Chancery Upholds Pre-Suit Demand Refusal By Board

A recent Delaware Court of Chancery opinion demonstrates the formidable challenge that a stockholder faces when she attempts to proceed with a derivative claim in the face of a pre-suit demand that was refused by the board. In Andersen v. Mattel, Inc., C.A. No. 11816-VCMR (Del. Ch. Jan. 19, 2017), we are presented with an example of the conventional wisdom that if a pre-suit demand is made on the board, and the board refuses to recognize the validity of the demand, there is a slim probability of prevailing on a claim in light of the pre-suit demand refusal.

Background: This derivative action involves allegations that the board of directors improperly investigated and wrongfully refused to bring suit to recover up to $11.5 million paid to the former chairman and CEO of the company as part of a severance package and consulting agreement. The court granted the motion to dismiss of the defendant directors based on failure to allege wrongful pre-suit demand refusal under Court of Chancery Rule 23.1, as well as failure to state a claim under Rule 12(b)(6).

In response to a pre-suit demand letter, the board conducted an extensive investigation involving interviews with about two dozen witnesses and the review of over 10,000 documents. After the investigation, the board determined that it would not pursue the claims. Among the reasons given for the board’s decision was that litigation would be a distraction to senior management and it would have an adverse impact on the business during a difficult period when the company was trying to focus on a turnaround strategy. There was no special committee formed. Although the stockholder asked the board for a copy of documents related to the investigation, the stockholder did not avail itself of DGCL section 220.

Analysis: The Court provides a useful recitation of standards that are of widespread applicability to those who make their living engaged in corporate litigation. For example, the court explained the following well-settled principles:

  • By making a pre-suit demand, a plaintiff concedes that the board is disinterested and independent for purposes of responding to the demand. (This imposes at the outset quite a barrier to overcome in the likely event that, as here, the board refuses the demand.)
  • Thus, the board’s decision is subject to the business judgment rule, and the only issue for the court to address in this context in order to analyze whether the board’s refusal was proper is: “the good faith and reasonableness of its [the board’s] investigation.” See footnote 21.
  • The plaintiff failed to plead particularized facts alleging that the board was grossly negligent, and it was insufficient to argue that: the board did not disclose its investigative report; did not disclose the identity of witnesses interviewed and did not create an independent committee. The court observed that a board has a duty to act on an informed basis in responding to a demand, but “there is absolutely no prescribed procedure that a board must follow.”
  • In order to plead bad faith sufficiently in the context of demand refusal, a complaint must plead particularized facts showing that the directors: “… acted with scienter, i.e., with a motive to harm, or with indifference to harm that will necessarily result from the challenged decision–here, that decision being rejection of the Plaintiff’s demand.”

SUPPLEMENT: The venerable Professor Stephen Bainbridge provides scholarly and erudite insights on this case and the standard applied by the court.

Court Grants Dismissal Based on First-Filed Rule

Justin M. Forcier, an associate in the Delaware office of Eckert Seamans, prepared this overview.

With the ever-increasing globalization of business, readers will appreciate this Court of Chancery opinion discussing dismissal based on the first-filed rule.  Gramercy Emerging Markets Fund, et al. v. Allied Irish Banks, P.L.C. et al., C.A. No. 10321-VCG (Del. Ch. December 30, 2016).

Background: Plaintiffs are an investment fund organized in the Cayman Islands and doing business in Connecticut. Plaintiffs’ fund had a 26% ownership interest in a Bulgarian bank. The majority of that Bulgarian bank was owned by a non-profit organization that was incorporated in Delaware. In 2008, the non-profit sold 49.99% of the Bulgarian bank to a holding company organized in Ireland. Plaintiffs filed an action in Illinois, but Defendants were successful in having that action dismissed because the Illinois court held that Bulgaria was the proper venue. Instead of going to Bulgaria, Plaintiffs refiled the action in Delaware. After Plaintiffs filed their complaint in Delaware, Defendants again filed a motion to dismiss.

Analysis: The court began its analysis by stating that a motion to dismiss based on forum non conveniens is addressed to the trial court’s sole discretion. That discretion is not unlimited, however. The court noted that the procedural posture of the case will dictate the court’s analysis.When a motion to dismiss based on forum non conveniens is filed, and the case was first filed in Delaware, the overwhelming hardship test applies. Quoting the Delaware Supreme Court’s decision in Lisa v. Mayorga, (highlighted on these pages): ‘“[T]he ‘overwhelming hardship’ standard does not apply to Delaware actions . . . that were not ‘first filed.”’

