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

Last year,  I replied to Professor J. Robert Brown's list of the top 5 Delaware cases that, in his view, supported his negative perspective of Delaware law that remains the constant refrain on his blog called: The Race to the Bottom.

My introductory explanation from my rebuttal of last year was as follows:

... I realize that there are many more qualified experts who can rebut the professor's arguments far more persuasively than I, and I am well aware that the Delaware bench certainly does not need my help to defend it. Nor have I been anointed by anyone to take on this role. Nonetheless, having just completed a review of key 2007 Delaware corporate decisions, I offer my own humble rebuttal and a "counter-list" of 5 cases in 2007 that demonstrate that the Delaware courts take shareholder rights and the duties of directors very seriously. If any readers can think of a better "top 5" list, than the one I compiled below, I welcome comments. Here is my top 5 "rebuttal list":

Well, I just finished my 4th annual overview of selected Delaware corporate and commercial cases for  2008, which will be published soon in The Delaware Law Weekly, at which time I will also post it on these pages. I also just saw Professor's Brown list of 5 cases from 2008 that he uses to support his unabashedly unflattering views of Delaware law. Here is his list and here is his introductory post.

My cursory review of the cases I selected below (from the approximately 200 or so that I have summarized on this blog during 2008), is not as scholarly as the good professor's treatment, and I do not have the time (thankfully, due to my busy practice) to engage in extended debate (at least for the next week or so), but until someone else picks up the baton, I offer the following cases to counterbalance the list offered by Professor Brown. I invite others to suggest other cases that they would rather see in my "top 5 list".

•  In Cargill, Inc. v. JWH Special Circumstance, LLC, (Del. Ch., Nov. 7, 2008), read opinion here, the Delaware Chancery Court issued a 68-page decision involving a Delaware statutory trust (formerly referred to as a business trust), and found that common law fiduciary duties would apply to a trustee as a "default rule" in light of the agreement among the parties being silent on the issue. Here is a more complete summary.
• In Julian v. Eastern States Construction Service, Inc.,  2008 WL 2673300 (Del. Ch., July 8, 2008), read opinion here, the Chancery Court required directors to disgorge a $1.3 million bonus they had given themselves in a self-interested manner, without any independent protections, and based on their failure to satisfy their burden to demonstrate the entire fairness of their decision. Here is a more complete summary.
•  In Ryan v. Lyondell Chemical Company, (Del. Ch., July 29, 2008), read opinion here, the Delaware Chancery Court  found that at the procedural stage of a summary judgment motion, it would allow to proceed to trial the issue of whether the independent directors should be exposed to personal liability  for their role in the sale of the company--despite selling the company to the only known buyer for a substantial premium. A whole article could be written on this case alone, and substantial commentary has already been penned about it. An equally weighty later decision denying a motion for reargument was summarized here. The case is now on appeal with the Delaware Supreme Court.

• In Steel Partners II, L.P. v. Point Blank Solutions, Inc., 2008 WL 3522431 (Aug. 12, 2008),  the initial complaint was filed to force the holding of a shareholders meeting (which had not taken place since 2005), pursuant to DGCL Section 211. After a stipulation was entered into for a date to hold the meeting, the defendant moved for leave of court to postpone the date of the meeting by 90 days. The Chancery Court denied the request. The request was based on allegations that the plaintiff and its CEO together own about 40% of the stock and would attempt to install their own directors and then seek to buy the company at the lowest possible price for its own investors. In addition, the postponement was requested due to an alleged conflict that the plaintiff's CEO had with the majority. The court reasoned that the best way to deal with the issues presented was to communicate them to the shareholders and let them decide, based on those facts, who they wanted as directors--instead of further delaying the exercise of the shareholder franchise, which under Delaware law is sacrosanct. The summary of the case on my blog is here.

• London v. Tyrrell, 2008 WL 2505435 (Del. Ch., June 24, 2008), read opinion here. This Chancery Court decision explained in detail the reasons why it denied a motion to dismiss a derivative claim based on Chancery Court Rules 9(b), 12(b)(6) and 23.1. The derivative complaint alleged that the defendants caused the company to issue stock options in contravention of an equity incentive plan by setting the exercise price of the issued options at an unfairly low value.After a thorough factual background description, the court emphasized that: “the burden remains on the movant to demonstrate that the plaintiff has not met the requirements of Rules 9(b), 12(b)(6) and 23.1." (see footnote 12). Moreover, the court described in detail the demand futility analysis under  the seminal case of Aronson v. Lewis, 473 A.2d 805 (Del. 1984) as well as Rales v. Blasband, 634 A.2d 927 (Del. 1993). The court explained the reasons why it concluded, as succinctly as I have seen it done, that both prongs of the Aronson case were satisfied. Specifically, the plaintiff demonstrated a reasonable doubt that: (1) the directors were interested and independent; or (2) the challenged transaction was otherwise the product of a valid exercise of business judgment.
  The first prong was satisfied because the directors had a financial interest in the challenged stock option plan and also because they stood on both sides of the transaction that was challenged. Moreover, the second prong was satisfied because the allegations rebutted the business judgment rule to the extent that the allegations supported an inference that the directors intended to violate the terms of a stockholder approved option plan. The court also dismissed the arguments under Rule 9(b) that there was insufficient particularity regarding fraud allegations which apparently relied on Sections 152 and 157(b) of the DGCL.

