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

Thanks to Mack Sperling of the North Carolina Business Litigation Report, we have a  very recent decision by a New York Court, applying Delaware law, holding that the business judgment rule was satisfied in the "fire sale" [my words] of Bear Stearns to JP Morgan. The decision, here,  was submitted to the court in North Carolina (mentioned below) hearing the Wachovia/Wells Fargo litigation that involved similar issues. 

Recall as noted here the decision of the Delaware Chancery Court a few months ago to stay the Delaware case involving the merger of Bear Stearns, and deferring to the pending related Bear Stearns case in a New York court in what was perhaps a sui generis procedural decision.  Here's how Mack Sperling introduces the New York court's Bear Stearns opinion:

... the Bear Stearns board did not breach its fiduciary duty in its quick approval of the merger with JPMorgan and in agreeing to the deal protection provisions that it did, including selling 39.5% voting control to JPMorgan: "The financial catastrophe confronting Bear Stearns, and the economy generally, justified the inclusion of the various merger protection provisions intended to increase the certainty of the consummation of the transaction with JPMorgan." (slip op. at 32).

Also on Friday, December 5, 2008, as reported by Mack Sperling here, the North Carolina Business Court found that the business judgment rule supported the merger of Wachovia and Wells Fargo that was arranged in similarly unusual circumstances in light of the economic turmoil that in very short order saw some of the country's largest financial institutions "go under" or need "bailouts".

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Lee Thomason is a lawyer-reader of this blog and often comments on my posts. He has authored an article about a recent decision by the U.S. District Court for the District of Delaware on patent-related procedural issues involving Markman hearings and the like, that can be found here.

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Advancement of legal fees under DGCL Section 145 is a quintessentially Delaware legal topic that has been the subject of 39 different posts over the last four years on this blog, (see list of posts here), either based on summarizing Delaware opinions on the issue or referring to discussions by others of recent developments. [This is post number 40.] Among those 39 posts was a highlight of the federal decision in U.S. v. Stein by Judge Kaplan of the Southern District of New York that dismissed claims against certain KPMG partners because the judge reasoned that prosecutors in that case, by "strong-arming" (my word) KPMG into refusing to provide advancement rights to the partners, KPMG in effect, denied the partners' right to effective counsel under the Fifth Amendment of the U.S. Constitution. Here is my blurb on Judge Kaplan's decision of last year. I am not aware of that same issue being addressed directly, in the same way, by courts in Delaware, but Judge Kaplan's decision remains as a milestone to highlight how important the right to advancement is, even in civil cases where the legal fees are so astronomical that most mortals could not afford to advance the legal fees on their own to defend a case brought against them, for example, in their capacity as a director of a company.

 The Wall Street Journal Law Blog writes today here about the prosecution's recent decision not to appeal the Second Circuit's affirmance of Judge  Kaplan's decision. A reading of Judge Kaplan's decision and the appellate court's affirmance should be required reading for anyone who wants a complete understanding of the full ramifications of the importance of the right to advancement and the consequences of that right being denied--where, of course, the right is established. Most Delaware cases address whether the right to advancement has been established and what the contours of that right are.

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In King Construction, Inc. v.  Plaza Four Realty, LLC, (Del. Super., Sept. 29, 2008), read opinion here, the Delaware Superior Court strictly construed the Delaware Mechanic's Lien statute and dismissed the efforts of a subcontractor to file a mechanic's lien based on non-compliance with the statute, such as the following: (i) failure to obtain written consent of the owner of the property before performing work for the tenant on leased premises; and (ii) not waiting until all work was completed before filing the mechanic's lien for amounts due (which date must be asserted in the court pleadings).

The court also recited several other prerequisites in the statute for successfully asserting a mechanic's lien, as well as discussing policy reasons and filing deadlines that is all useful information for anyone who needs to know the details about mechanic's liens in Delaware.

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Peter Mahler on his New York Business Divorce Blog, here, discusses a New York case that involves a claim by an LLC member against the accountant of a Delaware LLC that was the subject of a dissolution proceeding in the Delaware Chancery Court. The Chancery Court case settled but one member later claimed that the LLC's accountant impermissibly help the other member in the dissolution proceeding. Excerpts from the excellent blog post follow:

...  until Anda Management, LLC v. Needlemen & Schacter, LLP, 2008 NY Slip Op 31534(U) (Sup Ct Nassau County May 20, 2008), I'd never heard of spin-off litigation involving charges against a professional for improperly taking sides in the underlying dissolution case.

 

Here's what happened: Anda Management and Wilmington Paper Corp. formed a Delaware LLC called Worldwide Fibers to market paper products overseas. Worldwide retained the defendant accounting firm as its accountant without a written agreement. Three years later, Worldwide's principals had a falling out, prompting Wilmington to file a proceeding for judicial dissolution of Worldwide in Delaware Chancery Court. Wilmington accused Anda's principals of impermissibly withdrawing funds from Worldwide for personal reasons and then falsely booking them as legitimate business expenses.

