merger, and only one member of the board, Peter Raskind, was also an officer of NCC. There are no allegations that any of the other board members received change-of-control or unique payments as a result of the merger. The Delaware Supreme Court has “never held that one director’s colorable interest in a challenged transaction is sufficient, without more, to deprive a board of the protection of the business judgment rule presumption of loyalty.” Indeed, “self-interest, alone, is not a disqualifying factor even for a director. To disqualify a director, for rule rebuttal purposes, there must be evidence of disloyalty.”

Court Approves Settlement

Noting that the Court “applies its own sound judgment in deciding whether to approve a class action settlement as fair and reasonable”, the Court stated that “the settlement of a class action is unique because the fiduciary nature of the class action requires the Court of Chancery to participate in the consummation of the settlement to the extent of determining its intrinsic fairness.”

The Court noted that the probability that the plaintiffs would have been successful on the merits of their fiduciary duty claims was remote. The plaintiffs were able to cause NCC to provide its shareholders with additional information regarding conflicts of interest and “further insight into the strengths and weaknesses of the Company.” After characterizing the additional disclosures that resulted from the settlement of the action as “minor” providing a “meager benefit,” the Court concluded that the settlement was fair and reasonable as the plaintiffs only had a remote chance of success in litigation. The NCC board was entitled to the protections of the business judgment rule and plaintiffs had not offered any evidence to rebut the presumption. The Court held that the NCC directors’ interests were consistent with those of the NCC shareholders as the eleven outside directors held over one million shares of NCC stock and consequently desired the highest value for those shares. Despite weak claims, the plaintiffs nonetheless received a modest benefit from the supplemental disclosures. Taken together, the settlement was “a fair and reasonable compromise.”

Court Determines That Substantial Fee Award Not Justified

Finding that the disclosures constituted only a modest benefit to the shareholders, the Court determined that a substantial fee was not justified. The Court held that the disclosures represented a “non-monetary, therapeutic and modest achievement” that did not warrant the “princely sum of $1.2 million” for plaintiffs’ counsel’s fees and expenses.

In arriving at its conclusion, the Court began with the recitation of the long-standing Delaware policy “to insure[] that, even without a favorable adjudication, counsel will be compensated for the beneficial results they produced.” In a class action setting where the parties agree upon fees in a settlement, the Court “‘must make an independent determination of reasonableness’ of the agreed to fees” using the factors set forth in In re Abercrombie & Fitch Co. S’holders Derivative Litig., 886 A.2d 1271, 1273 (Del. 2005) (citing Sugarland Industries Inc. v. Thomas, 420 A.2d 142 (Del. 1980)):

(1) the results accomplished for the benefit of the shareholders; (2) the efforts of counsel and the time spent in connection with the case; (3) the contingent nature of the fee; (4) the difficulty of the litigation; and (5) the standing and ability of counsel involved.

Even though the parties’ negotiated the $1.2 million fee, the Court held that “independent judicial scrutiny” is still needed “because of the omnipresent threat that plaintiffs would trade off settlement benefits for an agreement that the defendant will not contest a substantial fee award. A negotiated fee arrangement ‘by its nature deprives the court of the advantages of the adversary process . . . [and] makes heightened judicial oversight of this type of agreement highly desirable.’” In addition, the Court recognized the skepticism present in class action litigations because the claim-holding shareholders are generally not involved with negotiating the settlement or fee agreement. The “Court is required to be vigilant, so that counsel’s fee requests do not take advantage of the agent-principal relationship between class action plaintiffs and their attorneys.”

In applying the Sugarland factors, the Court considered “the amount of fees [the] Court has typically awarded in modest disclosure cases . . . .” Given the modest benefit derived from the supplemental disclosures and the efforts expended, the Court arrived at $400,000. The disclosures were deemed to be of modest benefit because they did not warrant placement in an amended proxy, were only included on NCC’s 8-K, and did not appear to have a large effect on the shareholder vote. As to counsel’s efforts, there was only a motion to expedite and two depositions. Such effort “regardless of the amount of hours spent” did not warrant the agreed upon fee – especially in light of the modest benefit.

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TowerHill Wealth Management v. The Bander Family Partnership, L.P., No. 3830-VCS (August 3, 2009), read letter decision here.

Kevin Brady, a highly respected Delaware litigator, provided the synopsis for this unusual case.

Plaintiffs moved for summary judgment in this decision where the Court of Chancery was “troubled that the defendant seems to be more motivated by a desire to enmesh the plaintiffs in an unfocused discovery process that will be dragged out for far too long than is justifiable and far too extensive than is warranted given the issues and dollars at issue . . . .” Since the plaintiffs’ motion implicated facts about which the defendants wanted discovery under Rule 56(f), the Court gave the defendant until October 15, 2009 to complete limited additional discovery (and no more than five depositions).

The Court then took the unusual step and mandated that “the parties meet and confer in person with the senior Delaware lawyers involved in the representation present to work out a plan to finish discovery and brief the summary judgment motions.”

Prior to this order, the defendants had filed a Rule 56(f) application that according to the Court “suggest[ed] that a very limited number of players are involved in this unusual struggle, unusual in the sense that it remains difficult to determine why this case has not been resolved given that the underlying issues seem to involve less money in dispute than it will cost for the parties to litigate the case.” The Court went on to note that in the event of a dispute as to discovery and briefing schedules, a motion was to be filed along with “a certification that the senior Delaware lawyers involved believe in good faith that there was a genuine effort involving them directly to resolve the dispute short of bringing the matter to the court.”

The Court provided no background or explanation as to why it was requiring the involvement of senior Delaware lawyers in the discovery planning stage of the litigation. It is not at all unusual for the judges in the Court of Chancery (or any Delaware court for that matter) to expect that Delaware lawyers, when working with lawyers from other jurisdictions, will be actively involved in the substantive and procedural matters pending before the Delaware courts. That is exactly why the Delaware courts require lawyers from other jurisdictions to engage Delaware counsel. Nonetheless, it is unusual for such a requirement to be expressly articulated in an order.

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In Martinez v. Regions Fin. Corp. C.A. No. 4128-VCP (Del. Ch. Aug. 6, 2009),  read opinion here, the Court addressed a former bank executive’s claims to enforce a change of control agreement she had with her employer bank before that bank merged into a successor bank and for advancement of fees and costs with respect to this litigation.

Kevin Brady, a highly regarded Delaware litigator, provides the synopsis of this important decision on the topic of advancement rights.

Before Defendant Regions Financial Corporation (“Regions”) merged with AmSouth Bancorporation (“AmSouth”), Plaintiff Susan Martinez, who was an executive with AmSouth, had an employment agreement (the “Agreement”) that provided her with a golden parachute that would be triggered in the event of a change of control. When AmSouth and Regions merged, the change of control provision was triggered. However, instead of complying with the terms of the change of control provisions, Regions offered alternative agreements to Martinez on terms that were less favorable than the Agreement. Regions also said that any executive who declined the new offer would be terminated. In October of 2007, Martinez declined to accept the new contract. Regions therefore terminated her employment.

Despite severance benefits paid, pursuant to the Agreement, of more than $7 million, Martinez seeks additional benefits under the Agreement, “including payment of the salary she would have received had she continued to be employed by Regions for a second year in 2008, and a larger amount reflective of her bonus history and based on the annual bonus she contends she should have received for 2007.”

Martinez brought an action alleging the following: (i) breach of the Agreement by Regions for not providing Martinez with an annual bonus and salary under terms of the Agreement for the remainder of her employment period; (ii) breach of the covenant of good faith and fair dealing by failing to award a bonus for 2007; and (iii) specific performance of fee shifting and advancement provisions in the Agreement. Before the Court were Martinez’s motion for summary judgment as to Count IV and Region’s motion for summary judgment as to all counts.

It is interesting to note that the day after Regions filed an answer to the complaint, the plaintiff filed a motion for partial summary judgment on her claim for advancement. Regions thereafter “responded by seeking to preempt the advancement claim by shifting the focus of the litigation to the merits of the employee’s claims for additional compensation under the [Agreement]” and filing a motion for summary judgment on all counts in the complaint.

Court Finds That Having Received Severance Payments, Martinez Is Not Entitled To Both a Salary and Benefits for the Period After Her Termination

Martinez alleged that in addition to golden parachute payments, she is entitled to an unconditional salary and benefits through November 30, 2008 under the Agreement. The Court held that Martinez’s rights to the severance package precluded her from receiving additional salary payments and other compensation for the remainder of the employment period (a period when Martinez was no longer working for Regions). The Court looked to Gerow v. Rohm & Haas Co., 308 F.23d 721 (7th Cir. 2002), in finding that Martinez’s argument was unpersuasive in that it “makes no business sense” and would result in a windfall where “she would receive certain benefits or parts thereof twice, for no apparent reason.” Therefore, the Court granted Region’s motion for summary judgment holding Martinez’s interpretation that “she had a right to receive termination benefits, in the form of an attractive ‘golden parachute’ severance package, and employment benefits. . . .” to be untenable.