However, when the action in Delaware is duplicative of an action that is already pending in another jurisdiction, the court will apply the well-known McWane doctrine, also called the “first-filed rule”, which relies on the principles of equity to prevent parties from having to litigate the same claims in two different forums. McWane requires a finding that the two actions arise from the same facts and the first forum was capable of providing justice.

The court further clarified by quoting Lisa: “These two forum non conveniens doctrines––overwhelming hardship and McWane—operate consistently and in tandem to discourage forum shopping and promote the orderly administration of justice by recognizing the value of confining litigation to one jurisdiction, whenever that is both possible and practical.” Most readers are probably not familiar with the reference to the McWane doctrine (first-filed rule) being described as one of two theories under the category of the forum non conveniens doctrine.

Court’s Holding: Since this action was first filed in Illinois, the court declined to apply the overwhelming hardship test. Instead, the court held that the McWane doctrine was the appropriate standard to determine whether Delaware was the appropriate forum for Plaintiffs’ claims. Using the McWane doctrine’s analysis, the court found that the Illinois action and the Delaware action were virtually identical. Second, the Illinois court was capable of providing prompt and complete justice. In fact, the Illinois court “had a greater jurisdictional scope over the litigants than” Delaware. Therefore, the court dismissed the action.

 

Article on Board’s Fiduciary Duty of Oversight

In my most recent column for the publication of the National Association of Corporate Directors, I discussed a recent Delaware Court of Chancery decision that addressed the fiduciary duty of directors to provide oversight, and what must be alleged with particularity in order to survive a motion to dismiss. Members of the Delaware bench have described a claim for violation of this duty, sometimes referred to as the Caremark duty, to be one of the most challenging claims in Delaware corporate litigation to prevail on. The name of the case is Reiter v. Fairbank, and it was previously highlighted on these pages.

Supplement: Prof. Stephen Bainbridge, venerable corporate law scholar and friend of the blog, quotes from my article in the context of his larger discussion about what qualifies as a “red flag” for purposes of the Caremark oversight duties of a board.

Chancery Provides in Depth Analysis of Fair Value Determination in Appraisal Proceeding

Alexandra D. Rogin, an Eckert Seamans associate, prepared this overview.

The thorough 75-page post-trial decision in Merion Capital L.P. v. Lender Processing Servs., Inc., C.A. No. 9320-VCL (Dec. 16, 2016), is a must read for those involved in appraisal proceedings.  In the memorandum opinion, Vice Chancellor Laster provides a comprehensive analysis of the fair value of Merion Capital L.P.’s and Merion Capital II L.P.’s (collectively “Merion”) shares in Lender Processing Services, Inc. (“LPS”) upon LPS’s merger with Fidelity National Financial, Inc. (“Fidelity”).

Background: LPS provided services and analytics related to the mortgage lending industry.  Merion had purchased 5,682,276 shares of LPS stock after the merger with Fidelity was announced, but before a stockholder vote.  On January 2, 2014, the merger closed.  Fidelity’s stock price had increased in the interim, resulting in an increase in the merger consideration.  The “Initial Merger Consideration” was $33.25 per share.  The aggregate merger consideration received by LPS’s stockholders at closing was $37.14 per share (the “Final Merger Consideration”).

Merion demanded appraisal, did not withdraw its demand, and did not vote in favor of the merger.  Merion pursued the instant action to obtain a judicial determination of the fair value of its shares.  LPS asserted that the Final Merger Consideration was a ceiling for the fair value of the company.

Court’s Analysis: The Court provided a detailed overview of its valuation methodology.  Pursuant to DGCL § 262(h), it was required to consider all relevant factors to determine the fair value of the shares.  In contrast to other types of proceedings, in this statutory appraisal action, both sides were required to prove their respective valuation positions by a preponderance of the evidence.

Under Delaware law, the concept of fair value is different than fair market value.  Thus, as set forth by the Delaware Supreme Court in Tri-Continental Corp. v. Battye, 74 A.2d 71 (Del. 1950), the Court explained that “fair value” encompasses consideration of market value, asset value, dividends, earning prospects, the nature of the enterprise, and other relevant facts at the time of the merger.

The Court noted that deal price is a relevant factor in appraisal proceedings. However, price data alone is not conclusive in determining fair value.  The Court may only rely on the merger price as evidence of fair value when the process leading up to the transaction is reliable, which is a fact-specific inquiry.  Accordingly, the Court advised that a skillful and persuasive argument presented by counsel in a particular case may not prevail in another case given the unique qualities of different transactions.