UPDATE: The Wall Street Journal online highlighted this post here. 

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Hardy v. State, (Del. Supr., Dec. 9, 2008), read opinion here. Why, one might ask, is a criminal decision on this business litigation blog? This decision is relevant to this blog to the extent it demonstrates how the Delaware Supreme Court polices, on appeal, the conduct of lawyers at trial, in connection with its consideration of trial issues during appellate review. In this case, despite what would be despicable acts if found to be true, Delaware's High Court reversed a criminal conviction for rape because the prosecutor's statements interfered with one of the important aspects of a trial-- namely, a fair, truth-seeking process.

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In Ford Motor Company v. Department of Revenue, (Del. Supr., Dec. 8, 2008), read opinion here, the Delaware Supreme Court upheld the imposition of a Delaware tax on certain sales by Ford in the State of Delaware. (One might observe that Ford has not had much good news lately).

Here is a very short excerpt from the High Court's opinion describing the lower court decision it upheld:

... the Director [of Revenue for the State of Delaware] may lawfully impose an unapportioned tax on Ford’s receipts from sales of motor vehicles sold to independent dealerships located in Delaware.

The arcane minutiae of state taxation is beyond the scope of this blog, but this decision is clearly included within the broad scope of  "commercial litigation in Delaware", so I wanted to at least make passing reference to it here, and for those interested, the link to the whole opinion is above. Of course, the issues addressed in this opinion have potentially far-reaching impact on many companies across the country doing business in Delaware to the extent that this opinion deals with whether a certain state tax interferes with interstate commerce and whether that tax runs afoul of the U.S. Constitution's protection of that commerce.

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In Crescent/Mach I Partners L.P. v. Dr. Pepper Bottling Co. of Texas, (Del. Supr., December 1, 2008), read opinion here, the Delaware Supreme Court (in a rare occurrence) reversed the Chancery Court on a procedurally unusual basis in an appraisal case that was previously highlighted on this blog here. (That summary also includes links to prior opinions in the case). In a nutshell, the Supreme Court reversed the opinion of the trial court that had merely fixed a computational error pursuant to Rule 60(a). The High Court's reasoning was based primarily on the fact that the case had already been settled, so the matter was moot. The appellate opinion also includes a short explanation of the Discounted Cash Flow method of valuation (DCF) that was used by the trial court.

 The parties entered into a settlement shortly after the trial court entered a final judgment in the appraisal case and after the trial court dismissed a related fiduciary duty claim. After the settlement, one of the parties applied to the trial court under Chancery Court Rule 60 to modify what it argued was a clerical error in the computation (which was discovered by a disinterested person who was writing an article about the case). The opposing party argued that the error was substantive. The trial court relied on  In re IBP, S’holders Litig., 793 A.2d 396, 397 (Del. Ch. 2002), aff’d by Tyson Foods v. Aetos Corp., 818 A.2d 145, 148 (Del. 2003).

Delaware's High Court reasoned that:

IBP is inapposite. The IBP court’s pronouncement that judicial decisions are public documents was for the purpose of explaining why a party cannot use a settlement to seek vacatur of pre-settlement rulings. Although judicial decisions are public records, that fact cannot empower a court to modify a judgment rendered moot by settlement, even if the judgment contains errors. To hold otherwise would distort the doctrine of mootness and undercut the finality of settlements.

Also included in this opinion is a useful discussion of the impact, if any, of a recorded decision that precedes a settlement, as well as "justiciability" and "mootness" in general. Compare generally, a recent Chancery Court decision about vacatur highlighted here.

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In Lehto v. Board of Education of the Caesar Rodney School District, (Del. Supr., Dec. 2, 2008), read opinion here, the Delaware Supreme Court addressed the issue of immorality in connection with upholding the dismissal of a school teacher based on what was described as immoral conduct primarily engaged in by the teacher outside of the classroom, but with a nexus to the teacher's role in both the school and the community in general.

So what relevance does this case have to this blog on corporate and commercial litigation?

The answer is that legal ethics is one of the topics covered on these pages as part of business litigation generally, and although this particular aspect of legal ethics was not addressed in any way in the court's opinion, I am confident that the discussion of the nexus between the immorality of a teacher's conduct outside the classroom and that teacher's role in the community and effectiveness as a teacher (which is discussed in this opinion), may be used by analogy in some hypothetical case in the future that might involve an issue about whether the actions of a lawyer at home or  "off the job" have any bearing on his or her fitness and qualifications to be a lawyer. See generally, for example, Rules of Professional Conduct 8.3(a) and 8.4(b)(referring to misconduct that calls into question one's "fitness as a lawyer").