Extent of Martinez’s Bonus Raised Genuine Issues of Material Fact

Regions’ moved for summary judgment on the issue of whether Martinez was entitled to the benefit of a bonus for 2007. Under the Agreement, Martinez’s date of termination was the date she gave oral notice that she declined the new contract in October 2007. Martinez argued that she should be entitled to a bonus for the full year of 2007 because she worked through December 31, 2007. Because of the discrepancy as to dates when the actual employment ceased, the Court denied the motion for summary judgment due to factual questions as to what Martinez was entitled to in a bonus for 2007.

Martinez also claimed that she was entitled to the full bonus for 2007 because of a breach of the covenant of good faith and fair dealing. The Court likewise denied that motion as well. In support of its motion, Regions argued that “a claim for breach of the implied covenant of good faith and fair dealing cannot lie where a party relies on express language of a contract, such as the definition of ‘Date of Termination’ here.” The Court held that that argument was not “entirely persuasive . . . in this context. . . . [where t]he issue involves how the defined Date of Termination relates to a different last day of employment agreed to by all parties. The . . . Agreement does not expressly address that circumstance.” Because genuine issues of material fact remained as to the parties’ agreed upon last day of employment, this motion was denied.

A Broad Advancement Fee Provision Provides Advancement Regardless of the Merits of the Claims

Finally, the Court addressed both party’s motions for summary judgment as to Martinez’s entitlement to advancement fees. On this issue, the Court stated that:

[a]dvancement disputes are particularly appropriate for decision on summary judgment, as in most cases “the relevant question turns on the application of the terms of the corporate instruments setting forth the purported right to advancement and the pleadings in the proceedings for which advancement is sought.” As this Court has noted, resort to parol evidence in cases like this one is rarely appropriate, or even helpful, as corporate instruments addressing advancement rights are frequently crafted without the involvement of the parties who later seek advancement and often with little negotiation among any of the contending parties at all. Those factors are not problematic, however, as they tend to reinforce the legal policy of this State, which strongly emphasizes contract text as the overridingly important guide to contractual interpretation. Thus, if the contractual instrument unambiguously grants advancement, summary judgment is appropriate.

Region argued that the pertinent language “all legal fees and expenses which the Executive may reasonably incur” (emphasis added) required Martinez’s litigation to be reasonable in order to receive attorney fees. In light of Martinez’s dismissed claims regarding salary and severance benefits, Regions argued that Martinez’s claims were not reasonable. The Court disagreed finding that the Agreement provides

the right to reimbursement for “all legal fees and expenses” incurred as a result of a covered contest and to advancement of those fees “to the full extent permitted by law” “regardless of the outcome” of the contest. The imposition of a requirement that Martinez’s claims be substantively reasonable either as a precondition to advancement or as a basis for recouping advanced fees and expenses relating to an unsuccessful claim would undermine the plain meaning of that provision.

Even with this broad language, Regions contended that any award of advancement should be contingent upon a determination of reasonableness. Requiring such a determination “would defeat the purpose of advancing fees altogether . . . .” Nothing in the Agreement required a limitation of advancement based on reasonableness, and rather the advancement provision was quite broad. Citing to the Court’s decision in Lillis v. AT&T Corp., 904 A.2d. 325, 332-33 (Del. Ch. 2006), the Court reasoned, “[T]here is no requirement that advancement provisions be written broadly or in a mandatory fashion. But when an advancement provision is, by its plain terms, expansively written and mandatory, it will be enforced as written.”

The only limitation on advancement rights would be through the implied covenant of good faith and fair dealing where advancement could be denied if Martinez brought her claims in bad faith. Merely failing to prevail on her claim for the 2008 salary does not mean that Martinez litigated in bad faith. Thus, Martinez was entitled to reasonable attorneys’ fees and expenses incurred to date, plus interest, future fees and expenses, and even “fees on fees” for the actual indemnification suit.

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Governor Jack Markell has nominated Delaware lawyer Travis Laster to fill the vacancy on the Delaware Chancery Court. Here is the story in the local paper. Here  is a prior post on the selection process. The Delaware Senate is expected to convene a special session in September to confirm the nomination. Travis Laster is an experienced and well-respected veteran corporate litigator who frequently appeared before the court that he will now be a member of, and he will continue the long tradition of nationally recognized excellence among the jurists of that court.

UPDATE:  DealLawyers.com comments as well as compiles other links to this story here.

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In Kuo v. Genius Products, Inc.,  No. 3329-CC (Del. Ch., July 30, 2009), read opinion here, the Court of Chancery awarded counsel for Plaintiff Betty Kuo (“Kuo”), a minority shareholder in Defendant Genius Products (“Genius”), Inc., $100,000 in fees and expenses following a stipulation and dismissal recognizing the claims Kuo filed as moot.

Kevin Brady, a highly respected Delaware litigator, provided this synopsis.

In October 2007, Genius announced that its board and shareholders had approved a 1 to 8 reverse stock split of the company’s common stock. The objective of the reverse stock split was to meet NASDAQ’s minimum listing requirement of $5.00. Genius’s controlling stockholders approved the reverse stock split on October 29, 2007 and gave the Genius board one year to select an exchange ratio and effectuate the reverse stock split or alternatively abandon the transaction. As a result of the reverse split, Genius announced that shareholders with less-than-one post-split shares would be cashed out.

In November 2007, Kuo filed suit alleging that Kuo’s board had breached its fiduciary duties and that the reverse stock split violated the fair value requirement of 8 Del. C. § 155(2). Immediately after the filing of the complaint, the parties entered into settlement negotiations. During the negotiations, the stock price fell to such a low level that Genius alleged it could no longer list on NASDAQ. As a result, in October 2008, Genius abandoned the stock split and, with the litigation being moot, the parties stipulated to its dismissal. On October 29, 2008 the option to effectuate the reverse stock split expired and on November 7, 2008, the parties filed a stipulation and order of dismissal recognizing the plaintiff’s claims as moot. Plaintiff then sought an award of attorneys’ fees and expenses. Thus, the Court was faced with the issue of awarding attorneys’ fees in a mooted class action.

Court Finds Fee Warranted Under Common Corporate Benefit Doctrine

The Court considered Kuo’s application for fees under the common corporate benefit doctrine, where “a litigant who confers a common monetary benefit upon an ascertainable stockholder class is entitled to an award of counsel fees and expenses for its efforts in creating the benefit.” However, for the Court to award fees under this doctrine, “the applicant must show: (i) the suit was meritorious when filed; (ii) the action producing the benefit to the corporation was taken by the defendants before a judicial resolution was achieved; and (iii) the resulting corporate benefit was casually related to the lawsuit.”

In opposition, Defendants argued that fees were not warranted because the decision not to pursue the reverse split was not the result of the litigation, but rather the precipitous stock price decline. However, the Court noted that a “strong presumption in favor of plaintiff’s counsel exists in these types of cases” and defendants have the burden to show that the lawsuit did not “in any way” cause the action. In finding that the defendants had not met their burden and that the lawsuit “played at least some part in Genius’s decision to abandon the stock split,” the Court noted: (1) the onset of settlement of negotiations immediately after the filing of the complaint; (2) the failure to move for immediate dismissal (which it arguably would have done had the case been meritless); and (3) Genius’ inability to persuade the Court that the decline in stock price precluded the reverse stock split. The Court noted that the defendants failed to show why Genius “needed to obtain a $15 per share outcome rather than NASDAQ’s required $5 per share and why they could only do a 1 to 8 reverse stock split to achieve that goal.”

Despite a Benefit, Only a Modest Award Was Warranted

As the Court recognized, “[i]t has long been the policy of Delaware to ‘insure[] that, even without a favorable adjudication, counsel will be compensated for the beneficial results they produced.” Relying on the factors in Sugarland Indus. Inv. v. Thomas, 420 A.2d 142 (Del. 1980), the Court noted that:

[i]n arriving at the specific amount for the award, Sugarland rejected a more mechanical approach, establishing that the Court must exercise its sound discretion to determine fee awards. In assessing whether a fee is reasonable the Court typically considers a number of factors, including: “(1) the results accomplished for the benefit of the shareholders; (2) the efforts of counsel and the time spent in connection with the case; (3) the contingent nature of the fee; (4) the difficulty of the litigation; and (5) the standing and ability of counsel involved.” This Court has consistently noted that the most important factor in determining a fee award is the magnitude of the benefit achieved.

Plaintiff’s counsel requested $200,000 in fees and $2,440.67 in expenses. However, the Court was not persuaded that a “significant benefit was obtained or that counsel’s actions were solely responsible for the aborted transaction.” Instead, the Court found that the benefit was modest, in part, because no independent appraisal of shares had been done. Thus, the Court could not determine how much less shareholders would have received in the cash out. The Court reduced the award to $100,000 because “plaintiff’s counsel has expended modest efforts in this case.” As the Court reasoned, no substantive motions had been filed, the only brief or paper filed was the motion for fees, and, despite representing that they had expended 140 hours on the case, counsel failed to distinguish the hours spent working on the motion for fees from substantive work for the client.

