Supreme Court Affirms Application of M&F Case Standard of Review

A recent Delaware Supreme Court decision, in a one-page Order, affirmed a bench ruling by the Court of Chancery that appears to have been the first application of a deferential standard announced by Delaware’s high court in the case of Kahn v. M & F Worldwide Corp., Del. Supr., No. 334, 2013 (March 14, 2014), highlighted on these pages. The one-page en banc Order of affirmance was entered in the matter of Swomley v. Schlecht, et al., [SynQor], No. 180, 2015, Order (Del. Nov. 19, 2015).

The M & F Worldwide decision established a deferential standard of review if, and only if, certain prerequisites were followed, as quoted below from the opinion:

To summarize our holding, in controller buyouts, the business judgment standard of review will be applied if and only if: (i) the controller conditions the procession of the transaction on the approval of both a Special Committee and a majority of the minority stockholders; (ii) the Special Committee is independent; (iii) the Special Committee is empowered to freely select its own advisors and to say no definitively; (iv) the Special Committee meets its duty of care in negotiating a fair price; (v) the vote of the minority is informed; and (vi) there is no coercion of the minority.

Insights into the Supreme Court’s affirmance may be gleaned from the oral argument presented before the one-page Order was entered. The Chancery Daily, the unparalleled chronicler of corporate litigation before the Court of Chancery and appeals from that Court’s decisions, provided extensive reporting of the oral argument at which the Chief Justice questioned the utility of footnote 14 from the M & F Worldwide opinion. That footnote creates confusion in the minds of some readers because it can be read to be in tension with the larger holding in the case. If someone challenges the price in a deal, and that price issue could prevent dismissal even if all other criteria of the standard were satisfied, then the standard applicable in the case would be much less effective.

Supporting this interpretation is the rationale behind allowing fully informed and non-coerced stockholders to make decisions. Again courtesy of The Chancery Daily, is a reference to a Chancery decision from the Chief Justice while he was serving as a Vice Chancellor in the matter of Chesapeake Corp. v. Shore, et al., C.A. No. 17626-VCS, memo op. (Del. Ch. Feb. 7, 2000), in which he asked a somewhat rhetorical question: “… If stockholders are presumed competent to buy stock in the first place, why are they not presumed competent to decide when to sell in a tender offer after an adequate time for deliberation has been afforded them?”

That quote may be seen as a precursor of sorts to a theme presented by a current Vice Chancellor whose presentation at a recent seminar was highlighted on these pages. That presentation suggested a direction that Delaware corporate case law is moving in: acknowledging the increased sophistication of many investors who are in a position to decide certain issues for themselves without the need for a paternalistic approach from the courts.

Doctrine of Laches Bars Quasi-Appraisal Remedy

In Houseman v. Sagerman, C.A. No. 8897-VCG (Del. Ch. Nov. 19, 2015), the Delaware Court of Chancery described the form of remedy known as a quasi-appraisal. The Court of Chancery explained that quasi-appraisal is not itself a cause of action, but is instead a remedy that, where appropriate, awards stockholders damages based on the going-concern value of their previously owned stock upon a finding of a breach of fiduciary duty, such as a duty to disclose. See In Re Orchard Enters., Inc., S’holder Litig., 88 A.3d 1, 42 (Del. Ch. 2014) (The Delaware Supreme Court and the Court of Chancery have consistently upheld the view that “quasi-appraisal damages are available when a fiduciary breaches its duty of disclosure in connection with a transaction that requires a stockholder vote”). See generally 8 Del. C. § 262(d)(1) (requiring a written demand for appraisal to be submitted to the corporation before the taking of the vote on the merger). See also § 262(e), (a stockholder has 120 days after the merger, among other requirements, to commence an appraisal proceeding if a written demand had been previously been made on a timely basis).


The court conducted an analysis of the equitable doctrine of laches in this corporate litigation involving claims by a stockholder in connection with a merger and related transactions. The doctrine provides that a plaintiff’s request for equitable relief may be barred when he unreasonably delays in seeking that relief, and such delay has prejudiced the defendant. The court found that laches applied to bar claims in this case.

Practice Note

The court noted that each of the attorneys in this case made cross accusations against each other for an alleged breach of the duty of candor. The court observed that if counsel are alleging ethical violations that do not affect the administration of justice, as appears to be the case in this matter, the proper forum for the review of that claim is the Delaware Disciplinary Counsel and not the Court of Chancery.