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 Berns  v. Doan, (Del. Supr., Nov. 10, 2008), read opinion here, is a decision of the Delaware Supreme Court in which it was determined that the Premises Guest Statute barred the personal injury claim by a trespasser, as opposed to a public invitee, on another's property. This opinion by Delaware's High Court, sitting en banc, should be of interest to landowners who want to know what the applicable standard of review is that courts in Delaware will use if someone is injured on one's property, depending on whether the status of the injured party on one's property is regarded as a public invitee or a trespasser.

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 In Reserves Development LLC v. Severn Savings Bank, FSB, (Del. Supr., Oct. 21, 2008), read opinion here, the Delaware Supreme Court upheld a decision of the Chancery Court to grant only partial interim injunctive relief to a joint venture partner in a real estate development "gone bad" . The parsimonious provision of equitable relief, based on an unjust enrichment theory, pending resolution of a companion case for legal relief in Superior Court, was due to several equitable factors related to the self-help employed by the plaintiff, such as, in part, what was deemed to be unclean hands.

The decision of the Chancery Court, which provides many more details about this factually intensive case, including the denial of a Motion for Reargument, was briefly highlighted on this blog here. The High Court also upheld the denial of pre-judgment interest due, in part,  to the lack of a timely request for same either in the Amended Complaint or in the post-trial briefing.
 

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 In Motorola Inc. v. Amkor Technology, Inc., (Del. Supr., Oct. 8, 2008), read opinion here, the Delaware Supreme Court interpreted patent agreements that turned on an interpretation of the meanings in the context of those agreements, of the words "license" and "assignment".  Key contract interpretation principles, applicable generally to many types of cases, make this a useful decision for a business lawyer's toolbox.

Delaware's High Court also applied "trade usage" to interpret ambiguous terms in the agreement. (See page 8 of slip op.) Also, the Court recognized that there is a rule of construction that specific clauses carry more weight than general clauses (see  Restatement (First) of  Contracts, Section 236, which has been renumbered to Section 203 in the Restatement (Second) of Contracts). However, that rule is only a "secondary rule" that applies only after Sections 230 and 233 of the Restatement (First) of Contracts. Section 233(b) provides that:

Where a party manifests his intention ambiguously, knowing or having reason to know that the manifestation may reasonably bear more than one meaning, and the other party believes it to bear one of those meanings, having no reason to know that it may bear another  that meaning is given to it.

Slip op. at 17.

The Court also addressed the doctrines of equitable estoppel and "the law of the case".

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In Re Seneca Investments, LLC, 2008 WL 4329230 (Del. Ch., Sept. 23, 2008), is a Delaware Chancery Court decision about the unsuccessful attempt to petition the court for the dissolution of an LLC,  that I summarized briefly here.

Here is an in depth analysis of the case and a comparison on Peter Mahler's New York Business Divorce Blog  of how the New York courts may differ in their interpretation of the dissolution provisions of the LLC statute, noting that Section 18-802 of the Delaware LLC Act is very close to the analogous section of the NY LLC Act.

I am extremely grateful for the hat tip on the New York Business Divorce Blog which credited me for first summarizing the case and further described my blog as: "...  the premier online resource for coverage of the Delaware Chancery Court."

 

 

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In Maddrey v. Justice of the Peace Court 13, (Del. Supr., Sept. 5, 2008), read opinion here, the Delaware Supreme Court provides a "Guide for Practitioners" on Writs of Certiorari. Although the High Court's scholarly treatment of this somewhat arcane--but practical and necessary--topic, is more thorough than I can cover in this short post, a helpful reminder for business litigators is that when a landlord is attempting to evict a tenant for non-payment of rent, called a "summary possession" proceeding in Delaware, the Justice of the Peace Courts have exclusive jurisdiction over such actions. The only appeal of a trial on that action is to a three-person Justice of the Peace panel. The trial options end there based on the General Assembly's statutory framework for this type of proceeding. No traditional appellate review of such a case is available.

Rather, the court discusses the limited and restricted option of a writ of certiorari which is NOT an appeal de novo. Other types of cases from the Justice of the Peace Court are often appealable de novo, however, to the Court of Common Pleas for the State of Delaware.

An erudite analysis of other applications of a writ of certiorari, and  its historic origins, is also included in this important decision that is essential reading for any Delaware lawyer who wants a complete understanding of Delaware practice and procedure, including appeals from various state agencies to the Delaware Superior Court.

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Christiana Care Health Services, Inc. v. Connor, et al., (Del. Ch., Aug. 4, 2008), read opinion here,  and Encite LLC v. Soni, (Del. Ch., Aug. 1, 2008), read opinion here, are recent opinions of the Delaware Supreme Court and Delaware Chancery Court, respectively, that deal with procedural and substantive aspects of imposing liability on joint defendants.

In Christina Care, Delaware's High Court interpreted Section 2301(d) of Title 6 of the Delaware Code that relates to pre-judgment interest when a settlement demand is made in an amount less than the amount of damages awarded in a judgment. In this Supreme Court case, a pre-trial settlement offer was made to each defendant in the amount of $1.25 million each (which was not accepted) but the jury award was $2 million jointly for both defendants. Consistent with its recent ruling in Cahall v. Thomas (see summary here), regarding Rule 68 and pre-trial offers of judgment, the Supreme Court reasoned that because the $2 million judgment was a common liability of both defendants which the plaintiff could collect in full from either one, regardless of how the jury apportioned the fault, the entitlement to pre-judgment interest would apply.