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In the case of In Re: Trados Incorporated Shareholder Litigation, No. 1512-CC (July 24, 2009), read opinion here, the Court of Chancery  denied defendants’ motion to dismiss breach of fiduciary duty claims arising out of the approval by the Board of Directors of Trados Incorporated (“Trados”) of a transaction whereby Trados became a wholly-owned subsidiary of SDL, plc (“SDL”) and granted defendants’ motion as to claims of breach of fiduciary duty and aiding and abetting based on alleged revenue manipulation.

Kevin Brady, a highly regarded Delaware litigator, provides us with this synopsis.

Background

Trados started out as a German company in 1984, but in the mid 1990’s Trados was interested in going public so it moved to the United States and incorporated in Delaware. It started accepting investments from entities who became preferred stockholders in the company. Eventually, the preferred stockholders had a total of four designees on Trados’ seven member board. In April 2004, the Trados’ board began to discuss a potential sale of the Company. In June 2004, Trados engaged JMP Securities, LLC, an investment bank, to assist in identifying potential alternatives for a merger or sale of the Company. At the July 7, 2004 meeting of the board of directors, the board determined that the fair market value of Trados’ common stock was $0.10 per share.

By July 2004, JMP Securities had identified potential buyers including SDL. By August 2004, JMP Securities had conducted discussions with SDL which made an acquisition proposal in the $40 million range. Trados informed SDL that it was not interested in a deal at that price. At the same time, there was a concern that the executive officers of Trados might not be sufficiently incentivized to remain with the Company or pursue a potential acquisition of the Company, based upon “the high liquidation preference of the Company’s preferred stock.” In December 2004, the board approved a management incentive plan (the “MIP”), which set a graduated compensation scale for management based on the price obtained for the Company in an acquisition.

Even though Trados’ financial condition improved toward the end of 2004, the board continued to work toward a sale of the Company. In January 2005, SDL again expressed interest in a merger, and in response the Trados board said that “it was not interested in any transaction involving less than a “60-plus” million dollar purchase price.” On June 19, 2005, Trados and SDL entered into an Agreement and Plan of Merger for $60 million, approximately $7.8 million of which was scheduled to go to management pursuant to the MIP, and the remainder to go to the preferred stockholders in partial satisfaction of their $57.9 million liquidation preference. The common shareholders received nothing in the merger which was completed on July 7, 2005.

Appraisal Action Filed – Three Years Later Class Action Filed

Soon after the merger was completed, plaintiff filed a petition for appraisal. Three years later, plaintiff filed an individual and class action against the director defendants claiming: (i) the transaction was driven by certain preferred stockholders who wanted a transaction that would trigger their large liquidation preference and allow them to exit their investment in Trados because it was performing poorly; (ii) the Trados board favored the interests of the preferred stockholders “either at the expense of the common stockholders or without properly considering the effect of the merger on the common stockholders”; (iii) the four directors designated by preferred stockholders had other relationships with preferred stockholders and thus were incapable of exercising disinterested and independent business judgment; (iv) two Trados directors who were also employees of the Company received material personal benefits as a result of the merger and were therefore also incapable of exercising disinterested and independent business judgment; and (v) SDL and certain of its executive officers conspired with certain Trados directors to defer revenue until after the merger.

Court Rejects Defendants’ Defense of Laches

Defendants argued that the plaintiff’s claims for breach of fiduciary duty were barred by laches and should therefore be dismissed. Defendants argued that plaintiff’s three-year delay in bringing the fiduciary duty claims has caused them prejudice because “[t]he parties have been embroiled in the Appraisal Action for three years and have engaged in discovery battles, depositions and other motions.” The Court noted that “equity follows the law and will apply a statute of limitations by analogy in appropriate circumstances” but that the Court “is not bound by the analogous statute, and, “as the equities require, may apply a period either shorter or longer than that fixed by statute.”

The statute of limitations for breach of fiduciary duty is three years and the defendants conceded that plaintiff had filed the fiduciary duty claims within three years of the close of the merger. However, the defendants argued that the Court has the discretion to apply a shorter period if “in terms of equity, the plaintiff should have acted with greater alacrity, and when the plaintiff’s failure to seek equitable relief with alacrity threatens prejudice to the other party.” The Court however, did not find that there was any prejudice to the defendants, let alone the type of prejudice that would allow the Court to shorten the period of time since plaintiff sought monetary damages instead of injunctive relief or specific performance. As a result, the Court denied the defendants’ motion to dismiss based on laches.

Fiduciary Duty Claims

The plaintiff claimed that the director defendants breached their fiduciary duty of loyalty to Trados’ common stockholders by selling the company when they did because “the Company was well-financed, profitable, and beating revenue projections.” In addition, the plaintiff complained that the director defendants, in approving the Merger, never considered the interest of the common stockholders in continuing Trados as a going concern, even though they were obliged to give priority to that interest over preferred stockholders’ interest in exiting their investments.”

Plaintiff contends that the merger took place at the behest of certain preferred stockholders, who wanted to exit their investment. Defendants counter by arguing that plaintiff ignored the “obvious alignment” of the interest of the preferred and common stockholders in obtaining the highest price available for the company. Defendants assert that because the preferred stockholders would not receive their entire liquidation preference in the merger, they would benefit if a higher price were obtained for the Company.

The Court rejected the defendants “obvious alignment” argument saying that the interests of the preferred and common stockholders were not aligned because the merger triggered a $52 million preference payout to the preferred stockholders while the common stockholders would get nothing. The Court went on to note that “it is reasonable to infer that the common stockholders would have been able to receive some consideration for their Trados shares at some point in the future had the merger not occurred.” The Court noted that this “inference” was supported by, among other things, the recent improvement in the Company’s performance.

Rights of Preferred v. Common Stockholders

The Court noted that while the rights of preferred stock are contractual in nature, directors still owe fiduciary duties to preferred stockholders (as well as common stockholders) where the right claimed by the preferred “is not to a preference as against the common stock but rather a right shared equally with the common.” The Court went on to note that “generally it will be the duty of the board, where discretionary judgment is to be exercised, to prefer the interests of common stock—as the good faith judgment of the board sees them to be—to the interests created by the special rights, preferences, etc., of preferred stock, where there is a conflict.”

Thus, the Court concluded that in circumstances such as here where the interests of the common stockholders diverge from those of the preferred stockholders, it is possible that a director could breach his or her duty by improperly favoring the interests of the preferred stockholders over those of the common stockholders.

Were the Directors Interested or Lacking Independence?

Plaintiff also alleged that four directors were “interested” in the decision to pursue the merger with SDL which had the effect of triggering the large liquidation preference of the preferred stockholders because they were designated to the Trados board by a holder of a significant number of preferred shares and that each of the directors “had an ownership or employment relationship with an entity that owned Trados preferred stock.” In addressing the issue of whether a director is interested or independent, the Court stated:

A director is interested in a transaction if “he or she will receive a personal financial benefit from a transaction that is not equally shared by the stockholders” or if “a corporate decision will have a materially detrimental impact on a director, but not on the corporation and the stockholders.” The receipt of any benefit is not sufficient to cause a director to be interested in a transaction. Rather, the benefit received by the director and not shared with stockholders must be “of a sufficiently material importance, in the context of the director’s economic circumstances, as to have made it improbable that the director could perform her fiduciary duties . . . without being influenced by her overriding personal interest . . . .” Independence means that a director’s decision is based on the corporate merits of the subject before the board rather than extraneous considerations or influences.” At this stage, a lack of independence can be shown by pleading facts that support a reasonable inference that the director is beholden to a controlling person or “so under their influence that their discretion would be sterilized.”

While the Court noted that simply designating a director to a board is not enough to rebut the presumption of the business judgment rule, when that allegation is combined with the allegation relating to ownership or employment relations, that was sufficient on a motion to dismiss to rebut the presumption of the business judgment rule. As a result, the Court denied the motion to dismiss the fiduciary duty claims based upon the Board’s decision to approve the merger.

Court Dismisses Revenue Shifting and Aiding and Abetting Claims

Plaintiff alleged that two director defendants, Campbell and Hummel, breached their fiduciary duty of loyalty to the common stockholders by wrongfully agreeing to “shift revenue” by deferring certain revenue until after the close of the merger, which thereby caused the price of SDL stock to increase after the merger. Plaintiff alleges that this agreement was wrongful because of the possibility that a higher SDL stock price would provide a material benefit to Campbell and Hummel that would wrongfully give them an incentive to approve the merger. The Court disagreed with plaintiff finding that not only did plaintiff fail to specify what accounting rule or other requirement was violated by these actions, plaintiff also failed to show how these actions would directly cause harm to Trados. In addition, the Court found that the plaintiff had not alleged facts that “reasonably suggest than any benefit to Campbell and Hummel … would be material to them.” As a result, the Court dismissed that claim as well as the plaintiff’s allegations that the remaining defendants “aided and abetted” such a breach of fiduciary duty.