The Delaware proceeding ultimately settled when Anda acquired Wilmington's interest in Worldwide.

Anda and its principals subsequently brought a New York action against the accountant for breach of fiduciary duty and malpractice arising from its conduct in the Delaware case. The plaintiffs alleged that the accountant consulted with and assisted Wilmington's trial counsel by reviewing a proposed complaint, participating in conference calls with Wilmington's counsel, and submitting affidavits supportive of Worldwide's claims in which the accountant allegedly made false and contradictory statements concerning accounting advice previously given by the accountant to the plaintiffs prior to the dissolution. The plaintiffs also alleged that the accountant was aware that the expenses challenged by Wilmington were proper, and that the accountant had affirmatively counseled the plaintiffs to take some of the disbursements challenged by Wilmington. The plaintiffs further alleged that one of the accountant's employees gave the social security numbers of Anda's principals to Wilmington's counsel in order to perform credit searches on them.

 

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Street v. The End of The Road Trust, et al., (D. Del., Bankr., Sept. 17, 2008), read opinion here. Thanks to Delaware lawyer David Finger for bringing this decision to my attention.

A quote from the court's opinion highlighted the issues addressed:

There are a number of basic propositions in Delaware corporate cases that are helpful in clarifying the distinction between (1) indemnification and advancement, and (2) a mandatory advancement and discretionary advancement, with the former
constituting an enhanced benefit to an indemnitee.

Danielle Blount, an associate in our Wilmington office, prepared the following case summary:

 The United States Bankruptcy Court for the District of Delaware denied Plaintiff’s request for advancement for expenses arising out of acts related to his duties as Trustee. Plaintiff claimed that he incurred fees and expenses in excess of $169,049 prosecuting the petition to recover fees and $1.25 million defending an adversary proceeding.

On January 9, 2007, Plaintiff filed a petition in the Chancery Court asserting claims for advancement and indemnification. Thereafter, an adversary proceeding was filed against the Plaintiff alleging breaches of fiduciary and contractual duties. Subsequently, the Debtor removed the Chancery Court action to the District Court for the District of Delaware, thus bringing it before the Bankruptcy Court for the District of Delaware.

Notably, the court relied on Delaware Chancery Court and Delaware Supreme Court cases which clarify the distinction between (1) indemnification and advancement; and (2) mandatory advancement and discretionary advancement. Among the cases cited ihn this opinion by Bankruptcy Judge Walsh on these issues include the following: Majowski v. American Imaging Management Services, LLC, 913 A.2d 572 (Del. Ch. 2006), Advanced Mining Systems, Inc. v. Frincke, 623 A.2d 82, 84 (Del. Ch. 1992), and Havens v. Ahar, 1997 WL 695579 (Del. Ch. 1997).

 Delaware Court of Chancery decisions were helpful in the court's determination about how to assess an indemnitee’s entitlement under a discretionary advancement provision. In utilizing the precedent from the Court of Chancery, the court here held that in the context of an non-corporate entity that either a successor Trustee or Trust Advisory Committee can exercise the kind of judgment that a board of directors can undertake in a corporate discretionary advancement context. This case involved a trust as opposed to a corporation. 

ASIDE: For those involved in trust litigation, there is a helpful discussion at pages 19 to 20 of this opinion that addresses the factors that should be considered when a trust decides to pay for attorneys' fees that it incurs--out of the trust corpus.
 

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In re Intel Corp. Microprocessor Antitrust Litigation, 2008 WL 2310288 (D.Del. 2008), read opinion here. This is an opinion that should be read by anyone who wants to, or needs to, keep up to date on electronic discovery (EDD) pitfalls (read: all business litigators). The backdrop to this particular dispute in the litigation involved the inadvertent failure to retain data by certain Intel custodians of electronically stored information (ESI) who it seems did not follow instructions given to them regarding a "litigation hold".

Notably, the parties described this case as potentially involving "the largest electronic production in history". However, that did not  justify an exception to the applicable rules and analysis. See generally Fed. R. Civ. P. 37(f) and committee notes (recent amendment that allows for  a safe harbor under certain circumstances if ESI is inadvertently destroyed)

When it was determined that certain custodians had failed to properly preserve ESI, a law firm was engaged to interview those custodians to establish to the court that the error  in failing to preserve data was inadvertent human error. As a result of relying on those interviews to establish that "defense" to spoliation, however, the court adopted the findings of a Special Master that:

• the attorney/client privilege was waived; and
• the "non-core" attorney work product had to be produced. See Fed. R. Civ. P. 26(b)(3)(A)(ii)

The opinion has a helpful discussion of situations where the attorney/client privilege is waived as well as when the "attorney work product" (both core and "non-core") protection will NOT be allowed.

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Steve Jakubowksi's Bankruptcy Litigation Blog here, has a characteristically erudite analysis about the Lehman Brothers bankruptcy filing today, with links to actual documents filed in the case. I have to believe that part of the case will eventually involve claims against the officers and directors for their role in this "epic mess". Steve's post was also picked-up here on The Wall Street Journal's Law Blog.