With this background in mind, the Court determined that LPS demonstrated that its Initial Merger Consideration provided reliable evidence of LPS’s value at the effective time of the merger.  This holding was based on many factors, including the existence of meaningful competition among multiple, different types of bidders during the pre-signing phase, input from management and financial advisors regarding strategic alternatives, equal treatment and the availability of adequate and reliable information to each potential bidder, and the absence of evidence of collusion or favoritism.

Additionally, taken as a whole, the trial evidence established that the Final Merger Consideration was a reliable indicator of the fair value as of the closing of the merger.  Because of synergies and a post-signing decline in LPS’s performance, the fair value of LPS as of the closing date did not exceed the Final Merger Consideration.  Specifically, during the seven month period between signing and closing, no other bidder submitted an indication of interest or made a competing proposal.  While the Court was critical of go-shop and window-shop phases in the months prior to the stockholder vote, it found that the existence of such was inconclusive, as LPS was still able to entertain superior proposals.  Moreover, immediately after the merger was announced, the record indicated that Fidelity’s performance improved, causing an increase in the value of the merger consideration, as reflected by the Final Merger Consideration.

The Court also considered expert opinions in reaching its valuation determination.  Although the Final Merger Consideration was $37.14 per share, Merion proffered a DCF analysis to support that LPS’s fair value at closing was $50.46 per share.  LPS relied on a DCF analysis to support that the fair value at closing was $33.57 per share.  Vice Chancellor Laster noted that “[t]he DCF…methodology [as opposed to deal price] has featured prominently in [the Chancery] Court because it is an approach that merits the greatest confidence within the financial community.”  The Vice Chancellor outlined the DCF methodology, and adopted values from both sides’ experts at different steps based on the persuasiveness of their opinions.  Accordingly, the Court’s best estimate of the fair value of LPS based on the DCF methodology resulted in a figure of $38.67 per share.

However, the Court explained that it has discretion to adopt one methodology over another, i.e., deal price or the DCF methodology.  While noting that its DCF valuation was within 3% of the Final Merger Consideration, the Court gave 100% of its weight to the transaction price because a DCF analysis relies heavily on assumptions.

Conclusion: Ultimately, the Court found that the fair value of LPS on the closing date was $37.14 per share, the value of the Final Merger Consideration, or the deal price.  This conclusion was based largely on a finding of reliability in the process leading up to the transaction.

Supreme Court Clarifies Attorney Charging Liens

Readers of these pages who make their living by practicing law in private law firms will be interested in the recent Delaware Supreme Court opinion captioned Katten Muchin Rosenman LLP v. Sutherland, No. 151, 2015 (Del. Jan. 6, 2017). Others–not so much. Why would private lawyers care about this decision? Because, generally speaking, it will make it easier to collect attorneys’ fees from deadbeat clients.

Short Overview: This ruling permitted a charging lien to be imposed on a judgment obtained by a former client, which was awarded in her favor by the trial court, in order to allow a law firm to collect its unpaid legal fees owed by the former client. Delaware’s high court reasoned that such a lien is equitably justified because to hold otherwise would deny an attorney full compensation for the work he contracted to do on behalf of his client, and would discourage counsel from providing legal services by not protecting their contractual right to a fee.

Brief Background. The factual history of this case includes a multitude of prior Delaware decisions over many years in long-running litigation between family members who engaged in hotly contested internecine litigation in which the family members who were stockholders challenged the actions of siblings who managed the family-owned business. Highlights of 12 of those prior decisions, spanning the last 10 years, have appeared on these pages.

For the limited purposes of the narrow issue in this decision, the essential facts most noteworthy for fellow attorneys, is that the ex-client in this case incurred about $3.5 million in fees in just three years–apparently not including the fees incurred by local Delaware counsel. The ex-client only paid about $2.7 million of that amount–leaving about $766,000 unpaid. (The litigation continued for several more years with another attorney.) Last year, the Court of Chancery awarded the ex-client $250,000 and the Katten Muchen law firm intervened to impose a charging lien on that amount.

Even though there was somewhat of a factual issue regarding no clearly executed fee agreement, there was no genuine issue that the firm charged the ex-client on an hourly basis and that she paid a few million dollars based on that arrangement–before she just stopped paying.

The Court of Chancery held that no charging lien could be imposed because the unpaid services did not directly relate to the client’s recovery. The Supreme Court reversed, reasoning that such a prerequisite was not a proper obstacle to asserting the equitable right of a charging lien.