 In the Encite LLC case, the Chancery Court addressed the right to contribution between joint tortfeasors, and at footnote 76 refers to cases that confirmed the right to contribution as being governed by the Contribution Among Tortfeasors Law that has as an inherent requirement that the parties are jointly or severally liable in tort for the same injury to person or property. See Section 6301 of Title 10 of the Delaware Code.

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Courtesy of Professor Bainbridge is a link to an article by Professor Bob Thompson on the seminal  Delaware Supreme Court decision in Sinclair Oil v. Levien, from 1971, that addressed key issues of fiduciary duty and judicial review standards. Here is an excerpt from a quote that Professor B. included in his post about the article.

Sinclair provides room for “selfish” ownership for a majority shareholder, so long as the minority shareholders receive a proportional benefit, a standard that at the time seemed to expand the discretion for majority shareholders. Viewed from a point decades later, this part of Sinclair has not proved to be a template for broader applications and other doctrines have developed to constrain the actions of majority shareholders.

Keywords: director action, judicial review of corporate action, business judgment rule, intrinsic fairness, enhanced scrutiny, controlling shareholders, fiduciary duty

UPDATE: Here is an insightful analysis by Professor Larry Ribstein of the Sinclair case highlighted in Professor  Thompson's article. A quote  from Professor R's extensive discussion of the "contract aspect of the case"  follows:

Once you’re outside of fiduciary land, as you are in Sinclair, parties in a commercial relationship can act selfishly to each other, governed by their contracts. Sometimes the contract is implied and not obvious. But the court should look hard for these contractual guideposts. The fog of fiduciary language often obscures the search. This is the basic lesson of Sinclair

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In Hoag v. Amex Insurance Company, (Del. Supr., July 21, 2008), read opinion here, the Delaware Supreme Court upheld the trial court's imposition of the penalty of dismissal of a complaint against a plaintiff that failed repeatedly to comply with orders compelling discovery of data that was key to the claims and defenses in the case. The Court recited in detail the multiple orders that the appellant simply failed to comply with depsite ample opportunity.

Delaware's High Court acknowledged the severity of the penalty but reasoned that it  was warranted in light of the circumstances. The opinion includes "good quotable" language about the importance to the legal system of compliance with discovery obligations.

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CA, Inc. v. AFSCME Employees Pension Plan, (Del. Supr., July 17, 2008), read opinion here.(Revised opinion dated August 15, 2008, available here.)

This Delaware Supreme Court  decision has been anticipated by the corporate legal world with great interest since oral arguments were heard by Delaware's High Court last week.  My post with some background can be found here.  More background discussion of prior Delaware decisions that have addressed related issues, as provided by Professor Bainbridge, can be found here.

In sum, a shareholder of CA, Inc., the trillion dollar pension fund of AFSCME, proposed a bylaw amendment that would require the company to reimburse the shareholder for expenses related to nominating a less than full slate to the board of directors.

Here are the two issues presented by the SEC to the Delaware Supreme Court in a procedure authorized last year and now used for the first time:

1. Is the AFSCME Proposal a proper subject for action by shareholders as a matter of Delaware law?

2. Would the AFSCME Proposal, if adopted, cause CA to violate any Delaware law to which it is subject?

Bottom line of the decision: Yes and yes. Although bylaws, in general,  are permissibly used to address the process and procedures related to board elections, in the particular circumstances of this case, the bylaw proposed would impermissibly restrict the managerial and fiduciary duties of the board. However, the court suggested other means by which the shareholder could achieve the same goal in a way that would be consistent with Delaware law: for example, amend the certificate of incorporation.

 Here is the court's reasoning, in part, for its affirmative answer to the first question:

The shareholders of a Delaware corporation have the right “to participate in selecting the contestants” for election to the board. The shareholders are entitled to facilitate the exercise of that right by proposing a bylaw that would encourage candidates other than board-sponsored nominees to stand for election. The Bylaw would accomplish that by committing the corporation to reimburse the election expenses of shareholders whose candidates are successfully elected. That the implementation of that proposal would require the expenditure of corporate funds will not, in and of itself, make such a bylaw an improper subject matter for shareholder action. Accordingly, we answer the first question certified to us in the affirmative.

That, however, concludes only part of the analysis. The DGCL also requires that the Bylaw be “not inconsistent with law.” Accordingly, we turn to the second certified question, which is whether the proposed Bylaw, if adopted, would cause CA to violate any Delaware law to which it is subject. (footnotes omitted).

For its affirmative answer to the second question, the court provided the following reasoning:

... the Bylaw mandates reimbursement of election expenses in circumstances that a proper application of fiduciary principles could preclude. That such circumstances could arise is not far fetched. Under Delaware law, a board may expend corporate funds to reimburse proxy expenses “[w]here the controversy is concerned with a question of policy as distinguished
from personnel o[r] management.” But in a situation where the proxy contest is motivated by personal or petty concerns, or to promote interests that do not further, or are adverse to, those of the corporation, the board’s fiduciary duty could compel that reimbursement be denied altogether.