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It was reported that a federal judge in Allentown, PA, dismissed a case because no reply was filed to a motion to dismiss. According to the article (sorry, no link available), the court sent a filing deadline notice by email, but the lawyer did not receive the notice of the deadline--apparently due to his email spam filter. This was reported in the Delaware County (PA) Sunday Times on Sept. 14, 2008 at page 17.

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In Citizens Bank v. Design-A-Drape, Inc.,  Del. Super., (July 30, 2008), read opinion here, the Delaware Superior Court imposed attorneys' fees as a penalty for naming a co-defendant as a party for whom there was no (apparent) good faith basis to join as a defendant in the suit. ( I am up to date with summaries of the key decisions on business law of the Delaware Chancery Court and Delaware Supreme Court, so I am covering a decision of practical importance to business litigators from the trial court of general jurisdiction in Delaware, known as the Superior Court).

The Court provided the basis for its authority to make an exception to the "American Rule" that each party pays its own attorney's fees, including Rule 11. The Court also noted that Section 3904 of Title 10 of the Delaware Code, referred to as the "common name" statute, allows one to sue an unincorporated association of persons by their "common trade name" without the need to sue each of the members of that group. It was not availing for the plaintiff to argue that because the corporation also sued was defunct and not in good standing, he should have been entitled to sue the wife of the other defendant who had (alone) personally guaranteed the unpaid debt on which the suit was based. 

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This case summary comes to us courtesy of Maura Burke, one of our firm's summer associates.

In Miller v. McCown De Leeuw & Co., Inc. (In re Brown Schools), 386 B.R. 37 (Bankr. D. Del. 2008), the Delaware bankruptcy court held that the theory of deepening insolvency may be used to measure damages in an action for breach of the fiduciary duty of loyalty. This opinion revives the concept of deepening insolvency as a significant bankruptcy issue in Delaware.
In Trenwick Am. Litig. Trust v. Billett, 931 A.2d 438 (Del. 2007), aff’g Trenwick Am. Litig. Trust v. Ernst & Young, LLP, 906 A.2d 168 (Del. Ch. 2006), the Delaware Supreme Court closed the door on deepening insolvency, or the wrongful prolonging of an insolvent company by increasing its debt load, as an independent cause of action in Delaware. The Trenwick court did not address deepening insolvency as a measure of damages. In re Brown Schools confirms the Trenwick court’s holding while providing guidance as to deepening insolvency’s role in measuring damages for specific causes of action.
Brown Schools involved an action by a Chapter 7 trustee against the debtors’ controlling shareholder, McCown De Leeuw & Co. Inc. (“MDC”). In 1997, MDC indirectly acquired more than 65% of the stock of The Brown Schools, Inc. (the “Company”). As part of the Company’s recapitalization, the Company obtained $100 million in loans from various banks, $15 million in capital from Teacher’s Insurance and Annuity Association of America (“TIAA”) and additional loans from MDC. Over the next several years, the Company unsuccessfully attempted to restructure its debt and eventually filed for Chapter 7 relief in 2005. The Company’s appointed Chapter 7 trustee filed suit against MDC and its affiliates (the “Defendants”) claiming among other things deepening insolvency, breach of fiduciary duty, fraudulent and voidable transfers, and civil conspiracy.
The Defendants moved to dismiss the trustee’s claims alleging that (a) Delaware does not recognize deepening insolvency as a valid cause of action and (b) each of the plaintiff’s additional claims were based upon deepening insolvency and therefore were invalid in their own right.

The bankruptcy court, following Trenwick, dismissed the deepening insolvency claim, however the court disagreed that the other causes of actions were merely “disguised deepening insolvency claims.”

The bankruptcy court, narrowly construing the Trenwick decision, found that Trenwick did not bar traditional claims for breach of fiduciary duty. Additionally, the court rejected the argument that In re Radnor Holdings Corp., 353 B.R. 820 (Bankr. D. Del. 2006), mandated dismissal of the claims. In Radnor, the court dismissed a duty of care violation claim because it was merely a “deepening insolvency claim by another name.” In this case, the court distinguished Radnor, holding that breach of fiduciary duty of loyalty related to issues of self-dealing and fairness, not deepening insolvency, therefore the claim was not dismissible.

Finally, the bankruptcy court, relying on Alberts v. Tuft (In re Greater Southeast Cmty. Hosp. Corp. I), 353 B.R. 324 (Bankr. D.C. 2006), found that deepening insolvency may be used as a theory of damages for a claim based on a breach of duty of loyalty. Under this theory, damages are measured by the dissipation of corporate assets and/or the company’s increased debt load. Thus, damages could exceed the amount invested in, or benefits actually received by, the company.
Brown Schools reestablished the concept of deepening insolvency as a consequential bankruptcy issue in Delaware. Although not recognized as a separate cause of action, deepening insolvency may be implemented as a theory of damages for breach of fiduciary duty of loyalty. Accordingly, Brown Schools quashes any hopes previously held by directors and officers of distressed companies that Trenwick eliminated entirely the issue of deepening insolvency in Delaware.