UPDATE: Professor Bainbridge provides scholarly commentary about this post by Kevin Brady, and the Trados case here.

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In re: 14 Realty Corp., No. 20129-VCS (Del. Ch., August 5, 2009),  read opinion here.

This 30-page letter decision reviews de novo the determinations of a Trustee who was appointed to oversee the winding-up of a corporation.

Overview

This litigation began as a dissolution proceeding pursuant to DGCL Section 273 due to the sibling owners being deadlocked. The court granted dissolution and appointed a trustee to windup the affairs of the dissolving company and pursuant to that appointment signed an Order that set forth the powers and duties of the trustee in connection with winding up the affairs of the dissolving company.

Summary of Decision

The court reviewed the objections to the determinations of the trustee based on a de novo standard. However, in footnote 3, the court described that choice of a standard of review as follows: “This was a regrettable choice of review standard and not one I will sanction in my future orders. As this case amply demonstrates, de novo review of the determinations of a skilled and experienced trustee is duplicative and wasteful of judicial resources and parties’ time and money. Were the standard of review closer to a business judgment standard - - as it should have been - - this motion could have been decided far more expeditiously and efficiently on the basis of the trustee’s well reasoned determinations.” The trustee appointed in this matter was a retired Delaware Supreme Court Justice.

The court reviews the extensive factual background as part of its decision, but those detailed and extensive facts are beyond the scope of this short blog summary.

The point of this case, in which the court affirmed the determinations of a trustee appointed to oversee the winding up of a dissolved corporation, is that one should be careful to provide for a standard of review for a trustee’s determination in a dissolution matter that is "closer to a business judgment standard" in order to avoid what the court described in this opinion as a duplicative and wasteful review process by the court.
 

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 The Delaware Chancery Court case of  Parfi Holding AB v. Mirror Image Internet, Inc., 2008 WL 4110698 (Del. Ch., Sept. 4, 2008), the opinion for which was summarized on this blog here, was affirmed without a published opinion by the Delaware Supreme Court, and now may be on its way for consideration by the U.S. Supreme Court. The case is styled before the country's High Court as:  Lygren v. Mirror Image Internet Inc., et al., No. 09-50, cert. granted (U.S. July 16, 2009). This development was reported by the Andrews Delaware Corporate Litigation Reporter at the following citation:  HIGH COURT TO CONSIDER APPEAL OF DEL. 'DOT-COM BUBBLE' DECISION, Lygren v. Mirror Image Internet, 24 No. 2 Andrews Del. Corp. Litig. Rep. 4, Andrews Delaware Corporate Litigation Reporter , August 10, 2009. Briefs and other related documents for the SCOTUS appeal are available at:  2009 WL 2028919 (Petition for Writ of Certiorari), Appellate Petition, Motion and Filing (May 04, 2009).

Reviews on this blog of prior decisions in this case by  Delaware's Chancery Court and Supreme Court are available here. This case has a long and tortuous factual and procedural history, a discussion of which would exceed the temporal and space limitations of this short post. As reported in the referenced article in the Andrews Delaware Corporate Litigation Reporter,  the following provides more insight into the SCOTUS appeal:

" ... the state Supreme Court reversed and remanded the Chancery Court's decisions the first two times the case was appealed.

But the justices refused to revive the suit a third time, when Lygren said the Chancery Court wrongly dismissed his suit after Parfi's law firm withdrew and Delaware law prevented Lygren himself from representing the company as a non-attorney.

* * *

After the defendants declined to file a response to the petition, the high court notified the Delaware Supreme Court that the case had been placed on the U.S. Supreme Court's docket, so the petition will be considered for acceptance in the fall."
 

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Professor J. Robert Brown has an insightful article here on his blog called The Race to The Bottom  about the soon-to-be-announced successor to Vice Chancellor Lamb which refers to my prior post here on the topic. Good stuff for anyone who is following this important development.

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Brandt v. CNS Response, Inc., No. 4773-CC (Del. Ch., Aug. 3, 2009), read letter decision here.

This 2-page letter decision denied a Motion to Expedite Proceedings and an Application for Emergency Injunctive Relief in connection with a Section 220 action seeking books and records prior to an annual meeting.

The reasoning for the court’s decision was based on the understanding of the court that the director seeking books and records had been told that the books and records that he sought were available at the company’s offices more than three weeks previously for him to review and copy but that he did not avail himself of that offer. Thus the court concluded that the applicant's “leisurely approach to the matter . . . does not lead the Court to now believe that an emergency exists that the court must remedy today or tomorrow [which is when the applicant wanted an expedited hearing].” Thus, the Section 220 case would proceed, but not on an expedited basis. (Note that a 220 case is already considered a "summary proceeding".)

Of particular note is the concluding sentence of the court’s ruling which might apply to many lawsuits. The court concluded as follows:

"I will end with a bit of free advice: CNS and its stockholders would be well served if the litigants in this lawsuit would sit down and have a serious, reasonable and thoughtful discussion about how to find a compromise to this wholly unnecessary Section 220 lawsuit.”

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Deloitte LLP v. Flanagan, No. 4125-VCN (Del. Ch., Aug. 4, 2009),  read letter decision here.

In this very short letter opinion, the court decided a discovery issue in which Mr. Flanagan sought data and details regarding prior efforts by Deloitte to enforce a penalty provision against other Deloitte partners based on conduct similar to that alleged in this particular lawsuit in which Deloitte was seeking to enforce a liquidated damages provision against its former partner.

Several other Chancery Court decisions and a Delaware Supreme Court decision involving the Deloitte firm and its partnership disputes have been summarized on this blog here.

The court referred to the rather broad scope of discovery allowable under Chancery Court Rule 26, and concluded that: “To enable Mr. Flanagan to have access to the basic facts necessary to evaluate whether Deloitte’s past use of the liquidated damages provision may aid the Court in understanding his arguments, the Court concludes that limited discovery is appropriate.”

The court emphasized that nothing in its decision should be interpreted to express any views about any potential liability in any form of Mr. Flanagan. Rather, the court sought to find a way to compare the conduct alleged here with other efforts by Deloitte to impose penalty provisions against other partners with similar agreements.

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Mickman v. American International Processing, L.L.C., Del. Ch., No. 3869-VCP (July 28, 2009), read opinion here.

This opinion decides issues related to a demand for books and records pursuant to the terms of an LLC Operating Agreement.

The issues addressed are more precisely formulated as follows: (1) How broad is the definition in the agreement of the phrase “all books and records”; (2) Does “access” to such books and records include the right to photocopies; and (3) Is there a basis to award attorneys’ fees based on the conduct of the defendant?

Overview of Ruling

First, the court held that the plaintiff was entitled to copies of the general ledgers of the LLC - - and not simply the ability to read them, based on both: (1) The language of the Operating Agreement; and (2) Section 18-305 of the Delaware LLC Act, found in Title 6 of the Delaware Code.
The court observed that it has been previously established in Delaware that LLC Agreements can grant members inspection rights that exceed the rights provided for in the statute. Second, the court did not agree that the defendants conducted the litigation vexatiously or in bad faith and therefore denied the request for fees and costs filed by the plaintiff.

A specific sub-issue in this case was whether the phrase in the agreement: “shall have access to all books and records,” included the “general ledger.”

The court made the common observation that it often looks to Delaware corporate statutes and case law when interpreting similar provisions in an LLC Agreement “due to the paucity of reported decisions in the LLC context”.

The court reviewed prior case law and how those cases described what was included in the phrase “all books and records” and noted that the phrase commonly referred to the grant of broad inspection rights, including general ledgers. (citing Helmsman Mgmt. Servs., Inc. v. A & S Consultants, Inc., 525 A.2d 160, 163 (Del. Ch. 1999)).

The court’s reasoning included the fact that nothing in the Operating Agreement implied that defendants intended to limit the breadth of documents or to use the phrase “all books and records” in a more restrictive manner than in its ordinary meaning. Moreover, defendants did not offer any plausible alternative interpretation under which the general ledgers would fall outside the scope of the phrase “all books and records.” See generally Arbor Place, L.P. v. Encore Opportunity Fund, LLC, 2002 WL 205681, at *3 (Del. Ch. Jan. 29, 2002).