Supplement: The Chancery Daily, the unparalleled chronicler of “all things Chancery”, in its edition of Nov. 24, 2015, provided additional insight about this case regarding comments from the bench during a hearing on a discovery dispute in which the court counseled the attorneys for both sides to “think twice” before making the type of accusations referred to above in the Practice Note.

Top Three Delaware Corporate Decisions for 2015

For the last ten years or so on these pages, I have selected annually the top Delaware corporate law decisions. This is a somewhat subjective exercise in light of the estimated 200 or more notable corporate and commercial decisions issued each year by Delaware’s Supreme Court and Court of Chancery.

This year the top three Delaware corporate decisions were selected by The Honorable J. Travis Laster of the Delaware Court of Chancery. At a seminar today sponsored by the Weinberg Center for Corporate Governance of the University of Delaware and the Society of Corporate Secretaries and Governance Professionals, entitled “3rd Annual Delaware Law Issues Update,” at the Hotel duPont, Vice Chancellor Laster identified three noteworthy Delaware corporate law opinions decided over the past year: In re Cornerstone Therapeutics Inc. Stockholder Litigation, No. 564, 2014; Leal et al. v. Meeks et al., No. 706, 2014, opinion issued (Del. May 14, 2015)(highlighted on these pages here); Corwin, et al. v. KKR Fin. Holdings, et al., No. 629, 2014, 2015 WL 5772262 (Del. Oct. 2, 2015)(highlighted here); and C&J Energy Services, Inc. v. City of Miami General Employees’ and Sanitation Employees’ Retirement Trust, Del. Supr., No. 655/657, 2014 (Dec. 19, 2014)(highlighted on these pages here.) All three of the referenced decisions were authored by Chief Justice Leo Strine, Jr. of the Delaware Supreme Court. Among the comments that can be made about those decisions are that they are relatively short compared to the average length of many of the decisions of the Chief Justice when he was serving on the Court of Chancery.

There is some risk involved in doing a blog post that highlights key points of a presentation by a current member of the court. I want to emphasize that the key points of His Honor’s presentation included in this post should not be confused with a transcript and should not be attributable to the Vice Chancellor – – to the extent that my highlights are not a verbatim recording of the presentation. My intent is that this overview be faithful to the substance of what His Honor presented at the seminar.

The common themes exhibited by the referenced opinions include: the stability of Delaware corporate law, which evolves with time, and the responsiveness and nimbleness of the Delaware courts to address the changing business and legal climate. These three cases demonstrate how the Delaware courts fill the interstices of the enabling statutes, and acknowledge that the stockholder electorate is much more active and sophisticated in general than was the case several decades ago. This reality suggests that less judicial involvement is needed generally.

After providing an historical backdrop and comparison of the current state of affairs compared with the legal landscape of many decades ago, the Vice Chancellor provided the following highlights about the three cases he chose.

Regarding the C&J case, the thrust of the Supreme Court decision, which relied in part on the Chancery decision in Toys R Us, focused on the reality that stockholders are in the best position to decide whether to vote in favor of–or to reject a deal, and it acknowledges the sophistication of most investors today, as well as honoring the rights of the acquirer. The opinion is indicative of a shift towards a disinclination to use an injunction to negate the contract rights of an innocent buyer.

Regarding the Cornerstone case, one takeaway from the decision is that regardless of the standard of review, a plaintiff must allege a claim that is not exculpated under DGCL Section 102(b)(7).

As for the Corwin case, the ruling follows the Delaware decision in Lukens, and it makes clear that an effective and informed stockholder vote will lower the judicial standard of review.

Additional conclusions that can be drawn from the three Supreme Court decisions include the following: (1) The current disinclination of the Delaware courts to use targeted injunctions to enjoin a deal in the absence of a competing bid; (2) Unless there is a basis to support a claim for aiding and abetting, it is less likely that deals will be enjoined pre-closing; and (3) Unless a stockholder vote is uninformed and is lacking in fairness or independence, it is unlikely that a deal would be enjoined. Stated another way, there is a disinclination to enjoin a deal that the stockholders are able to vote in favor of, or to reject.

In addition, the Vice Chancellor indicated that Delaware courts can be seen as “stepping back” from pre-closing intervention in light of stockholders generally being more sophisticated and not in as much need of judicial protection as they may have been in the past.