 

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In Kamco Building Supply v. Kearney and Schweitzer, 95 Delaware County (PA) Reports 180 (2007), Pagano, J., read opinion here, the Delaware County (PA) Court of Common Pleas discussed the Pennsylvania Long Arm Statute and refused to find jurisdiction over a New Jersey lawyer in Pennsylvania when that lawyer was not licensed in PA and did not have an office in PA and apparently had no ties to PA other than suing a PA company in New Jersey.

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This is another case summary by associate Carl Neff about another example of the Bankruptcy Court's application of Delaware corporate law. The Harvard Corporate Governance Blog  also published their own summary of the case noted below.
 

In Bridgeport Holdings Inc. Liquidating Trust v. Boyer, et al., Adv. No. 07-51798, 2008 WL 2235330 (Bankr. D.Del. 2008), read opinion here,  a liquidating trust brought an action against the former officers and directors of Bridgeport Holdings, Inc., along with the restructuring professional appointed to the position of chief operating officer.

The liquidating trust asserted claims for breach of fiduciary duty and corporate waste. In granting in part and denying in part Defendants’ Motion to Dismiss, Bankruptcy Judge Peter Walsh held:

(i) Delaware's statute of limitations barred certain claims for breach of fiduciary duty; (ii) the trust stated claims for breach of the duty of loyalty and acting in bad faith under Delaware law; (iii) the exculpatory provision in the certificate of incorporation did not defeat a claim for breach of duty of care by former directors; (iv) complaint failed to state claim for breach of duty of due care and lack of good faith against former officers; (v) complaint stated claim for breach of fiduciary duties against restructuring professional; and (vi) complaint failed to state claim for corporate waste.
In denying the motion as to the duty of loyalty claims, the Court held that the trust properly stated a claim for breach of duty of loyalty and acting in bad faith. The trust properly asserted that the breach of loyalty was premised upon the failure of a fiduciary to act in good faith, consistent with Stone v. Ritter, 911 A.2d 362, 370 (Del. 2006).

 In denying the motion as to the duty of loyalty and acting in bad faith under Delaware law, the Court held that neither the exculpatory provision nor the business judgment rule vitiates this count. The Court relied on the Delaware Supreme Court decision in McMullin which held that a board of directors has a duty under 8 Del. C. § 251(b) to act in an informed and deliberate manner in determining whether to approve an agreement of merger before submitting the proposal to the stockholders.

In the absence of a majority shareholder, the directors “may not abdicate that duty by leaving to the shareholders alone the decision to approve or disapprove the agreement.”
Additionally, the Court granted the Motion to Dismiss as to the duty of care claims against the D&O defendants, as the Complaint is too short on facts regarding the conduct of the officers in pursuing the sale transaction to survive the motion to dismiss with regards to these counts.

Finally, the Court granted the Motion as to waste claims, holding that the Complaint did not allege facts that support the conclusion that no reasonable person would find $28 million adequate for the Assets of a failing entity. The Court added that only “extraordinary circumstances can justify a finding of waste and the Complaint here does not present those circumstances.”
 

 

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Courtesy of associate Carl Neff is a summary of a decision from the U.S. Bankruptcy Court for the District of Delaware in a case styled: In re Troll Communications, LLC , 385 B.R. 110, 113 (2008). This Bankruptcy Court  in Delaware is often called upon to apply Delaware corporate law and frequently applies it in the context of a claim brought by a trustee for a bankrupt corporation against the former directors and officers. This is such a case.

In this Bankruptcy Court decision, a Chapter 7 trustee (the “Trustee”) brought adversary proceedings for breach of fiduciary duty, and fraudulent and preferential transfers. The Trustee filed an amended complaint and the defendants moved to dismiss. The motions to dismiss were granted in part and denied in part.

A. Count One: Claims for Breach of Fiduciary Duty Against Individual Defendants.

Count One of the amended complaint alleged claims for breach of fiduciary duty against Troll Communications directors and officers. See id. at 113. In support of these claims, the Trustee cited: (1) the board and officers’ suspect authorization of the use of proceeds from an equity transaction to pay debts owed by Quad Ventures Partners SBIC (“Quad”); and (2) the board and officers’ failure to prevent Troll’s deepening insolvency. See id. at 117. Supporting their motions to dismiss, the defendants cited: (1) the Trustee’s failure to plead around the business judgment rule; (2) the amended complaint’s lack of specificity regarding the officers’ knowledge and participation; and (3) the invalidity of a “deepening insolvency” cause of action. See id. at 119-122.