It is in this respect that the proposed Bylaw, as written, would violate Delaware law if enacted by CA’s shareholders. As presently drafted, the Bylaw would afford CA’s directors full discretion to determine what amount of reimbursement is appropriate, because the directors would be obligated to grant only the “reasonable” expenses of a successful short slate. Unfortunately, that does not go far enough, because the Bylaw contains no language or provision that would reserve to CA’s directors their full power to exercise their fiduciary duty to decide whether or not it would be appropriate, in a specific case, to award
reimbursement at all. (footnotes omitted)

Footnote 14 which directly addresses the issue of:  "what is the scope of shareholder action that Section 109(b) permits [regarding bylaws] yet does not improperly intrude upon the directors’ power to manage a corporation’s business and affairs under Section 141(a),"   explains exactly what the court did--and did not--decide:

 We do not attempt to delineate the location of that bright line in this Opinion. What we do
hold is case specific; that is, wherever may be the location of the bright line that separates the shareholders’ bylaw-making power under Section 109 from the directors’ exclusive managerial authority under Section 141(a), the proposed Bylaw at issue here does not invade the territory demarcated by Section 141(a).

One of the great things about covering this area of the law on this blog is that many experts in the field cover the same issues, so I can link to their scholarly analysis as a supplement (and sometimes in place of) any comments I have. A few samples of the corporate law professors who have already provided scholarly analysis of this opinion within hours of its release, are: here, here, here, here and here.

 

 

 I invite readers to tell me if they are aware of any other state's highest court that can be counted on, predictably, to render such a weighty decision within a week of hearing oral argument--and when the briefs were only submitted a mere two (2) days prior to oral argument.
 

UPDATE: As one would expect, an enormous amount of high quality commentary continues apace in the blogosphere about this case, and I may update this post or supplement it in the coming days. Also, as an aside, perhaps I will never get accustomed to it, as I am still thrilled when one of my posts is quoted by a luminary like Professor Bainbridge, as he was kind enough to do today here.

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Hazel v. Delaware Supermarkets, Inc., (Del. Supr., July 14, 2008), read opinion here. While most of the corporate legal world is awaiting the Delaware Supreme Court's expedited decision on the SEC-related issue argued before it last week, today the court published an unrelated decision that reversed a trial court's grant of summary judgment that dismissed a negligence claim.

The decision is relevant to this blog because negligence claims "not infrequently" arise in connection with business disputes, and the de novo standard of review when a summary judgment has been granted below to dismiss a case is a useful appellate review analysis for one to be aware of generally.

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Courtesy of the Harvard Law School Corporate Governance Blog , Professor J.W. Verret provides a summary of the oral arguments yesterday before the Delaware Supreme Court on a bylaw issue presented to the Court by the SEC. Here is a short prior post  with background on this historic "collaboration" between the SEC and the Delaware Supreme Court.

Professor Verret's post follows:

AFSCME Employees Pension Plan submitted a shareholder proposal for inclusion in CA’s proxy materials for their annual meeting scheduled to be held on September 9, 2008. That proposal sought to amend CA’s bylaws to require the company to reimburse the reasonable expenses incurred by a dissident nominating a rival slate of directors, provided that at least one nominee from the dissident slate was victorious. CA sought no-action relief from the SEC permitting it to exclude that proposal under Rule 14a-8 as illegal under Delaware law, and the SEC certified the question to the Delaware Supreme Court.

The Court’s opinion stands to re-define the nature of corporate federalism and ring in a new collaborative relationship between the Delaware Courts and the SEC. Indeed, it may encourage the SEC to include more state law carve-outs in future rule-making.

I wrote an essay (available here) on this issue in March predicting that the SEC would certify the bylaw question to Delaware soon. For more on the growing trend of shareholder democracy behind this challenge, see Pandora’s Ballot Box, or a Proxy with Moxie: Majority Voting, Corporate Ballot Access, and the Legend of Martin Lipton Re-Examined (available here). For more on bylaws, see Profs. Coates and Faris’s work (Second-Generation Shareholder Bylaws: Post-Quickturn Alternatives, 56 Bus. Law. 1323 (2001) (with B. Faris)) and Prof. Hamermesh’s article (available here). Anticipating that the opinion in this difficult case might make use of dicta guidance, see also my article with Chief Justice Steele on the Delaware Guidance Function (available here).

This post summarizes a very lively oral argument in Dover, Delaware this morning. The Justices and the parties displayed a rigorous command of this intricate subject, working in a very short timeframe. It was a fascinating to watch these masters of the Delaware General Corporation Law at the height of their craft.

Arguing on behalf of Computer Associates was Robert Guiffra of Sullivan & Cromwell. His presentation focused on two key issues: first, he argued that this bylaw does not relate to an election of directors, but merely comes into play after the election, and thus is not protected by the principles in the Blasius line of cases. As a mandated payment of expenses it relates to control of the corporate treasury, part of the business and affairs of the corporation as defined in Rule 141(a). As such, limitations on the Board’s authority may only appear in its Certificate of Incorporation, not its bylaws. Second, he argued that the Board must be permitted to make a determination of whether a reimbursement was consistent with its fiduciary duty, where this bylaw mandated payment under all circumstances.