Key takeaways: The court reasoned that: “[I]n the case of hourly billing, unlike with a contingency fee, the total amount the client is required to pay her lawyer is not based on the client’s recovery.” The opinion added that: “it is no secret that litigation is expensive and that the costs of prosecution easily can exceed recovery.” The court explained that the client was required to pay the firm’s reasonable fees whether she won or lost.

The opinion concluded by observing that by agreeing to pay on an hourly basis, the ex-client assured her counsel that it would not suffer the damages of unpaid services if it pressed her case as aggressively as she requested and as the law permits.

Chancery Rejects Fee-Shifting for Forum Selection Clause

The recent Chancery decision invalidating a fee-shifting bylaw in connection with a forum selection provision was the subject of an article authored by my colleagues Gary Lipkin, Justin Forcier and Alexandra Rogin, which appeared this week in the Delaware Business Court Insider. The article appears below.

In Solak v. Sarowitz [C.A. No. 12299-CB (Del. Ch. Dec. 27, 2016)], the Delaware Court of Chancery held that a corporate bylaw ran afoul of 8 Del. C. § 109(b), as recently amended, where it purported to shift attorneys’ fees and expenses to an unsuccessful stockholder that filed an internal corporate claim outside of the State of Delaware.

Two recent amendments to the Delaware General Corporate Law (“DGCL”) were at issue in the case.  The first was the addition of Section 115, which expressly authorized Delaware corporations to adopt bylaws requiring internal corporate claims to be filed exclusively in the State of Delaware.  The second was the amendment of Section 109, which, in the wake of the Delaware Supreme Court’s decision in ATP Tour, Inc. v. Deutscher Tennis Bund, 91 A.3d 554 (Del. 2014), precluded Delaware stock corporations from issuing bylaws imposing liability on shareholders for the corporation’s or other parties’ attorneys’ fees and expenses in connection with internal corporate claims.

Shortly after these amendments were codified, the board of Paylocity Holding Corporation (“Paylocity” or the “Company”) adopted new bylaws that: 1) required all internal corporate claims to be filed in the State of Delaware (the “Forum Selection Bylaw”); and 2) purported to shift fees and costs to unsuccessful shareholders that filed internal corporate claims outside the State of Delaware without the Company’s permission (the “Fee-Shifting Bylaw”).  As the Solak Court recognized, to trigger the Fee-Shifting Bylaw, a shareholder must first violate the Forum Selection Bylaw.

Following the adoption of the bylaws, a Paylocity shareholder brought suit, seeking, among other things, a declaration that the Fee-Shifting Bylaw violated Section 109(b) and was thus invalid.  The Company responded in two primary ways.  First, the Company argued that the suit was unripe because there was no action pending in another jurisdiction that could trigger the Fee-Shifting Bylaw, nor did the plaintiff plead any intention to file such a suit.  The Company next argued that, in any event, the Fee-Shifting Bylaw was permitted by law.

With respect to Paylocity’s ripeness defense, although Paylocity correctly asserted that no suit was pending (or threatened by the plaintiff in the complaint), the Court determined that the dispute was ripe for decision.  The Court explained that it was highly unlikely that a rational shareholder would ever file an internal claim outside of Delaware due to the risk of personal liability triggered by the Fee-Shifting Bylaw.  Thus, according to the Court, “[t]o decline to review the Fee-Shifting Bylaw . . . would mean, as a practical matter, that its validity under the DGCL would never be subject to judicial review.”  Moreover, the Court noted that hearing the case now would help clear up any uncertainty and inform other corporations and investors as to the permissibility of fee-shifting bylaws following the recent DGCL amendments.

As to the merits of the Fee-Shifting Bylaw, the defendants advanced three arguments in their defense – all of which were rejected by the Court.  First, defendants argued that the amendment to Section 109(b) should be read in tandem with Section 115, as those provisions were simultaneously adopted.  Thus, according to defendants, Section 109(b) should not be read to preclude fee-shifting for internal corporate claims filed outside of Delaware where the Company had first enacted a bylaw requiring internal corporate claims to be filed in Delaware.  The Court rejected this argument, however, holding that nothing in the text of either provision reflected any intent by the legislature for them to be read in concert.  Additionally, Section 109(b) did not distinguish between internal corporate claims filed inside or outside of Delaware.

The Court next rejected defendants’ argument that Section 109(b) did not displace the common law, which generally permitted fee-shifting.  In doing so, the Court, citing A.W. Financial Services v. Empire Res., Inc., 981 A.2d 1114 (Del. 2009), noted that the common law could be repealed by implication where “there is fair repugnance between the common law and [a] statute, and both cannot be carried into effect.”  To the extent the ATP decision, which prompted the amendment to Section 109(b), could have been read to approve the use of fee-shifting bylaws for stock corporations as they related to internal corporate claims, the legislature expressly removed such a possibility in its recent amendment of that statute.