First, the court held that the business judgment rule was not a basis for dismissal of a breach of loyalty claim against the board of directors. See id. at 119. Count One alleged that certain members of Troll’s board of directors breached the duty of loyalty when they authorized the use of proceeds from an equity transaction in September 2002 to pay debts owed by Quad. See id. at 117. The complaint alleged that a majority of the directors had a financial interest in both Troll and Quad and one director failed to perform an independent review of the decision. See id. at 119. The defendants argued that the Trustee failed to plead around the business judgment rule and therefore the count should be dismissed. See id. at 118. The court rejected this argument because the complaint sufficiently pled facts questioning the disinterestedness of a majority of the directors. See id. at 119. Accordingly, the motion to dismiss was denied. See id. at 120.

Also under Count One, the court dismissed claims against Troll’s officers for breach of fiduciary duty because the complaint failed to allege specific details about the officers’ knowledge and participation. See id. at 120-21. To state a valid claim for breach of fiduciary duty, the Trustee must demonstrate: “(1) the existence of a fiduciary relationship; (2) a breach of that relationship; and (3) knowing participation by the defendant in the fiduciary’s breach.” See id. at 120. The complaint failed to allege with sufficient detail the officers’ knowing participation in the payments to Quad. See id. at 120. Therefore, the court dismissed the allegations, gave the Trustee leave to amend and directed him to specify which officers breached, or aided and abetted in the breach, of the fiduciary duty. See id. at 120-21.

Finally, the court dismissed Count One’s request for relief based on deepening insolvency, because deepening insolvency is not a valid cause of action under Delaware law. See id. at 121. Count One alleged that by failing to take prompt corrective action in the face of the company’s financial decline, the directors and officers “caused the corporate life of the debtors to be artificially extended beyond the point of economic viability.” See id. at 121. Although the Trustee did not explicitly assert this as an action for deepening insolvency, the court interpreted it as such. See id. Noting that the Delaware Supreme Court had rejected deepening insolvency as a cause of action, the court dismissed Count One’s request for relief based on this theory. See id. at 121 (citing Trenwick Am. Litig. Trust v. Billett, 931 A.2d 438 (Del. 2007), aff’g Trenwick Am. Litig. Trust v. Ernst & Young, LLP, 906 A.2d 168, 204-07 (Del.Ch. 2006)).

B. Counts Two and Three: Avoidance and Recovery of Fraudulent and Preferential Transfers
Both counts Two and Three of the amended complaint sought avoidance and recovery of three specific payments from Troll to Quad. See id. at 122. Count Two sought avoidance and recovery of the payments under the theory that they were fraudulent transfers. See id. Count Three sought avoidance and recovery of the same three transfers under the theory that they were preference payments. See id. at 123. The defendants moved to dismiss these counts arguing that (1) the Trustee did not sufficiently allege facts establishing Troll’s insolvency at the time of the transfers; and (2) the Trustee failed to plead the fraud claim with the requisite specificity. See id. The court denied the motions to dismiss.

The Trustee adequately alleged Troll’s insolvency at the time of the challenged payments. See id. at 124. To state a valid fraudulent transfer claim, the complaint must allege that the debtor was insolvent at the time of transfer. See id. The amended complaint, referencing Troll’s internal financial statements, alleged that at the time of the transfers Troll had “a negative net worth and was unable to meet maturing obligations.” Id. The court accepted the allegations as true and rejected the defendants’ argument that the facts alleged only a “mere suspicion” of insolvency. See id. The Trustee sufficiently alleged Troll’s insolvency, therefore the court denied the defendants’ motion to dismiss. See id. The amended complaint sufficiently pled fraud with the specificity required by Federal Rule of Civil Procedure 9(b). See id. at 125. The defendants argued that the Trustee’s pleading was deficient because it failed to identify a creditor and other factual information. See id. at 124. The court rejected the defendants argument holding that courts do not “require a trustee to plead the existence of an unsecured creditor by name.” See id. at 125. Additionally, the court held that the amended complaint contained sufficient factual information including: (1) the applicable statutory language; (2) the date and amounts of each transfer; (3) a claim that the transferees were insiders; and (4) specifics regarding Troll’s financial status. See id. The amended complaint sufficiently pled fraud with the requisite specificity, therefore the court denied the defendants’ motion to dismiss. See id.

C. Trustee’s Request to Further Amend the Amended Complaint.
The Trustee requested the opportunity to add certain corporate entities to Count One, Two and Three. See id. at 125. The defendants objected to the addition of one business entity to Count One arguing that the Trustee could not meet the requirements for relation back under Federal Rule of Civil Procedure 15(c). See id. The court scheduled a hearing to address the issue of whether the Trustee may further amend the complaint as requested. See id. 




 

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 In Orr v. Travelers Insurance Company, 95  Delaware County (PA) Reports 145 (2008), read opinion here, the Delaware County (PA) Court of Common Pleas discusses the high standard in Pennsylvania that must be met for overturning a binding arbitration decision. The court held that the failure of one of the arbitrators to disclose a prior affiliation with one of the parties was enough to trigger the "irregularity" threshold as a basis to set aside the award.

 

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For those of us who labor in the trenches of business litigation and need to concern ourselves with the quotidian details of long-arm service, this is an important sharp implement for your toolbox: This week the Governor signed legislation that provides for a new procedure to follow for long-arm service. Here is a link to a summary of the Bill--and the complete copy of the Bill. I hope to summarize the new procedures soon (for those who may not prefer to read the actual linked legislation.)