Arguing on behalf of AFSCME was Michael Barry of Grant & Eisenhofer. His presentation focused on two key issues: first, he argued that this bylaw relates to an election, implicates the shareholder franchise and Blasius review, and is not a part of the ordinary business affairs of the corporation. As such, it does not undermine the Board’s authority under section 141. He also argued that where directors are mandated to reimburse expenses, they cannot be doing so for the purposes of entrenchment, and thus cannot logically do so in violation of their fiduciary duties. He also cited Delaware’s approval of mandatory indemnification bylaws as binding precedent on this issue.

Both Counsel admitted that, though the bylaw was unclear, reimbursement of expenses for the full contest and not just for the successful nominee was anticipated. Both parties also skillfully argued that the Court need not permanently resolve any looming contradiction between section 109 and section 141(a) to rule in their favor. Section 109 of the DGCL grants shareholders the right to adopt bylaws, and section 141(a) reads that “the business and affairs of every corporation…shall be managed by…a board of directors.” Thus, the oft referenced “recursive loop” in which a bylaw adopted under section 109 might limit a board’s authority under 141(a). The Court nevertheless asked counsel’s opinion concerning the intent of the legislature in creating two conceivably conflicting sections of the code.

Questions from the Court during oral argument make any predictions difficult. The Justices pushed counsel for CA over whether the prospect of reimbursement was inextricably linked to the success of an election, and whether the bylaw would be legal if adopted by the Board. The Justices pushed counsel for AFSCME over whether there might be any circumstances under which a bylaw could force inequitable reimbursement and whether the Board’s authority to adopt bylaws was co-extensive with that of shareholders. Interestingly, Justice Berger, when she served as a Vice Chancellor, suggested in dicta that stockholders create a bylaw limiting the board’s power to amend a stockholder adopted bylaw in American Int’l Rent a Car, an opinion from 1984, which may indicate her view on whether the right to adopt bylaws is co-extensive. The Court also questioned whether the “reasonable” qualifier in this bylaw left enough room for board discretion not to reimburse wasteful expenses.

My own prediction is a substantive victory for AFSCME is possible, but the holding would be limited. If the Court allows election bylaws that mandate board action, it may require bylaws mandating board action have a “fiduciary out” clause similar to what we see in deal lock-in measures. This could be accomplished, I think, either by ruling that the bylaw is illegal only for lack of a fiduciary-out or ruling that the bylaw is legal but that a Board could ignore it if it’s fiduciary duty required it (board action which would then be critically reviewed under subsequent challenge, and the standard of that review for such a decision could be formulated in this opinion). The one thing I am most confident about is that the Court is likely to leave open the possibility to rule that other forms of bylaws, especially poison pill related bylaws, run afoul of 141(a).

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In Rehoboth Mall Limited Partnership v. NPC International, Inc., (Del. Supr., July 2, 2008), read opinion here, (and revised opinion here), the Delaware Supreme Court interpreted a waiver provision in a lease to prevent a landlord from using it to refuse a second renewal of a lease. Most contracts have a "no waiver" provision that ostensibly allows a party to selectively enforce provisions--or stated another way, the landlord in this case reserved the right to enforce the penalties in the lease for default in the future even if those provisions were not always enforced in the past.

Delaware's High Court determined that because there were no defaults during the first renewal period, the landlord could not reach back to the original lease period to deny a second renewal. That is, the court reasoned, the "no  waiver" provision could only be applied to allow the landlord to enforce prospective defaults--as opposed to retroactively penalizing prior defaults that  were already waived.

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 Wood v. Baum, (Del. Supr., July 1, 2008), read opinion here. This Delaware Supreme Court decision is an important ruling regarding the defense by LLC managers to fiduciary duty and Caremark claims against them in light of  the exculpatory terms of an LLC agreement.

Based on the exculpatory terms of the Operating Agreement and the LLC Act, Delaware's High Court summarized what the plaintiff needed to establish as follows:

Therefore, under the Operating Agreement and the LLCA, the MME directors’ exposure to liability is limited to claims of “fraudulent or illegal conduct,” or “bad faith violation[s] of the
implied contractual covenant of good faith and fair dealing.”

The money quote from the opinion, (which is precious "manna from heaven" in light of the relative paucity of Supreme Court decisions on liability of LLC members), follows:

Where directors are contractually or otherwise exculpated from liability for certain conduct, “then a serious threat of liability may only be found to exist if the plaintiff pleads a non-exculpated claim against the directors based on particularized facts.”13 Where, as here, directors are exculpated from liability except for claims based on “fraudulent,” “illegal” or “bad faith” conduct, a plaintiff must also plead particularized facts that demonstrate that the directors acted with scienter, i.e., that they had “actual or constructive knowledge” that their conduct was legally improper.14 Therefore, the issue before us is whether the Complaint
alleges particularized facts that, if proven, would show that a majority of the defendants knowingly engaged in “fraudulent” or “illegal” conduct or breached “in bad faith” the covenant of good faith and fair dealing. We conclude that the answer is no.