One might also expect less post-closing judicial intervention. The Vice Chancellor sees this as a new and better world which allows market forces to play their role instead of a court determining the outcome of a deal.

Director Who Was Tricked into Resigning Reinstated

In Martin v. Med-Dev Corp., C.A. No. 10525-VCP (Del. Ch. Oct. 27, 2015), the Court of Chancery  invalidated the resignation of a director who was tricked into resigning from his board position, and the Court reinstated him as chairman. The Court’s opinion is also notable for its discussion of what steps must be taken for a director’s resignation to be effective.

The ousted director instituted a summary proceeding pursuant to  DGCL Section 225(a), seeking to revoke his resignation and obtain a declaration reinstating him as Chairman.  Although he had agreed to resign, with conditions, from the board if two stockholders of his choice were appointed to the board, and had documents to that effect drafted, the board secretly changed the terms of his resignation letter.  The revised resignation letter made his resignation unconditional, and the changes were never communicated to the director before he signed it.  The board instead led the director to believe that the terms he had agreed to remained in force.

The Court rejected the director’s contract based arguments, and instead concluded that the resignation was invalid because it was obtained through trickery or misrepresentation.  Finding the transaction to be voidable because it was entered into in reliance on a material misrepresentation, the Court ordered the director to be reinstated to his position as chairman.

Chancery Determines that BJR Applies Instead of Revlon Standard

The Court of Chancery in the recent decision styled In re Zale Corporation Stockholders Litigation, C.A. No. 9388-VCP (Del. Ch. Oct. 29, 2015), in a rare grant of a motion for reargument pursuant to Rule 59, dismissed a financial advisor after the court had previously denied the same motion to dismiss the financial advisor. The current ruling is based on the application of a Delaware Supreme Court decision that was issued the day after the original opinion in this case.  The crux of the motion for reargument addressed the issue of whether the director defendants breached their fiduciary duties – – and more specifically, whether the business judgment rule standard of review applied or the enhanced scrutiny standard of review under Revlon should apply.  The Delaware Supreme Court decision of Corwin v. KKR Financial Holdings LLC, 2015 WL 5772262 (Del. Oct. 2, 2015), held that a fully informed vote of a majority of disinterested stockholders invokes BJR review in cases in which the Revlon standard would otherwise apply.

The basis for granting the motion for reargument and changing the result of the initial decision was an incorrect application of the Revlon standard rather than BJR to determine whether the directors breached their fiduciary duties.

The BJR more appropriately applied, based on the recent Corwin decision of the Delaware Supreme Court, because:  (1) The Supreme Court held that the fully informed vote of a disinterested majority of stockholders invokes BJR review in cases in which Revlon otherwise would apply; and (2) The prior decision in this Zale matter held that the merger was approved by a majority of disinterested stockholders in a fully informed vote.

The Standard for a Breach of the Duty of Care is Gross Negligence

This reconsidered ruling also explained that gross negligence is the standard for a breach of the duty of care.  In Corwin, the Supreme Court suggested that the gross negligence standard for director due care liability is the proper standard for evaluating post-closing money damages claims.

Distinguishing the Recent TIBCO Decision

This decision in Zale went to considerable lengths to distinguish the recent Chancery decision in which the court denied a motion to dismiss the financial advisor.  See In Re TIBCO Software, Inc. Stockholders Litigation, 2015 WL 6155894 (Del. Ch. Oct. 20, 2015).  The author of the TIBCO decision was the same Chancellor who authored the KKR decision referenced above which was affirmed by the Delaware Supreme Court in Corwin.  In TIBCO, the Court of Chancery denied a motion to dismiss after it found that it was reasonably conceivable that the directors had breached their duty of care by acting in a grossly negligent manner despite the merger apparently being approved by a majority of disinterested stockholders in a fully informed vote.

Based on the language in Corwin and TIBCO, this decision in Zale concluded that when a reviewing board of directors acts during a merger process after the merger has been approved by a majority of disinterested stockholders in a fully informed vote, the standard for finding a breach of the duty of care under BJR is gross negligence.  See footnote 18 in which the court observes that the threshold for finding a breach of the duty of care under Revlon is lower than in the BJR context which is predicated upon concepts of gross negligence.