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 In D.C. v. Heller, the United States Supreme Court issued an opinion today interpreting the Second Amendment of the U.S. Constitution to disallow a law in the District of Columbia that prohibited the purchase and possession of handguns. Read opinion here (157 pages, including dissents).

Here is one of  the posts today on the topic at The Wall Street Journal's Law Blog. Here is a take on the case that focuses on the comparison of the dissent by Justice Stevens with the majority opinion written by Justice Scalia, as reported by the Blog of the Legal Times.

Apart from the obvious reasons, this SCOTUS opinion has a big impact on businesses. Just ask any owner of a gun store. Of course, the person who lives in Montana and uses a gun for recreational hunting has a different view of the right to bear arms as would a mayor of a big urban city where mostly illegally obtained guns are part of a serious problem of senseless death and violence. Whatever one's views on the politically charged issues of guns, the opinion could serve as a mini-textbook on constitutional interpretation principles.  This lengthy opinion also offers an insight into the hotly contested views held by members of the nation's highest court who find themselves on opposite sides of big issues like this.

UPDATE: Another post on the WSJ's Law Blog today here quoted a lawyer who filed an amicus brief in the case who described the Heller decision as one of the most important majority opinions by Justice Scalia during his approximately 22 years on the High Court, and also more broadly referred to the opinion thusly:

"It is not hyperbole to describe today’s decision in Heller as the most significant opinion of this century, and likely, of the last two generations.”

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

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

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

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

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

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

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

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

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

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

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

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

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

The court reasoned that:

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

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

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

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

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

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

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

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

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

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

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

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In New Jersey v. Delaware, case No. 134, (Orig.), the United States Supreme Court decided today, (read opinion here), that Delaware has the right, in essence, to veto a plan approved by New Jersey,  for a company to build a liquefied natural gas (LNG) terminal that starts on the New Jersey side of the Delaware River (that forms the boundary between the two states), but which terminal proceeded over the boundary line, into Delaware State. Admittedly, this case does not involve--directly--Delaware corporate or commercial law, but this blog provides this blurb on the decision due to its importance as one of the rare cases that invokes the "original jurisdiction" of the U.S. Supreme Court (where the parties (two states) filed their lawsuit directly with SCOTUS). Also, at least tangentially, because the dispute at its core involves a proposed multi-million dollar project of a major company (whose plans are now dashed), it has "business relevance".

As an aside, regardless of the result, Justice Scalia provides an example of the best that the English language has to offer in the following excerpt of his dissent, as highlighted by Carolyn Elefant on law.com:

 But for Scalia, this decision wasn't just about Delaware and New Jersey. It was also about... bean sprouts and tofu. Here's Scalia's "money" quote:


   After all, our environmentally sensitive Court concedes that if New Jersey had approved a wharf of equivalent dimensions, to accommodate tankers of equivalent size, carrying tofu and bean sprouts, Delaware could not have interfered.

On the serious side, Scalia pointed out the economic impacts that Delaware's denial of authorization of the facility would have on New Jersey's economy and the nation's energy supply. As such, Scalia emphasized that the Court owed New Jersey and the nation much more than casual statements that the wharf is an "extraordinary" type of facility that would justify allowing Delaware to veto it under the Compact.

P.S. My friend and fellow Delaware lawyer, Matthew Boyer, was one of the winning attorneys for the State of Delaware on the case. Congrats, Matt.

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Courtesy of The Wall Street Journal Law Blog here is a story about the recent decision from a federal court that allows the outside attorrneys for Qualcomm to be freed from the constraints of the attorney/client privilege, based on the self-defense exception, in connection with the ongoing imbroglio about who was responsible for the failure to produce relevant emails during discovery (which omission was not uncovered until the last part of the trial). Here is the most recent of several prior blog posts I have written on the mess.

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Courtesy of Fox lawyer Carl Neff, here is a summary of a recent decision by the U.S. District Court for the District of Delaware, granting summary judgment in favor of an employer against a plaintiff that made claims based on the ADA and FMLA.