The court provides a pithy summary of the demand futility tests under Aronson and Rales, and then explains the lack of particularity in the conclusory allegations in the complaint--juxtaposed against the provisions of the operating agreement requiring a showing of fraud or bad faith before the defendants could be found liable. Specifically, the court explained:

The Board’s execution of MME’s financial reports, without more, is insufficient to create an inference that the directors had actual or constructive notice of any illegality.

* * *

Delaware law on this point is clear: board approval of a transaction, even one that later poves to be improper, without more, is an insufficient basis to infer culpable knowledge or bad faith on the part of individual directors.

Footnote:  See, e.g., Guttman v. Huang, 823 A.2d 492, 498 (Del. Ch. 2003) (dismissing complaint that was “devoid of any pleading regarding the full board’s involvement in the preparation and approval of the company’s financial statements” and of “particularized allegations of fact demonstrating that the outside directors had actual or constructive notice of the accounting improprieties.”)

Other reasons the court dismissed fiduciary claims and Caremark claims are more easily quoted than summarized. The court explained its affirmance of the Chancery Court 's dismissal of the claims with the following recitation of black letter Delaware law:

Plaintiff also asserts that membership on the Audit Committee is a sufficient basis to infer the requisite scienter. That assertion is contrary to well-settled Delaware law. In Rattner v. Bidzos, for example, the Court of Chancery declined to infer that the directors had a culpable state of mind based on allegations that certain board members served on an audit committee and, as a consequence, should have been aware of the facts on which the plaintiff premised her interpretation of “SEC rules and regulations, and FSAB and GAAP standards.”19  (emphasis added).

Finally, plaintiff claims that the Board knowingly ignored “red flags.”20   Under Delaware law, red flags “are only useful when they are either waved in one’s face or displayed so that they are visible to the careful observer.”21
(emphasis added).

I will leave you with a gem from the court's opinion. I call it a gem because the "implied duty of the covenant of good faith and fair dealing" is not as fully developed in the LLC context as are common aspects of corporate law in Delaware:

The implied covenant of good faith and fair dealing is a creature of contract, distinct from the fiduciary duties that the plaintiff asserts here.22  The implied covenant functions to protect stockholders’ expectations that the company and its board will properly perform the contractual obligations they have under the operative organizational agreements.23  Here, the Complaint does not allege any contractual claims, let alone a “bad faith” breach of the implied contractual covenant of good faith and fair dealing. Nor, as discussed above, does the Complaint contain any particularized allegations that the defendants acted with the requisite scienter (in “bad faith”).

This case is but another replay of other similar cases where the plaintiff failed to allege with particularity any facts from which it could be inferred that particular directors knew or should have been on notice of alleged accounting improprieties, and any facts suggesting that the board knowingly allowed or participated in a violation of law.24

UPDATE: Professor Larry Ribstein posts about the case here, with his customarily insightful analysis, including his observation that one of the reasons this case is important is because Delaware's High Court has now confirmed that exculpatory provisions of an LLC will be honored even when the LLC is publicly-held. That is, this case "enshrines in judicial concrete" (my words) what is already in the LLC statute--namely, unlike in corporations, fiduciary duties can be waived in an LLC. In this case, in order to avoid dismissal, the complaint had to satisfactorily allege fraud and other "higher threshold" claims, which it failed to do.

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Courtesy of Wilmington lawyer Brian Rostocki, comes a report of the first example of the SEC availing itself of a procedure authorized last year that allows the SEC to ask the Delaware Supreme Court for rulings on particular issues of Delaware law that impact the SEC. Here is a post on this blog describing the new procedure when it was authorized last year. Here is an article from Securities Law360 describing the SEC's request in more detail.

The issue that the SEC has asked for the Delaware Supreme Court to rule on  is whether companies must reimburse shareholders for the costs of an only partially successful short-slate proxy contest. AFSCME asked the SEC for its position on the reimbursement for costs that it will incur in a proxy contest for a minority of the CA, Inc. board at a shareholders' meeting scheduled for September. In turn, the SEC asked the Delaware Supreme Court for a definitive ruling on this issue of Delaware law. 

The Delaware Supreme Court may hear oral arguments on the issue next week.

The CorporateCounsel.net  Blog here provides an insightful review of the matter.

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The Delaware Supreme Court was asked by the Governor of the State of Delaware, pursuant to established procedure, to answer a question of law about whether a person she wanted to nominate to a minor judicial position, was disqualified due to a drug offense committed when he was 17 years old, in light of a provision in the Delaware Constitution that disqualifies from such office persons convicted of certain types of crimes. The Governor asked for the opinion within 5 days--before a scheduled vote by the State Senate. The High Court rendered its decision one day early. Read the court's decision concluding that there was no disqualification here. The State Senate confirmed him today as a Family Court Commissioner, as reported here.

UPDATE: Here is the backstory from veteran political commentator Celia Cohen on her DelawareGrapevine site.