Gross Negligence Defined

To support an inference of gross negligence, a decision has to be so grossly “off-the-mark” as to amount to reckless indifference or gross abuse of discretion.  See footnote 19.  Delaware law instructs that the “core inquiry in this regard is whether there was a real effort to be informed and exercise judgment.”  This involves: “an examination of whether the directors informed themselves, before making a business decision, of all material information reasonably available to them.”  Gross negligence requires facts “that suggest a wide disparity between the process the directors used and a process which would have been rational.”

In TIBCO, the court found that it was reasonably conceivable that the target’s board was grossly negligent in the context of a merger price that was possibly due to an error in several capitalization tables as to the number of outstanding target company shares.  Although the target’s financial advisor notified the board of the error, “it did not notify the board that the acquirer had relied on erroneous number of shares in making its bid.”  After learning of the error, the board met several times to assess and respond to the situation just as the director defendants did after learning of Merrill Lynch’s presentation to Signet, “but the board [in TIBCO] did not inquire further with their financial advisor to determine if the acquirer had relied on the erroneous share count in making its bid.”  In TIBCO, the board was exculpated for a breach of a duty of care under Section 102(b)(7) but the financial advisor in that case was not so protected and the court found that it was reasonably conceivable that the financial advisor aided and abetted the board’s duty of care breach by withholding data about the reliance by the acquirer on the erroneous share count in order to increase the odds of the merger being consummated, thereby earning a significantly larger fee for its services.

Court Provides Guidance to Boards When Hiring Financial Advisors

This decision provides specific practical advice regarding the duties of a board in connection with retaining a financial advisor.  The court instructs that:  “Directors must act reasonably to identify and consider the implications of the investment banker’s compensation structure, relationship and potential conflicts.”  (quoting In re Rural Metro Corp., 88 A.3d 54, 90 (Del. Ch. 2014)).  The court found the conduct of Merrill Lynch in this case troubling and expects that boards in the future will “take additional steps to obtain information material to the evaluation of their financial advisors’ independence, such as by negotiating for representations and warranties in the engagement letters as well as asking probing questions to determine what sorts of past interactions the advisor has had with known potential buyers.”  Although the court found that the performance of Merrill Lynch was less than ideal in this case, because there was no basis for a predicate fiduciary duty breach by the board, the allegations against Merrill Lynch for aiding and abetting such breach failed.  Therefore, the court granted the motion to dismiss as to Merrill Lynch and the complaint was also dismissed.

Chancery Denies Claim for Piercing the Corporate Veil

The relatively short Chancery opinion in Doberstein v. G-P Industries, Inc., C.A. No. 9995-VCP (Oct. 30, 2015), is noteworthy for its examination and dismissal of a claim for piercing the corporate veil. It is notable not only because the court describes the standard that will be applied in connection with such a claim, but of equal importance is the fact that the court considered and dismissed the claim on a substantive level, but did not dismiss it for procedural irregularities such as, for example, the failure to obtain a judgment against the entity–before bringing such a claim against the underlying individual.

Notwithstanding the reprehensible behavior of the individual behind the entity involved in this case, this opinion also exemplifies how difficult it is to pierce the corporate veil under Delaware law.


Chancery Enforces Covenant Not To Compete

The Chancery opinion in Revolution Retail Systems, LLC v. Sentinel Technologies, Inc., C.A. No. 10605-VCP (Del. Ch. Oct. 30, 2015), discusses many issues in connection with the breach of contract for the sale of a business. The sale involved an ongoing collaborative relationship. Although Texas law applied to many aspects of the case, the court cited to applicable Delaware case law on the enforceability of covenants not to compete. See, e.g., footnote 182 (citing Merrill Lynch, Pierce Fenner & Smith, Inc. v. Price, 1989 WL 108412 at *5 (Del. Ch. Sept. 13, 1989) (this case enforced a covenant not to compete against a former broker who had competed against his former firm with a customer list he took with him).

In connection with enforcing the covenant not to compete, the court also reviewed the prerequisites for a permanent injunction which was also granted in this case. The court also reviewed claims for loss profits and observed that when measuring money damages for an unproven technology, it is nearly impossible not to be speculative, which does not satisfy the basis for awarding lost profits. See footnote 193 (citing Amaysing Techs. Corp. v. CyberAir Commc’ns, Inc., 2004 WL 1192602, at *5 (Del. Ch. May 28, 2004)(case involving product with unproven technology).