Access Includes the Right to Obtain Photocopies

The court reasoned that in the context of this case the right to access the general ledgers included the right to obtain photocopies of those ledgers. Although the agreement did not define the term “access,” the term is commonly used in defining inspection rights under the analogous corporate books and records statute in Section 220(b) of the Delaware General Corporation Law, where, for example, “if a shareholder is granted inspection rights, the shareholder has a right ‘to make copies of the document. Long before the statute was enacted, courts similarly found that, ‘if there be a right to examine . . .  a corresponding right is to make the examination beneficial by taking copies thereof.’” (citing State v. Superior Oil Corp., 13 A.2d 453, 463 (Del. Super. 1940); and Ostrow v. Booney Forge Corp., 1994 WL 114807, at *10 (Del. Ch. Apr. 6, 1994)). The court noted that in the Ostrow case, the Chancery Court had granted inspection rights that included the right to make copies even though an applicable agreement did not expressly provide a right to make copies.

However, the court noted that the demand under Section 18-305 of the Delaware LLC Act is different than the demand based on the terms of the Operating Agreement in this case which only required one-day written notice prior to a request for access to documents.

Request for Attorneys’ Fees

The court carefully considered but quickly rejected the request for attorneys’ fees that were sought based on the claim that the defendants refused in bad faith to provide the documents requested. The court referred to the American Rule followed in Delaware which is that, generally speaking, each party pays its own fees, with limited exceptions based, for example, on bad faith in opposing the relief being sought in the lawsuit. That bad faith exception authorizes an award of attorneys’ fees if defendants’ conduct “forced the plaintiff to file suit to ‘secure a clearly defined and established right’” (citing McGowan v. Empress Entm’t, Inc. 791 A.2d 1, 4 (Del. Ch. 2000)). In order to prevail based on that argument, the plaintiff was required to show “by clear evidence that she had a clearly defined right to inspect defendants’ books and records, and defendants’ conduct forced her to litigate to enforce that right.”

In part, the court rejected any fee shifting because of the factual and legal issues that remained for trial, about whether or not plaintiff was a member of one of the LLCs involved, in light of the discrepancy between the reference to her as a member in the tax return and Schedule K-1, but her omission from the list of members in the Operating Agreement. (This issue of membership was not waived but for purposes of the instant decision only it was not contested.)

In closing I want to point out a key part of this opinion that will be important for those involved in business litigation. Specifically,  notwithstanding one of the parties being included in the tax return of the LLC and the Schedule K-1, the court allowed to proceed to trial an issue of whether that person was a member of the LLC because she was not listed as a member in the LLC’s Operating Agreement. Thus, being included as part of the tax return, ipso facto, was not enough to establish ownership in the LLC, at least in light of other contrary documentary evidence.

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Medek v. Medek, No. 2559-VCP (Del. Ch., July 27, 2009), read opinion here. A prior decision in this case by the Court of Chancery was reviewed on this blog here.

This letter decision denied a Motion for Reconsideration of a Fee Award that was previously granted in a prior decision which can be found at 2009 WL 2005365 (Del. Ch. July 1, 2009).
This case is a helpful reminder of the high threshold that must be met pursuant to Chancery Court Rule 59 (f).

In essence, the court explained in a 7-page letter that there was nothing presented in the motion which would have changed the original opinion of the court. In particular, the plaintiff sought reargument on the refusal to award fees and costs on two of the claims. However, Rule 59(f) provides that a Motion for Reargument will only be successful when “the court has overlooked a controlling decision or principle of law that would have controlling effect, or the court has misapprehended the law or the facts and the outcome of the decision would be different.” More importantly, the moving party must make a showing that “the court’s misunderstanding of a factual or legal principle is both material and would have changed the outcome of its earlier decision.” As additional support for its opinion, the court interpreted the applicable provision providing for attorneys’ fees, as requiring more than simply establishing a breach. Rather, in order for fees to be awarded pursuant to the terms of the agreement, the non-breaching party also had to prove a claim for relief based on the breach. Thus, the Motion for Reconsideration was denied.

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Bosse v. WorldWebDex Corp., Del. Ch., No. 4443-CC (July 30, 2009), read letter decision here.

 In this short letter opinion, the court addressed a demand for books and records under DGCL Section 220. The court granted, sua sponte, judgment on the pleadings to a pro se plaintiff, in part due to the long history of the defendant’s failure to produce documents despite a clear right of the shareholder to those documents from the company (who was represented by counsel).

The issue presented in this short 2-page letter decision was whether “a proper purpose" was established in connection with the Section 220 demand.

The court recognized well established precedent for the position that a valuation of an interest in a privately-held company is a proper purpose under Section 220. Thus, the court required that the stockholder be given the right to inspect “such documents, board minutes and financial reports as are necessary and essential to the stated purpose of valuing his stock and determining his ownership interest in the company.”

The court ordered that the company, within ten days from the date of the letter decision, identify “specifically the records, books, reports and minutes that the company will make available for inspection and copying, at [the stockholder’s] expense, in order to facilitate its proper purpose."

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Credit Suisse Securities (USA) LLC v. West Coast Opportunity Fund, LLC, No. 4380-VCN (Del. Ch., July 30, 2009), read opinion here.

Overview

The issue addressed by the Chancery Court in this case was whether an entity known as Investment Hunter, LLC was bound by an agreement that was signed by a person named Gary Evans “as CEO.” A separate company called GreenHunter was involved but  was not a party to the agreement. Evans did not sign the agreement in his capacity as a member or a manager of Investment Hunter. The court followed the ordinary rule that only formal parties to a contract are bound by its terms. (citing Alliance Data Sys. Corp. v. Blackstone Capital Partners V L.P., 963 A.2d 746, 760 (Del. Ch. 2009)).

Background

Investment Hunter, LLC pledged the shares it owned in GreenHunter Energy Inc. With those pledged shares, Investment Hunter established a margin account and borrowed substantial sums from Credit Suisse. Gary Evans, in his capacity as manager of Investment Hunter, signed a pledge agreement. Evans is the CEO and President of GreenHunter. An investor in GreenHunter required it to deliver a lock-up agreement from Evans that prohibited the transfer of GreenHunter stock for a certain period of time. Evans signed that lock-up agreement as CEO, but he was not the CEO of Investment Hunter. All of his holdings in GreenHunter were held indirectly by Investment Hunter. Evans is the sole owner, member and manager of Investment Hunter - - but is not the CEO.

Though Evans had signed the agreement purportedly to confirm his agreement not to transfer the shares of GreenHunter stock,  he did not personally own GreenHunter stock nor did any entity for which he was CEO own any GreenHunter stock. Thus, the agreement was not effective to prohibit the transfer of shares of GreenHunter. 

This suit sought to prevent the transfer of GreenHunter stock owned by Investment Hunter to Credit Suisse in satisfaction of a margin clause. Even if Evans had intended that the agreement would prohibit the transfer of shares, nothing on the face of the agreement expressed any intent to bind Investment Hunter or any other entity in which Evans had a relationship. Rather, it only bound Evans.

Conclusion

Because Investment Hunter was not bound by the agreement, there was no other document that prohibited the transfer of GreenHunter’s shares to Credit Suisse, and because Evans was not a party before the court, the court could not address whether he violated the agreement by pledging GreenHunter’s shares owned by Investment Hunter. (As an aside, the court did not address the culpability of Evans in what appears to have been, based on the description of facts in the opinion, a lack of forthrightness on his part.)

UPDATE: Here  is a later decision by the Chancery Court  in this case to grant a somewhat unusual request for an interlocutory appeal of its decision. Now the Delaware Supreme Court must decide whether or not to accept the interlocutory appeal.

 

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Louisiana Municipal Police Employees’ Ret. Syst. v. Fertitta,  No. 4339-VCL (Del. Ch. Jul. 28, 2009), read opinion here.

Kevin Brady, a prominent Delaware litigator, prepared this synopsis.

In his final written opinion before leaving the bench on July 28, 2009, Vice Chancellor Lamb denied a motion to dismiss class action and derivative claims, noting that plaintiff Louisiana Municipal Police Employees’ Retirement system had adequately alleged claims for breach of the duty of loyalty and grounds to excuse demand as to the claim of waste with respect to an “abortive going-private transaction”. See Louisiana Municipal Police Employees’ Ret. Syst. v. Fertitta, C.A. No. 4339-VCL (Del. Ch. Jul. 28, 2009). He also gave followers of Delaware corporate law a practice pointer in Footnote 27 regarding Rule 12 motions and 100% wholly-owned shell corporation merger vehicles.

Background -- June 2008 Merger Agreement

In January 2008, Tilman J. Fertitta, the Chairman, President, CEO and 39% stockholder of Landry’s Restaurants, Inc. (“Landry’s), made an offer to acquire all of Landry’s outstanding common stock for $23.50 per share. In response to the offer, the company formed a Special Committee of independent directors to evaluate the offer and consider any alternative proposals. On June 16, 2008, Landry’s and Fertitta, along with two of his wholly owned entities, Fertitta Holdings, Inc. (“FHI”) and Fertitta Acquisition Co. (“FAC”), entered into an agreement where FAC would be merged into Landry’s, and all outstanding common stockholders other than Fertitta would be cashed out at $21.00 per share (the complaint did not explain why there was a $2.50 decrease in the offer price from January to June 2008). The merger agreement also contained “two way” termination provisions. Landry’s would be required to pay $3 million to FAC if Landry’s terminated the transaction during a 45-day “go-shop” period, or $24 million if Landry’s terminated the merger agreement at any time after the “go shop” period. FAC would be required to pay Landry’s a $24 million reverse-termination fee if it failed to close the deal. Moreover, in the event of a material adverse effect (“MAE”), FAC was permitted to terminate the agreement without having to pay the reverse-termination fee. Prior to entering into the Merger Agreement, to finance the acquisition Fertitta entered into a debt commitment letter with three Lending Banks which also had an MAE clause in place to give them a carve-out in the event of such an MAE.