Finally, the Court rejected defendants’ argument that the Fee-Shifting Bylaw was valid because it contained a savings clause, making it enforceable only to the “fullest extent permitted by law.”  The problem, in the Court’s view, was that there was no part of the Fee-Shifting Bylaw that was permitted by law.  Thus, after the invalid portions of the Fee-Shifting Bylaw were removed, there was nothing left to save.

While the Court held that the Fee-Shifting Bylaw violated Section 109(b), the Court dismissed a similar challenge based on Section 102(b)(6), which generally prevents a corporation from imposing personal liability on shareholders for corporate debts except as specifically set forth in the certificate of incorporation.  The plaintiffs argued that the Fee-Shifting Bylaw violated Section 102(b)(6) because, if upheld, shareholders could be forced to reimburse the Company for its attorneys’ fees and expenses even though there was no provision authorizing the shifting of corporate debts to shareholders in Paylocity’s certificate of incorporation.

In dismissing plaintiffs’ claim, the Court held that plaintiffs failed to meet their heavy burden of establishing that Section 102(b)(6) renders the Fee-Shifting Bylaw “invalid under any circumstances.”  While it is possible that the fees and expenses set forth in the Fee-Shifting Bylaw constitute “debts,” as that term is used in Section 102(b)(6), the Court noted that plaintiffs failed to provide authority supporting that position.  The Court also stated that it was possible that by filing an action outside of Delaware in contravention of the Forum Selection Bylaw, the exception to Section 102(b)(6) may apply, which permits corporations to look to shareholders for corporate debts caused by the shareholders’ own acts.  Finally, the Court noted that dismissal of the Section 102(b)(6) claim was warranted in light of the fact that the Court already found that the Complaint stated a claim under Section 109(b), and as such, there was no practical need for further relief.

The Court similarly dismissed plaintiffs’ claim for breach of fiduciary duty against Paylocity’s directors, in which plaintiffs alleged that the Paylocity board may have acted in bad faith by approving the Fee-Shifting Bylaw and by failing to properly disclose it to the shareholders.  In doing so, the Court observed that Paylocity’s certificate of incorporation contained a Section 102(b)(7) provision exculpating its directors from breaches of the duty of care, and plaintiffs pled no facts from which one could reasonably infer that the Paylocity board acted in bad faith or otherwise knew they were violating the law.

Annual Review of Key Delaware Corporate and Commercial Decisions

This is the twelfth year that I am providing an annual list of key Delaware corporate and commercial decisions. In one of my past annual reviews, I listed only three key cases, and in other years I listed a few dozen. This year I am taking the middle ground and selecting eleven cases that should be of widespread interest to those who engage in corporate and commercial litigation in Delaware, or to those who follow the latest developments in this area of law. In preparing this list, I eschewed some widely-reported 2016 cases that have already been the subject of extensive commentary in other legal publications. Thus, the list this year may omit one or more blockbuster cases that readers likely have already read about elsewhere. This list is an admittedly subjective exercise, and I invite readers to contact me with suggestions for cases that they believe should be added to–or deleted from–this list. (Unlike last year, this year I don’t have the benefit of adopting the list of cases that a member of the Delaware Court of Chancery publicly described as the 2015 opinions that he thought were especially noteworthy.)

Delaware Supreme Court Decisions

Hazout v. Tsang. This opinion changed the law that prevailed for the last 30 years regarding the basis for imposing personal jurisdiction in Delaware over corporate directors and officers. The accepted case law for the last three decades limited jurisdiction over directors and officers of Delaware corporations, if that position was the only basis for imposing jurisdiction, to claims such as breaches of their fiduciary duties. Now, however, Delaware courts can impose personal jurisdiction over directors and officers if they are “necessary or proper parties” to a lawsuit even if there are no fiduciary duty claims or violations of the DGCL. This opinion from Delaware’s high court features a new interpretation of Section 3114 of Title 10 of the Delaware Code, which provides that when a party agrees to serve as a director or officer of a Delaware entity, she thereby consents to personal jurisdiction in Delaware. This opinion also provided a new application of the registration statutes found at Section 371 and 376 of Title 8. A more detailed discussion of the case appeared previously on these pages.