A permanent injunction was also issued to remedy a breach of a confidentiality provision, in addition to the enforcement of the covenant.

There are many other substantive parts of this 73-page decision, but for purposes of highlighting the most practical aspects with the widest application, I have focused on the enforcement of a covenant not to compete and the grant of an injunction as a remedy.

Delaware Supreme Court to Hear Argument on When Stockholders Can Demand Records of Aborted Merger

Tomorrow, the Delaware Supreme Court will hear oral argument on an appeal of the decision of the Court of Chancery which denied a request by a stockholder for books and records, pursuant to DGCL Section 220, related to the aborted merger of AbbVie, Inc., a pharmaceutical spin-off of Abbott Labs, and Shire, a pharmaceutical company based in Ireland. If completed, the inversion would have had major tax benefits for AbbVie, but before the deal was completed, the Treasury Department enacted regulations to terminate the tax benefit from such an inversion. The net result was that AbbVie was required to pay a termination fee to Shire of $1.6 billion. The case is Southeastern Pennsylvania Transportation Authority v. AbbVie Inc., No. 239, 2015, oral argument scheduled (Del. Nov. 4, 2015). The Chancery decision relates to two affiliated cases styled:   Se. Pa. Transp. Auth. v. AbbVie Inc., No. 10374; Rizzolo v. AbbVie Inc., No. 10408, 2015 WL 1753033 (Del. Ch. Apr. 15, 2015).

Frank Reynolds of Thomson Reuters has written a timely and insightful article with more background details and additional insights into the issues to be addressed by Delaware’s high court.

Appellate Court Reverses Decision Based on Apparent Impartiality

In my latest ethics column for The Bencher, the national publication of The American Inns of Court, I wrote about an appellate opinion from Michigan that reversed a trial court’s decision based on what the appellate court, after applying a five-part test, viewed as an apparent lack of impartiality by the trial judge.

Chancery Allows Advancement for Motion to Intervene by Former CEO

The Delaware Court of Chancery, in the decision styled In re Genelux Corporation, C.A. No. 10612-VCP (Del. Ch. Oct. 22, 2015), determined that a former CEO and Chairman of the Board was entitled to advancement in connection with his Motion to Intervene in a proceeding in which the corporation was a party and in which actions he had taken as the CEO were being challenged, and the election of directors was also being contested. Typical advancement proceedings involve a former officer or director who was named as a defendant. Delaware case law also recognizes advancement eligibility for compulsory counterclaims. This is an unusual case where advancement is sought in connection with fees incurred by a former CEO who intervened to become a party in a pending matter. A companion decision in this case involving a resolution of the disputed director election was decided the same day as the instant ruling.

The corporation refused to make advancement payments based on the argument that the former CEO intervened based on purely personal reasons to pursue personal rights. The court, however, viewed the intervention as the equivalent of a mandatory counterclaim, which prior Delaware cases have found eligible for advancement. Moreover, the intervention related to the validity of an election for directors in addition to issues related to the fiduciary duties of the former CEO who sought to intervene. The court reasoned that if he had not intervened, he might otherwise be barred on collateral estoppel grounds from arguing that he had discharged his fiduciary duties properly. See footnotes 15 and 17.

In addition, the court explained that it would be inequitable to deny the former CEO his right to advancement based on the facts of this case. The terms of the agreement which provided for advancement purported to require that prior to a former officer being eligible for advancement in a matter for which he initiated a court filing, the corporation’s board of directors first had to authorize the commencement of such a filing. By contrast, the Court of Chancery found the terms of that condition for advancement in this matter to be inequitable because, for example, it would allow the company to allege misconduct of a former officer or director in a suit that the former officer or director was not named in, but in that instance the company could use that condition to prevent advancement for the necessary intervention by that former officer or director, as in this matter, to defend allegations made about him for actions taken while he was an officer or director.

This important equitable limitation on the conditions sought to be imposed on advancement obligations of a company will have widespread applicability and importance.

This decision also rejected the argument that advancement should not be available where D&O insurance is already covering the fees incurred. The rejection of that argument was based on the reasoning that advancement must be allowed to extent that the applicable D&O coverage imposed limits on the hourly rate of the former officer’s counsel, and also because the coverage was also subject to a cap, for which advancement should be available when the cap is exceeded.