Hurricane Ike: A Material Adverse Effect?

On September 13, 2008, Hurricane Ike made landfall in Galveston Texas and damaged many of Landry’s restaurants and properties in the Galveston area to the point that a number of the restaurants were closed. After the hurricane, Landry’s issued a press release addressing the financial impact Ike had on Landry’s stating that the damage was limited to three cities, was temporary and that Landry’s intended to rebuild.

However, prior to any of the Lending Banks inspecting the damage to Landry’s restaurants, Fertitta sent a letter to the Landry’s Special Committee stating that due to the damage from Ike, the turmoil in the credit industry and the continued worsening of general economic conditions, Fertitta “believed” that the Lending Banks would likely determine that an MAE (as defined in their lending agreements) had occurred, which would result in a decision by the Lending Banks to withdraw funding which would give Fertitta “no choice but to exercise his right to terminate the original merger agreement.” Fertitta did not stop there however. He told the Special Committee that “he believed that he could possibly persuade the Lending Banks to move forward with the debt financing if he revised his offer to reflect Landry’s reduced value which he believed at that time was $17.00 per share.” There was no evidence proffered by Fertitta that the Lending Banks would do what he said they would. At the same time Fertitta was communicating with the Special Committee, he began purchasing Landry’s stock on the open market. He eventually purchased a total of 400,000 additional shares at prices from $11.83 to $14.11 per share.

In response to his letter, the Special Committee requested information regarding Fertitta’s financing efforts. Fertitta indicated that the Lending Banks were the only institutions interested in providing debt financing. He also demanded that the deal price be reduced to $17.00 per share. After a great deal of negotiation between Landry’s and Fertitta, on October 1, 2008, the Special Committee proposed a revised deal of $19 per share. Thereafter Landry’s publicly announced that the deal was in trouble, which resulted in the stock price dropping 35% to $8.44 in three days.

With Fertitta continually pressing for a lower offer, the two sides ultimately agreed in October 2008 to an acquisition price of $13.50 per share and a reduced reverse-termination fee from $24 million to $15 million. In exchange, Fertitta and the Lending Banks agreed not to claim an MAE for any event known as of the date of the amended agreement. Fertitta also negotiated on behalf of Landry’s an amended commitment letter where the Lending Banks would provide an alternative financing commitment, which would prevent Landry’s from defaulting on $400 million in senior notes in the event the merger was not consummated. Throughout this entire process, Fertitta increased his ownership of Landry’s stock from 39% of the company’s stock to nearly 60% by December 2008.

SEC Inquiry Leads to Termination of Agreement

In response to an SEC inquiry requesting certain information, the Lending Banks for some undisclosed reason refused to permit Landry’s to disclose the amended debt commitment letter and threatened to terminate their agreement if Landry’s disclosed the letter. Faced with a potential termination by the banks and a potential inability to refinance the senior notes, Landry’s terminated the merger agreement which in turn resulted in a waiver of the $15 million reverse-termination fee.

Class Action and Derivative Litigation Ensues

In February 2009, a class action and derivative complaint was filed alleging four counts: “(i) a class claim for breach of fiduciary duty against Fertitta; (ii) a class claim for aiding and abetting breach of fiduciary duty against FAC and FHI; (iii) a class claim for breach of fiduciary duty against the directors of Landry’s; and (iv) in the alternative, a derivative claim for waste against the board for failing to require Fertitta to pay the reverse-termination fee.” The defendants moved to dismiss under Rule 12(b)(6).

Court Denies Motion to Dismiss Because of Facts Suggesting Fertitta’s Influence

The Court denied the motion to dismiss, identifying three facts that taken together, “lead to the reasonable inference, though by no means the certain conclusion, that Fertitta used his influence on the corporation as controlling stockholder and/or corporate officer to his own benefit and to the detriment of the interests of the minority stockholders. These are: 1) Fertitta’s negotiation (and the board’s acquiescence to his taking that role) of the refinancing commitment on behalf of the company as part of the amended debt commitment letter; 2) the board’s apparent and inexplicable impotence in the face of Fertitta’s obvious intention to engage in a creeping takeover; 3) the board’s agreement to terminate the merger agreement, thus allowing Fertitta to avoid paying the $15 million reverse-termination fee.” The Court also noted that “these same facts also lead to the reasonable inference that the board and/or the special committee willingly acquiesced to Fertitta’s scheming because he was the controlling stockholder.”

Footnote 27 -- Aiding and Abetting – Corporate Shells – Rule 12(b)(6) Motion

It is interesting to note the Court’s discussion about the inability to grant a Rule 12(b)(6) motion for aiding and abetting a claim for breach of fiduciary duty where there are 100% wholly-owned shell corporations used as acquisition vehicles. The Court noted:

Because FAC and FHI were vehicles with little existence other than to serve Fertitta’s purposes in the acquisition, and were integral to the transactions at issue, the court cannot dismiss the aiding and abetting claim against them. To state a claim for aiding and abetting a breach of fiduciary duty, the plaintiff must allege (i) an underlying breach of fiduciary duty, (ii) that the alleged aider and abettor knowingly participated in that breach, and (iii) damages resulting from the breach. [citations omitted]. Having already determined that the plaintiff has adequately alleged the first prong (and the third prong in this case being beyond contention by the defendants for the purposes of a motion to dismiss) the issue firmly rests on the question of knowing participation by FAC and FHI. “Knowing participation in a . . . fiduciary breach requires that the third party act with the knowledge that the conduct advocated or assisted constitutes such a breach.” [citations omitted]

********

Here, two 100%-owned corporate shells, created for no other purpose than to facilitate related transactions of the fiduciary, are alleged to have “knowledge” of the alleged breach. It would elevate form too far over substance to suggest, in the procedural posture of a Rule 12(b)(6) motion, that it is not a reasonable inference that facts known to Fertitta were also known to FAC and FHI.

Court Rejects Defendants’ Argument that Fertitta did not have Fiduciary Obligations

The question arose as to whether Fertitta was a controlling stockholder (at least until December, when he had gained majority control) and as an extension of that issue whether Fertitta owed fiduciary duties to the minority stockholders in any of those actions. In analyzing the case, the Court quoted the Delaware Supreme Court’s decision in Citron v. Fairchild Camera & Instrument Corp. on the “control by a non-majority stockholder” issue: “[f]or a dominating relationship to exist in the absence of controlling stock ownership, a plaintiff must allege domination by a minority shareholder through actual control of corporation conduct.” 569 A.2d 53, 70 (Del. 1989).

In finding that Fertitta was subject to a fiduciary duty to act in the best interests of the corporation and the stockholders as a whole, the Vice Chancellor noted that “Fertitta exercised actual control of Landry’s at all relevant times -- he was not only the 39% stockholder, but the CEO and chairman of the company as well” and with respect to the negotiation of the refinancing commitment in the amended debt commitment letter, the Court stated that either: 1) “Fertitta was negotiating as CEO of the corporation, with at least tacit permission of the board; or 2) Fertitta was negotiating with the Lending Banks as controlling stockholder of Landry’s.” The Court found that under either scenario, Fertitta had fiduciary obligations.

The Court also noted that “with respect to Landry’s decision to act to terminate the merger agreement, by January 2009 it is indisputable that Fertitta was actually the majority owner of Landry’s, raising a presumption of control on his part.” The Court also rejected the board’s contention that it “had no choice but to terminate the agreement, rather than forcing Fertitta to do so” and risking bankruptcy. The Court noted that “the board must have recognized that the risk that Fertitta would have permitted that to happen, rather than terminating the agreement and paying the reverse break-up fee himself, was low.” At this point in time, Fertitta owned common stock worth between $78 million and $119 million which presumably would have dropped precipitously in value if Landry’s “had defaulted on the $400 million note redemption and been forced into bankruptcy.” The Court found that it was “unreasonable to think” that Fertitta would allow that to happen to save the $15 million termination fee. While that raised the issue of whether “the board’s decision to terminate and entirely excuse Fertitta’s performance constituted a rational exercise of business judgment,” the Court noted that that issue could not be resolved at the pleading stage.

Court Finds that Complaint Alleges Grounds to Excuse Demand

Because the Court had already noted that there was an issue about whether the board’s activities were “the product of a valid exercise of business judgment” (which is one of the tests of demand futility under Aronson v. Lewis), the Court concluded that demand was excused.