Genuine Parts Co. v. Cepec. In contrast to the foregoing Hazout case, which made it easier to impose personal jurisdiction in Delaware over certain parties to a lawsuit, this opinion did the opposite. Again departing from thirty years of prior Delaware case law, in connection with Delaware’s long-arm statute found at Section 3104 of Title 10 of the Delaware Code, this ruling reasoned that: “In most situations where the foreign corporation does not have its principal place of business in Delaware, that will mean that Delaware cannot exercise general jurisdiction over the foreign corporation.” A prior overview of this case appeared on these pages.

OptimisCorp v. Waite. This ruling provides indispensable insights from Delaware’s high court on the duties and limitations imposed on directors who are appointed by particular stockholders. These board members, sometimes referred to as “blockholder directors,” are often torn between their allegiance to the corporation and their ties to the stockholder that appointed them–often by written agreement as a condition to an investment in the company. Although it reads like an opinion, the format of this ruling is an Order of the court. (The name of the plaintiff is not a typo; it’s a conjoined name with no space, but with a capital in the middle.) Most readers know that transcript rulings and Orders can be cited in briefs as authority in Delaware, and this Order contains many eminently quotable gems. The decision affirmed a 213-page opinion by the Court of Chancery, but provided slightly different reasoning and more authoritative insights. Specifically, the Court expressed displeasure with a “Pearl Harbor-like . . . ambush” of a stockholder board member when that stockholder had the ability to remove the directors that ambushed him if he had known of their insurgent intentions prior to the meeting. Highlights of this ruling previously appeared on these pages.

El Paso Pipeline GP Co., LLC v. Brinckerhoff. This decision features a relatively rare reversal of a Court of Chancery decision on the perplexing issue of whether a stockholder claim is derivative or direct–or both. It should be encouraging, even for those who follow this area of the law, that this issue can be so nuanced and difficult to understand that even the Chancellor could be mistaken, though his friends on the Supreme Court called his reversed decision “thoughtful.” In sum, this ruling rejected the Chancery Court’s conclusion that a merger occurring after trial but before the decision of the court had been issued, did not extinguish the plaintiff’s derivative claims. Because the claims were only derivative, the claims were extinguished.

In a concurrence, the Chief Justice argued that the Delaware Supreme Court’s 2006 decision in Gentile v. Rossette should be overruled because it “cannot be reconciled with the strong weight of our precedent.” He argues that Gentile is wrong “to the extent that it allows for a direct claim in the dilution context when the issuance of stock does not involve subjecting an entity whose voting power was held by a diversified group of public equity holders to the control of a particular interest….”

Court of Chancery Decisions

Marino v. Patriot Rail Company LLC. This Court of Chancery opinion is noteworthy for providing the most detailed historical analysis, doctrinal underpinning and legislative exegesis of the statutory scheme that requires corporations under certain circumstances to provide advancement to former directors and officers that has come along in many years. The decision also explains why companies are barred from terminating such advancement for former directors and officers unless certain prerequisites are satisfied. An overview of this decision previously appeared on these pages.

In Re Trulia Inc. Stockholder Litigation.  This Court of Chancery decision has been the subject of such extensive commentary that virtually every reader of this blog has already read about it. This decision sharply curtailed (but did not entirely eliminate) the viability of stockholder class actions based on claims that insufficient disclosures were made in the context of a challenged merger. This decision was issued in January 2016. The Chancery Daily reports that the number of lawsuits filed in the Delaware Court of Chancery during the year 2016 subsequently declined substantially. Of course, some of these disclosure suits might have been filed in other states during 2016. Extensive expert commentary is available at this link, including from Professor Stephen Bainbridge, a good friend of this blog and a nationally prominent corporate law scholar often cited in Delaware court opinions addressing corporate law issues.

Amalgamated Bank v. Yahoo! Inc. This opinion provides a treasure trove of corporate law jewels. Those who need to keep abreast of this area of the law should read this scholarly 74-page gem. This decision will likely be cited often, and it belongs in the pantheon of seminal Delaware decisions because it is the first opinion to directly and comprehensively discuss directors’ obligations to produce electronically stored information (ESI) in connection with a stockholder’s request for corporate books and records pursuant to DGCL Section 220. The court also required the production of relevant personal emails of directors and officers from personal email accounts. Additionally, the court provided exemplary guidance in how to fulfill fiduciary duties when considering and approving executive compensation proposals. A synopsis of the case appeared on these pages.

Though not related in any way to my recommendation that this opinion is a must-read, as an added bonus, at page 20, the court’s opinion cited to a law review article recently co-authored by yours truly in which it was argued that ESI should be included within the scope of DGCL Section 220.