In Pagonakis v. Express, LLC a/k/a Limited Brands, Inc., No. 06-027, slip. op. (D. Del. Feb. 14, 2008), read opinion here, the United States District Court for the District of Delaware granted Defendant Express, LLC’s motion for summary judgment in connection with the complaint filed by Plaintiff Paula Pagonakis which alleged three counts: (i) discrimination under the Americans with Disabilities Act of 1990 (“ADA”); (ii) retaliation under the ADA; and (iii) retaliation under the Family and Medical Leave Act (“FMLA”). Plaintiff was involved in a car accident in 1995 which left her with several mental and physical impairments which impeded her processing of auditory and visual information, ultimately restricting her ability to work. Plaintiff alleged in her Complaint, among other things, that Defendant failed to reasonably accommodate for her disabilities and further that Defendant created a hostile work environment.
The Court held that Plaintiff failed to satisfy her burden of showing that there is any genuine issue of any material fact with respect to each of the three counts set forth in the Complaint. With regards to the first count alleged, discrimination under the ADA, the Court held that Plaintiff failed to establish two required elements of this claim: (i) that she is otherwise qualified to perform the essential functions of the job, with or without reasonable accommodations by the employer; and (ii) she has suffered an otherwise adverse employment decision as a result of discrimination. The Plaintiff’s inability to work forty-hour work weeks, her inability to work long enough hours to open or close the store, along with the lack of evidence suggesting that Plaintiff would be able to perform these essential functions with reasonable accommodations, all weighed heavily in the Court’s decision to grant summary judgment in favor of Defendant with respect to the first count Plaintiff alleged in her Complaint.
Further, the Court held that Plaintiff failed to establish a prima facie case of retaliation under the ADA and the FMLA. To establish such a claim under the ADA, a plaintiff must show: (i) protected employee activity; (ii) adverse action by the employer either after or contemporaneous with the employee’s protected activity; and (iii) a causal connection between the employee’s protected activity and the employer’s action. The Court found that Plaintiff failed to present questions of material fact on her adverse employment action claims, and the actions of Defendant towards Plaintiff, which may have included offhand comments, isolated incidents of chastisement of other employees for speaking with her, and the abdication of her authority, are not sufficient for a reasonable jury to find discrimination or harassment. Therefore, the Court granted summary judgment in favor of Defendant with respect to each count set forth in Plaintiff’s Complaint.

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Prof. Larry Ribstein, the nation's leading authority on "alternative entiies" such as LLCs and LPs, flags a recent decision by a bankruptcy court in New York that misses the mark on an issue of liability of a limited partner in the context of a bankruptcy claim. Here is the introductory quote:

In re Adelphia Communications Corp., 376 B.R. 87(Bkrtcy.S.D.N.Y., 2007), involv[es] a creditor's (Lucent) $45 million claim against a limited partner for liability for the debts of a Delaware limited partnership.

As most lawyers know, limited partners in most states are generally protected from vicarious liability by provisions based on Revised Uniform Limited Partnership Act Section 303

Here  is the whole post that should be read by anyone interested in the risk of bankruptcy courts interpreting state law in a way that may not be consistent with enforcing the limited liability concepts of most state law in this area.

Prof. Ribstein summarizes the gist of the opinion and his problem with it thusly:

The limited partner argued in Adelphia that the plaintiff had actual knowledge of its status as a limited partner. But even accepting this, the court denied summary judgment because the relevant creditor belief under the statute has to be "based on the limited partner's conduct" and "material issues of fact exist as to whether the conduct of ACC would support a reasonable belief that ACC was a general partner."

Yikes! It seems that while the court was focusing on the "based on the . . . " language, it forgot about the "reasonable" belief part. How can the plaintiff have a reasonable belief in the limited partner's status as a general partner when it actually knows the limited partner is a limited partner?

 However, the good professor provides solace for those fearing this decision may be a sign of more to come:

I doubt any state courts will follow the Adelphia case because they would not want to frustrate the protection their legislatures clearly intended to provide. But Adelphia suggests that limited partners may not have limited liability precisely when they need it most – in bankruptcy, at least in the important Southern District of NY

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Grosset v. Wenaas is the name of a very recent California Supreme Court decision that followed Delaware law. Read the opinion here. This West Coast jurisprudence comes to us courtesy of  Justin Myer Lichterman, a lawyer in the San Francisco office of the Orrick firm who was kind enough to forward the case to me with the following introductory summary:

 Though the real issue in the case was whether CA requires continuous ownership, as well as contemporaneous, the Court brought CA into line with Delaware on the contemporaneous and continuous ownership requirements for standing in derivative actions. The Court punted on the potential 2115 and internal affairs issues that it could have addressed in deciding the case.

Money quote: "Not only does a requirement for continuous ownership further the statutory purpose to minimize abuse of the derivative suit, but the basic legal principles pertaining to corporations and shareholder litigation all but compel it." (pg. 16 )

UPDATE: Prof. Larry Ribstein comments here on the case. In addition to being the nation's leading expert on LLCs and alternative entities, he has an extensive amount of scholarship on the issue of "choice of law" and the internal affairs doctrine such as was addressed (dodged?) in this case.

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Here  is a post by Prof. Bainbridge which refers to recent scholarship by his fellow UCLAW professor Lynn Stout, as well as an article by  Prof. Gordon Smith on the seminal 1919 Michigan Supreme Court decision in Dodge v. Ford Motor Co. and whether it should still be taught by corporate law professors.  Prof. Bainbridge also provides excerpts from his own writings--with citations to Delaware Chancery Court decisions, that address the same concept most often identifed with the case, which is: whether the primary goal of the corporate enterprise is to maximize shareholder value.