Supplement: Prof. Steven Davidoff on The New York Times' DealBook  blog here, provides his commentary on the case.

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Wayne County Employees’ Retirement System v. Corti, Del. Ch., No. 3534-CC (July 24, 2009), read opinion here. A prior Chancery Court decision in this case was highlighted on this blog here.

In this 50-page decision, the Court of Chancery discusses claims of a former shareholder in a purported class action challenging the conduct of the board of directors in negotiating and approving a transaction that resulted in Vivendi S.A.  obtaining a majority of the voting stock of Activision, Inc. The court provides extensive and thorough descriptions of the background facts, a summary of  which would exceed the temporal and format limitations of this blog.

Overview of Claims

The plaintiff alleged that the Activision directors breached their fiduciary duties by failing to disclose allegedly material information to the shareholders of Activision in connection with the vote required to approve the combination of Vivendi S.A. and Activision (the “Combination”). The plaintiff also alleged that two directors of Activision, who were also Activision managers, led negotiations with Vivendi and breached their duty of loyalty by, among other things, favoring their own interests in obtaining employment benefits of the combined company over the interests of the shareholders of Activision. Plaintiff also alleged that other Activision directors breached their duty of loyalty by allowing those two managers to allegedly control both negotiations with Vivendi and advisors of Activision. In addition, the plaintiff asserted a claim under Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986). In this decision, the court explained why it granted a motion to dismiss pursuant to Chancery Court Rule 12(b)(6).

Overview of Issues Addressed

This decision has helpful discussions of the standards that the court will apply to disclosure claims. Also instructive is the discussion regarding the contours of Revlon duties. In addition to explaining why the entrenchment claims were rejected, the court provides useful clarity regarding the types of details that will be required to successfully assert claims for breach of the duty of loyalty that are needed to overcome the hurdles presented by the protections of Section 102(b)(7), related to a claimed breach of the duty of care.

Discussion of Claims

This case was initially filed to seek an injunction in connection with claims that the Director Defendants breached their fiduciary duties by failing to provide full and fair disclosure to shareholders in connection with the shareholder vote required for the Combination to proceed. In an opinion of July 1, 2008, the Court of Chancery denied that request for preliminary injunction. See Wayne County Employees’ Ret. Sys. v. Corti, 954 A.2d 319 (Del. Ch. 2008). A business unit of one of the parties is the creator of a video game called World of Warcraft, which the court described as the “enormously popular then-market leader in the massively multiplayer online game segment of the video gaming industry." In footnote 2, the court cited to its prior opinion in which it compared massively multiplayer role playing games such as World of Warcraft to the “world of Mergers and Acquisitions.” (citing Corti, 954 A.2d at 321 – 322).

The court exhaustively explained why the disclosure claims failed at this stage of the case for largely the same reasons that the court previously denied the motion for preliminary injunction.

Disclosure Obligations

The court recited the familiar disclosure obligations of directors. Specifically, the court observed that “when a board of directors seeks shareholder action the fiduciary duty of disclosure, which is a specific application of the duties of care and loyalty, requires that the board ‘disclose fully and fairly all material information within the board’s control.'" The court emphasized that a plaintiff bringing a disclosure claim must “identify the facts that are allegedly missing from the proxy statement and ‘state why they meet the materiality standard and how the omission caused injury.’” (citing Corti, 954 A.2d at 330.)

The court then explained the well known standard of materiality as requiring the following: “to establish the materiality of omitted facts under Delaware law, a plaintiff must show a substantial likelihood that the omitted facts would have assumed actual significance in the deliberations of a reasonable stockholder because, if disclosed, those facts would have significantly altered the total mix of information available to the stockholders.”

The court provided instruction on the preference under Delaware law to address disclosure claims before a shareholder vote, rather than after the vote and after the challenged transaction is completed--in part because it is almost impossible to remedy the situation “after the eggs have been scrambled.” (citing In Re Transkaryotic Therapies, Inc., 954 A.2d 346 (Del. Ch. 2008)).

Barrier of Section 102(b)(7)

The court described the claims by the plaintiff for alleged breaches of fiduciary duty based on inadequate disclosure as purporting to be breaches of the duty of loyalty, but the court emphasized that the complaint failed to adequately plead facts that state a claim for damages that are not barred by the provision in the certificate that, pursuant to 8 Del. C. Section 102(b)(7), eliminates the personal liability of Activision’s directors for monetary liability for breaches of the duty of care. The court reasoned that a “mere conclusory allegation that the alleged disclosure violations also constitute a violation of the duty of loyalty is not sufficient to survive a motion to dismiss, particularly in light of the holding that the complaint fails to otherwise state a non-exculpated claim against the Director Defendants for breach of fiduciary duty.”

Fiduciary Duty Claims

The court reiterated well-established Delaware law that “directors of Delaware corporations are bound by the traditional fiduciary duties of care and loyalty. The appropriate starting place in evaluating plaintiff’s fiduciary duty claims, however, is with the well established presumption of the business judgment rule, which reflects and promotes the role of the board of directors, and not the Court, as the appropriate body to manage the business and affairs of the corporation. The business judgment rule, of course, is a presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken is in the best interests of the company.” (citing Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984)). Referring to the recent Delaware Supreme Court decision in Lyondell Chem. Co. v. Ryan, 970 A.2d 235, 239 (Del. 2009), the court recited the recent reiteration of the Revlon standard that applies when a board of directors decides to sell control of the corporation, in which case the “board must perform its fiduciary duties in the service of a specific objective: maximizing the sale price of the enterprise. Thus, a sale of control of the corporation does not implicate additional fiduciary duties, but instead requires the directors to exercise their fiduciary duties in the context of the particular decision being made.” (footnotes omitted.)

The court supported its holding by referring to the fact that because Activision had a certificate that contained a provision that bars claims for money damages against their directors based on breaches of the duty of care, in order to survive dismissal, plaintiff had to allege facts that were sufficient to state a claim that was not exculpated by the certificate, “such as a claim that the Director Defendants violated the duty of loyalty by, for example, acting in their own self-interest at the expense of the Company or otherwise failing to act in good faith.”

After reciting the applicable facts as alleged, the court concluded that the complaint failed to state that the directors were interested in the transaction or otherwise violated their fiduciary duty of loyalty.

The court also dispelled any arguments that entrenchment was involved. Specifically, the court noted that the employment agreements of directors Kotick and Kelly were approved by the directors which quashed any notion that the new employment agreements were either kept secret from the board or that the employment benefits were obtained without the knowledge of the Activision directors. Moreover, the court underscored that the plaintiff had not alleged facts to rebut the presumption that the members of the compensation committee exercised their independent and disinterested business judgment in approving the employment agreements. See pages 28 and 29 at footnote 52.

Revlon Standard

The opinion provided practical insights on the current state of the law in Delaware regarding the standard applied to directors involved in the sale of their companies. The court explained as follows:

“Delaware law does not hold directors liable for failing to carry out a perfect process in a sale of control. Moreover, a provision in Activision’s certificate exculpates Director Defendants from personal liability for monetary damages for breaches of the duty of care. Although plaintiff frames its attacks on the process employed by the Director Defendants as breaches of the duty of loyalty, the factual allegations in the complaint do not support such a claim.”

The complaint failed to establish that the directors suffered from a conflict of interest nor did it establish that they lacked independence or disinterestedness. Thus, in order to survive dismissal, the complaint had to plead facts that supported a failure of the directors to act in good faith.

However, the court emphasized that: “bad faith will be found if a fiduciary intentionally fails to act in the face of a known duty to act, demonstrating a conscious disregard for his duties. Bad faith cannot be shown by merely showing that the directors failed to do all they should have done under the circumstances. Rather, only if they knowingly and completely failed to undertake their responsibilities would they breach their duty of loyalty. As the Delaware Supreme Court has recently proclaimed, the relevant question is whether the Director Defendants utterly failed to attempt to obtain the best sale price.” (citing Lyondell, 970 A.2d at 243 – 244).

There are many more details of the court's opinion that warrant reading the entire 50-page opinion, but for present purposes I am merely highlighting key passages.

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As reported today in The Wall Street Journal  here, Vice Chancellor Stephen Lamb will spearhead a Delaware office for the New York based firm of Paul Weiss after he leaves the Chancery Court when his term expires imminently.

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One of Delaware's "sister states" is Pennsylvania, an adjoining jurisdiction that many of Delaware's corporate lawyers return home to each night. (Now that I have a connection to the scope of this blog, I can get to the point.) Here is an article in the Philadelphia Inquirer about the budget battles now being engaged in "next door" between the Governor of the Keystone State and the Senate Majority Leader, Dominic Pileggi. The article also provides an extensive description of my big brother, whom the article refers to as "Cool Hand Dom".  In addition to fiscal realities, an aspect of the issues involved in our neighboring state's budget imbroglio is the different perspectives of the parties, one of which focuses on the importance of reducing spending, and the other which favors looking for solutions by raising taxes.