Obeid v. Hogan. This Court of Chancery opinion will be cited often for fundamental principles of Delaware corporate and LLC law, including the following: (1) even in derivative litigation when a stockholder has survived a motion to dismiss under Rule 23.1, for example where demand futility pursuant to DGCL Section 141 is in issue, the board still retains authority over the “litigation assets” of the corporation, and if truly independent board members exist or can be appointed to create a special litigation committee (SLC), it is possible for the SLC to seek to have the litigation dismissed under certain circumstances; (2) if an LLC Operating Agreement adopts a form of management and governance that mirrors the corporate form, one should expect the court to use the cases and reasoning that apply in the corporate context; (3) even though most readers will be familiar with the cliché that LLCs are creatures of contract, the Court of Chancery underscores the truism that it may still apply equitable principles to LLC disputes; (4) a bedrock principle that always applies to corporate actions is that they will be “twice-tested,” based not only on compliance with the law, such as a statute, but also based on equitable principles. This opinion is also noteworthy because it provides a roadmap for how a board should appoint an SLC with full authority to seek dismissal of a derivative action against a corporation. Additional highlights about this decision were previously noted on these pages.

Medicalgorithmics S.A. v. AMI Monitoring, Inc. This opinion earns a place among my annual list of noteworthy cases for its counterintuitive finding that a non-signatory was bound by the agreement at issue. Although other Delaware opinions have found that non-signatories were bound by the terms of an agreement, in this decision, the non-signatory was an affiliate of the signatory, and was controlled by the signatory; moreover, the agreement applied to affiliates. Additionally, the non-signatory also accepted the benefits of the agreement. See generally provisions of the Delaware LLC Act that bind non-signatory members of an LLC Operating Agreement to the terms of that agreement, and amendments by a majority of members that do not include the non-signatory. A prior overview of this case appeared on these pages.

Bizzarri v. Suburban Waste Services, Inc. This decision should be read by all those who advise directors or their corporations on what corporate records a director is entitled to–or not. This opinion provides an excellent recitation of the many nuanced prerequisites for demanding corporate books and records and when the otherwise unfettered right of directors to corporate records can be circumscribed and restricted. In addition to being noteworthy for providing corporations with defenses to demands for corporate records from directors and stockholders, this ruling explores the types of data that one can demand in connection with asserting the proper purpose of valuation of an interest in a closely-held company. A fuller discussion of this case appeared previously on these pages.

Larkin v. Shah. This Court of Chancery decision should be read by those interested in one of the most pithy restatements in any recent opinion of basic corporate governance principles such as the: (1) articulation of the fiduciary duties of directors; (2) presumption of the BJR as a standard of review; (3) when the BJR applies; and (4) how the BJR is rebutted. This opinion also provides an eminently clear articulation and application of the various permutations of one-sided or both-sided controlling stockholder transactions, and what standard of review applies in those circumstances, as well as the standard that applies in this case, where there is no controlling stockholder, but there is stockholder approval. An overview of the opinion appeared previously on these pages.

Supplemental Bonus: For the last twenty years, I have published a bimonthly column on legal ethics for the American Inns of Court. Because of the importance of legal ethics, which of course apply generally to the corporate and commercial litigation focus of this blog, and in particular in light of a controversial proposal by the ABA to amend the Model Rules to make it unethical to oppose, notwithstanding good faith religious reasons, certain behavior that until a few months ago was completely legal, I include a link to my recent article that quotes the views of nationally prominent legal scholars on a new ABA rule of professional conduct.

In addition, in honor of the passing in 2016 of U.S. Supreme Court Justice Antonin Scalia, I include a link to highlights that appeared on these pages of a concurrence by Justice Alito and Justice Thomas in the recent Caetano case that emphasizes the importance of the natural right of self-defense and in which those members of this country’s highest court rebuke Massachusetts’ highest court for flagrantly ignoring the clear authority expressed in the U.S. Supreme Court decisions in Heller and in McDonald regarding each person’s natural right to self-defense.

Chancery Grants Stay and Refers Indemnification Claims to Arbitrator to Determine Arbitrator’s Jurisdiction

Alexandra D. Rogin, an Eckert Seamans associate, prepared this overview.

In Meyers v. Quiz-Dia LLC, C.A. No. 9878-VCL (Dec. 2, 2016), the Chancery Court stayed indemnification claims to determine whether they were arbitrable.

Background: This matter involves the perenial issue of arbitrability.  Plaintiffs sued three Quiznos sandwich shop entities for indemnification and advancement pursuant to multiple agreements.  Plaintiffs Greg MacDonald and Dennis Smythe were officers of Quiznos’ primary operating entity, QCE LLC (“OpCo”).  MacDonald and Smythe left the company after it restructured a large amount of debt in 2012, which transferred ownership of OpCo and its subsidiaries to investors who owned the debt (the “Funds”).