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In Wright v. Moore, (Del. Supr., June 17, 2008), read opinion here, the Delaware Supreme Court addressed yesterday the standard that applies to requests for modifications of pre-trial orders which control such things as discovery deadlines and the like. The specific issue in this interlocutory appeal was whether the trial judge abused her discretion for refusing to allow for new discovery after the Supreme Court remanded and reversed the case last year for a new trial. The court discussed the "manifest injustice" test under Rule 16(e) and found that it did apply here. Delaware's High Court also took the unusual step of ordering that the case be assigned to a different trial judge.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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 In the Matter of the Philadelphia Stock Exchange, Inc., (Del. Supr., March 27, 2008), read opinion here, the Delaware Supreme Court (two days ago) affirmed the Chancery Court's decision to both approve the class action settlement in the case as well as upholding the trial court's bifurcation of the settlement proceedings to address an objector's argument that the settlement proceeds were not fairly distributed among the class members. In its 44-page opinion, the Supreme Court addresses the long list of substantive and procedural objections to the settlement. Some of the objections, which the court refers to as "multitudinous" and a "plethora", were waived for not having been fairly presented to the Chancery Court, and others were rejected after careful analysis and reference, for example, to Delaware and federal cases that have allowed bifurcation to consider a settlement as a whole, and a separate proceeding to address allocation among class members. Prior Chancery Court decisions in this case were summarized here and here. One of the prior Chancery decisions in this case was cited in a recent ethics article, here, that  I published about the attorney/client relationship among class members and their lawyers.

UPDATE: For those interested in what the entrance to the Delaware Supreme Court Building in Dover looks like, below is a photo of it that I obtained free from the Internet via flickr and the Creative Commons license, by someone who is identified only as katicabogar.

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In Reddy v. MKBS Company Limited, (Del. Supr., March 3, 2008), read opinion here, the Delaware Supreme Court  (yesterday) affirmed a Chancery Court decision, summarized here,  finding that an attempt to "cancel" shares, whether via the certificates representing those shares or the shares themselves, did not comply with statutory and related requirements. Both courts also addressed the difference between "void" and "voidable" stock.  The money quote follows:

The cancellation of those shares could only be accomplished by complying with the procedure mandated by 8 Del. C. § 242—a written charter amendment, authorized by the board of directors, approved by the shareholders, and filed with the Delaware Secretary of State. Reddy concedes that those requirements are applicable to cancellations of stock, and that no charter amendment for either MKBS company was ever effected.

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In Schoon v. Smith, (Del. Supr., Feb. 12, 2008), read opinion here, the Delaware Supreme Court ruled yesterday that a director qua director may not sue fellow directors of a corporation derivatively. This may sound esoteric for some, but any time the Delaware Supreme Court decides an issue that relates to the duties and/or rights of directors of a Delaware corporation, most serious students of corporate law and Delaware litigation pull up their socks and pay attention. Three prior decisions by the Chancery Court regarding litigation between (at least some of) the parties in this case were summarized here, here and here. 

 Fortunately for me, we have the benefit of a prompt and insightful comment on the case here, that comes to us courtesy of Steven M. Haas of Hunton and Williams LLP via the Harvard Corporate Governance Law Blog.

Does a Director Qua Director Have Standing to Sue Derivatively? No, so said the Delaware Supreme Court yesterday in Schoon v. Smith. The Supreme Court affirmed the Court of Chancery’s little-noticed ruling last year that dismissed a derivative claim brought by a director against the company’s other directors, including its controlling stockholder. The plaintiff-director, who was not a stockholder of the company, charged his fellow directors with, among other things, breach of fiduciary duty and unjust enrichment. The court held that, notwithstanding the equitable origins of derivative suits, the issue of director standing today is best left to the legislature. “Although the Delaware General Assembly has the prerogative to confer standing upon directors by statute,” the court wrote, “it has not chosen to do so.” Rejecting the American Law Institute Principles that give individual directors standing to sue on behalf of their corporations, the court continued that, “[b]ecause a stockholder derivative action is available to redress any breach of fiduciary duty, we decline to extend the doctrine of equitable standing to allow a director to bring a similar action.” The court concluded, however, by leaving itself a little room to permit directors to bring derivative suits, but only where the failure to do so would result in a “complete failure of justice”—a seemingly high standard.

As a practical matter, the decision is unlikely to have much significance because most directors are also stockholders. But the decision is still significant and may draw criticism with respect to its implications for corporate governance and director duties. In particular, the court noted that the concept of being an “independent director” does not mandate “a duty to sue on behalf of the corporation.”

UPDATE: Here is a post on the case by Professor Bainbridge who was kind enough to link to this post but more importantly he provides a prescient excerpt from his treatise on Corporation Law and Economics that addresses the same issue decided by the court in this opinion.

 

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  As I have done for opinions issued in 2005 and 2006, I have prepared a review here of key corporate and commercial decisions from the Delaware Chancery Court and Delaware Supreme Court during the year 2007. See my two prior yearly summaries here. The summary was prepared as an article that was published in the Jan. 16, 2