Also, available here is a new license plate that a friend of mine just proposed to support the views of the Senate Majority Leader on the topic.

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CBOT Group, Inc. v. Chicago Board Options Exchange, Inc., No. 2369-VCN (Del. Ch., July 29, 2009), read letter decision here.

Summaries of the several prior decisions by the Chancery Court in this case are available here, here and here.

This letter decision is one in a series of resolutions by the Chancery Court, after a class action settlement was approved, of claimants who "appealed" to the court from the denial by class counsel of their requests to participate in the funds available from the class action settlement in this case. Other similar decisions by the court are linked above. The issue in this decision (and the others) relates to the consequences of the alleged (and in some instances admitted) failure to comply with the procedures and prerequisites established by the court for participation in, or receipts of funds from, the class action settlement. In its prior decisions involving similar claimants, the court has been quite lenient regarding use of the "wrong form", or understandably late submissions of forms to class counsel, or other lack of strict compliance with the process for seeking funds from the settlement.

 In sum, in this decision, the court allowed one claimant who qualified to participate in the "Group B Class Settlement" but instead filed a form to participate in the "Class A Group Settlement", to be permitted to participate in the Group B Class Settlement. However, the other claimants addressed in this decision did not fare so well. The other claimants in this ruling were found not to have satisfied the equitable factors or meritorious reasons that would justify, in the court's view, the lack of compliance with various conditions for participation in the settlement.

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Latesco, L.P. v. Wayport, Inc., Del. Ch., No. 4167-VCL (July 24, 2009),  read opinion here.

Background

This 26-page  Chancery Court opinion involves the efforts of a shareholder to monetize a part of his illiquid, minority interest in a private company he co-founded, but in which he was no longer an insider.  His sales of stock were governed by an agreement to give the corporation and certain insiders the right of first refusal.  In a second transaction, however, the stockholder was asked, and agreed, to sell more shares than originally negotiated with a third party.  That is, those shares were outside the agreement.

The stockholder claims that “in deciding whether or not to exercise the right of first refusal and in requesting that extra shares be made available for purchase, the corporate insiders should have but did not disclose the assets sale” that the insiders allegedly knew about when they purchased his shares.

Overview of Holding

The court recognized that:

“the performance of a Stockholder Agreement giving corporations or corporate insiders rights of first refusal over the shares of other stockholders is not governed by any generalized fiduciary duty of disclosure nor is it governed by any generalized application of the duty of loyalty.  Instead, the contours of such an insider’s duty to the selling stockholder is defined by the terms of the agreement itself and the normal prohibitions against fraud.  In contrast, where transactions are made outside the confines of such an agreement, insiders should expect to observe the normal obligations of fiduciaries not to engage in transactions with stockholders while in the possession of material information known to be available to the sellers.” (emphasis added).

Key Facts

The key facts at this motion to dismiss stage of the proceedings, as described by the court, include the observation that the conduct of the defendant insiders did not fall entirely within the scope of the right of first refusal agreement.  Instead, the court found that there were well pleaded allegations of fact that a sale of stock involved more than that contemplated by the terms of the agreement between the parties.  Specifically, the corporation asked the stockholder to make a large number of additional shares available for sale beyond those for which they had any right of first refusal.  Because the sale of those shares was outside of the analytical framework of the right of first refusal agreement, the court decided this motion to dismiss based on the normal standard of fraud, as applied to transactions between “corporate insiders” and minority stockholders. 

In footnote 16, the court defined “insider” for purposes of this opinion as a “stockholder-party that, by virtue of board representation or observers, possesses additional information about the fortunes of the company beyond that generally made available by corporate management to the stockholders.”

Standards Applied

The court explained that the applicable standard of fraud in this case is a “scienter-based standard that, in the case of a fiduciary, may include a duty to speak when, in purchasing or selling stock, a fiduciary is aware that material information is known to him but not to the counter party to the transaction.”  See footnote 17 for cases cited.

The court emphasized that:

“This standard is not an instance of the fiduciary duty of disclosure that results from a call for stockholder action.  The rule requiring calls for stockholder action to be accompanied by full and fair disclosure of all material information regarding the decision presented to the stockholders is premised on the collective action problem that stockholders, in the aggregate, are faced with when asked to vote or tender their shares.” See footnote 18.

The court explained that the general fraud standard that the court applied was not directly derived from the fiduciary duty of loyalty nor was it the same as a fiduciary insider trading claim pursuant to the decision in Brophy v. Cities Service Co., 70 A.2d 5 (Del. Ch. 1949).  The court distinguished a Brophy claim as being fundamentally derivative in nature because it arises “out of the misuse of corporate property – that is, confidential information – by a fiduciary of the corporation, for the benefit of the fiduciary and to the detriment of the corporation.

Issue Raised

In the instant case however, the court framed the precise question presented thusly:

“If the court were to ignore the extra shares or otherwise regard the second sales transactions as governed by the contract, the question then becomes what, if any, disclosures was an insider who was a party to a right of first refusal agreement  required to make to an outsider when exercising such a right.  This appears to be a matter of first impression both in Delaware courts, and, to the best of the court’s research, elsewhere.  Courts have addressed a similar, not entirely analogous, issue that arises when corporations act to exercise contractual repurchase rights triggered by death or termination of employment but it is hard to discern any general rule.”  (emphasis added.) See footnote 24 for cases cited and distinguished.

Contract v. Fiduciary Analysis

POSTSCRIPT: A subsequent decision from California involving a similar issue but based on much different facts, rendered on Jan. 6, 2010, by the Fourth Appellate District, Division Three, styled Le v. Pham, is available here.

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For those would enjoy watching a trial in the Delaware Court of Chancery--live,  from the comfort of their computer, via an online video/audio feed, made available (for a price) by the folks at www.courtroomview.com, see the link here.  The name of the case being tried this week before Vice Chancellor Leo Strine, Jr., is CA, Inc. v. Ingres Corp. It involves an expedited request for specific performance and injunctive relief relating to software and licensing agreements. The complaint filed is available here. The docket entries are here.

A short video/audio clip is available free for your viewing and listening pleasure from your desktop here.

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Akande v. Transamerica Airlines, Inc., Del. Ch., No. 1039-VCP (July 22, 2009), read opinion here. Two prior decisions in this case by the Court of Chancery were reviewed on this blog here and here.

Kevin Brady, a prominent Delaware litigator, provides the following synopsis:

In a unique and somewhat esoteric exercise for devotees of Delaware corporate law, the Court of Chancery entered a judgment in this case of approximately US$2.2 million related to a longstanding attempt by plaintiff to enforce a 1999 Nigerian judgment. After eight years of failing to collect on the judgment, the plaintiff filed an action against Transamerica Airlines, a Delaware corporation, in the Court of Chancery under the Uniform Money-Judgments Recognition Act. See 10 Del. C. §§ 4801-4808. Numerous issues arose with respect to the proper interpretation of the Nigerian judgment and for those readers who are interested in the nuances of this dispute, Vice Chancellor Parsons has already issued two prior opinions in this matter. See Akande v. Transam. Airlines, Inc., 2007 WL 1555734 (Del. Ch. May 25, 2007); and Akande v. Transam. Airlines, Inc., 2008 WL 509817 (Del. Ch.Feb. 25, 2008).

While much of Vice Chancellor Parsons’ 37-page opinion pertains to interpretation of Nigerian law, the relevant discussion for this blog is the Court’s determination as to which currency should apply for a portion of the judgment to be awarded – U.S. dollars or Nigerian naira. While a Nigerian court addressing this dispute made an award in naira, the Court of Chancery determined that it could only enforce the Nigerian judgment in U.S. dollars. In order to convert the judgment from naira to dollars, the Court applied the “generally accepted principle in American law that, ‘if the obligation to pay in foreign currency arose in the foreign country and the non-defaulting party would get damages in that country in the foreign currency, the currency will be valued as of the date of judgment . . . .” Accordingly, the Court used the exchange rate from the date the judgment was entered in 1999 with post-judgment interest accruing from that date onward.
 

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Tunnell Companies, LP v. Delaware Division of Revenue, No. 2450-VCL (July 13, 2009), read letter decision here.

This short two-page letter decision transferred a complaint to the Delaware Superior Court based on a lack of equity (i.e., subject matter) jurisdiction in Chancery Court. The complaint sought a declaratory judgment pursuant to § 6501 of Title 10 of the Delaware Code regarding a dispute over the proper construction of the provision in the State Tax Code that was allegedly being interpreted incorrectly by the Attorney General of Delaware. The court explained that the Delaware Declaratory Judgment Act had no impact on the equitable jurisdiction of the Court of Chancery and requires that there be a separate independent basis for exercising Chancery Court jurisdiction which was not present in the complaint filed in the instant case.

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