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We previously noted here a recent decision in the Qualcomm case by a Federal Magistrate Judge in California that delivered a living nightmare to a group of lawyers who found themselves on the wrong side of an electronic discovery problem on the last day of a long trial (read: witness revealed that large numbers of emails had not been produced).  

Here is a recent online article by John Tredennick that extracts five (5) lessons that he believes every lawyer (especially litigators) should learn from the case. He explains them in detail but I will just list the "lessons" below along with selected excerpts from the longer explanations under each of the 5 points he makes. The court order is as painful to examine as a horrific train wreck, as it is every litigator's nightmare. Here are the lessons from the case as explained in the article:

1. You Better Check Your Witnesses’ Computer Before Allowing Him/Her to Testify. 
Were the lawyers required to audit Qualcomm’s collection work or supervise it. According to the court, the answer is yes.
Opinion at 27 lines 3-9. 

2. It Doesn’t Help to be a Lowly Associate
The team working on this phase of discovery included a senior partner, a senior associate and an associate. The associate's attorney argued that he raised concerns about the thoroughness of the production to his superiors. The court cut him no slack.
Opinion at 27 note 10.

3. Whatever You Do, Don’t Be Cutesy When You Question Your Witnesses.
This case unraveled on the last day of trial. That’s when Qualcomm witness Viji Raveendran admitted on cross that there were relevant emails showing Qualcomm participation in the JVT. Patch asked Raveendran whether “she had ‘any knowledge of having read’ any emails” from the JVT mailing list. Opinion at 9, line 25-26. She conveniently answered “no,” maybe because she did not call actually reading them. However, she clearly had received them, which was more than enough to kill the case for legal purposes.

On cross, and maybe with a lucky shot, opposing counsel asked her whether she had ever received emails of this type. That’s when the bottom fell out. She admitted truthfully that she had. She also noted that they were pulled from her production by the attorneys and all heck broke out. Patch was nailed for “carefully [tailoring] his questions to ensure that Raveendran did not testify about the unproduced emails.” Opinion at 30, line 10-12.

What do you make of this? Arguably Patch asked Raveendran a question that she could answer honestly in a way that helped his case. He did not go further and have her clarify the limits of her answer; he left that work for opposing counsel to do or not do. 

The lesson is this: Don’t be cute with testimony but if you get caught don’t try to bull your way out of it. When the game’s up, stop playing.

4. The Smarter They Are, The Harder They Fall
The warning here is that the big firm pedigree can cut both ways. Although there was no evidence that any of the lawyers were aware of the Qualcomm documents until the end, that didn’t stop the court. Laying out each attorney’s work and educational background, the court essentially said they were too smart to allow discovery violations of this magnitude to happen.

5. The Legal Team May Be Responsible for Your Client’s Collection Efforts.
In naming individual attorneys to be sanctioned, the Magistrate repeatedly voiced the theme that the attorneys are responsible to supervise their clients collection and production of documents. I guess that fits with the notion that attorneys are officers of the court but it should make you think.

As is often the case with big corporations, outside counsel worked with a number of internal counsel, all of whom were members of the bar and likely had excellent credentials. Undaunted, Magistrate Major created a new rule of conduct for the attorneys, one which may give you pause:

[T]he Court believes the federal rules impose a duty of good faith and reasonable inquiry on all attorneys involved in litigation who rely on discovery responses executed by another attorney. … Attorneys may not utilize inadequate or misleading discovery responses to present false and unsupported legal arguments and sanctions are warranted for those who do so. … The facts of this case also justify the imposition of sanctions against these attorneys pursuant to the Court’s inherent power.

Opinion at 26 note 9.

 

Continue Reading...

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Here is a post from the Delaware Business Litigation Report that flags a recent decision from the U.S. District Court for the District of Delaware which found personal jurisdiction based on aspects of a transaction that created ties to Delaware.  See G & G LLC v. White. Read opinion here. The post included the following summary:

Plaintiff pointed to numerous instances where the Utah corporation, the Delaware corporation, their counsel, the directors/officers of the Delaware corporation (who were appointed by the investor defendants), and the investor defendants failed to notify Plaintiff of the merger and/or made misrepresentations regarding the continuing status of the corporation as a Utah corporation. Taking the allegations as true, the Court found that the actions of the investor defendants and the directors they appointed was sufficient to confer specific jurisdiction over them.

The opinion discusses the application of the Delaware long-arm statute in the context of both general and specific jurisdiction and cites to the many federal decisions in Delaware that have applied the statute. Interestingly, the opinion does not cite to the recent Chancery Court opinion that  found personal jurisdiction based on the actions of an outside attorney of a corporation in connection with aspects of a transaction that created ties to Delaware. See Sample v. Morgan summarized here.

Notably,  however, the District Court  did cite to the recent Troy Corp. v. Schoon Chancery decision, summarized here, that also dealt with a forum selection clause that was not artfully drafted. In particular, even though one of the clauses quoted by the court gave exclusive jurisdiction to the Delaware Chancery Court, the District Court for the District of Delaware could not rely of that provision to impose jurisdiction in federal court simply because it was also in Delaware.

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