In 2014, OpCo filed for bankruptcy and disclosed that the Funds would pursue litigation against various individuals, including MacDonald and Smythe.  Thereafter, the two former officers demanded indemnification and advancement for expenses incurred in connection with the threatened litigation.  The plaintiffs then filed the present action, asserting, inter alia, indemnification claims pursuant to various agreements.  The original complaint did not seek indemnification under the plaintiffs’ respective employment agreements.

Approximately two weeks later, the Funds asserted fraud and securities-related claims against MacDonald, Smythe, and other individuals, alleging that they induced the Funds to participate in the restructuring by creating financial projections that made it appear that the post-restructuring debt burden would be sustainable.  After that litigation had been pending for two years, MacDonald and Smythe amended the complaint in the present action to assert indemnification claims pursuant to their employment agreements, which contained broad arbitration provisions.

Parties’ Allegations: The defendants argued that the amended claims should be dismissed because they were subject to arbitration pursuant to the employment agreements.  In response, MacDonald and Smythe argued that the defendants waived their right to arbitrate.  Although the employment agreements were not previously explicitly raised, the original claims were rooted in the employment agreements.  Therefore, the plaintiffs argued that the defendants should have demanded arbitration sooner, as the provisions in those agreements extended to claims for indemnification and advancement under separate and distinct agreements.

Court’s Analysis: The Court first decided the threshold question of whether it or an arbitrator should decide the issue of arbitrability.  The employment agreements, which were governed by Colorado law, provided that any claims arising out of the agreements were to be settled by arbitration in accordance with the Commercial Arbitration Rules of the American Arbitration Association (the “Rules”).  The Rules provided that the arbitrator shall have the power to rule on his or her own jurisdiction.  Thus, according to the employment agreements, it was for the arbitrator to decide arbitrability.

The Court then determined whether it was appropriate to stay or dismiss the action pending the arbitrator’s decision.  Because that question was procedural, the Court analyzed the issue under Delaware law, more specifically, the Delaware Uniform Arbitration Act, which generally incorporates the terms of the Federal Arbitration Act (the “FAA”).  Under the FAA, proceedings should be stayed when the issue involved  is referable to arbitration.  Because the issue of arbitrability was referable to arbitration, the Court stayed MacDonald’s and Smythe’s claims pending the arbitrator’s decision.  See generally, the Delaware Supreme Court’s seminal Willie Gary opinion on this topic highlighted by this blog here.

The Court noted that if the arbitrator determined that the claims were arbitrable, it would dismiss the action for lack of jurisdiction, and it would defer to the arbitrator to determine whether the defendants waived their right to arbitrate.  Finally, the Court explained that the stay was restricted solely to the claims under the employment agreements.  Although there existed some risk for overlap, because those claims were not sufficiently intertwined with other agreements at issue in the action, a broader stay was not warranted.

Conclusion: The Court issued a limited stay pending referral to an arbitrator to determine the issue of arbitrability of the indemnification claims under the employment agreements.  This decision is notable for those who may not have realized that indemnification claims are subject to arbitration provisions.

Chancery Dismisses Action for Lack of Personal Jurisdiction over LLC and LLC Owners

Alexandra D. Rogin, an Eckert Seamans associate, prepared this overview.

In IMO Dissolution of Arctic Ease, C.A. No. 8932-VCMR (Dec. 9, 2016), the Chancery Court rejected personal jurisdiction under Delaware’s Limited Liability Company Act and the conspiracy theory of jurisdiction.  The Court provides helpful guidance on when someone can be considered an LLC manager for purposes of personal jurisdiction in Delaware.

Background: In this dissolution action, members of a Delaware limited liability company filed third-party complaints against certain individuals, alleging breach of fiduciary duty, fraud, misrepresentation, and other related claims.

There were multiple parties involved in the action.  Summetria, LLC (“Summetria”) was the 100 percent owner of Arctic Ease, LLC (“Arctic Ease”).  A group of entities referred to by the Court as the “Forden Entities,” owned sixty percent of Summetria.  Summetria’s remaining ownership was split evenly between a group of individuals referred to by the Court as the “Heck Parties,” and Costar Partners, LLC (“Costar”).  William Cohen and Mitchel Weinberger were the only members of Costar.  Pursuant to Summetria’s LLC Agreement, Carol Forden was the only member of Summetria.

On September 20, 2013, the Forden Entities filed a petition seeking dissolution of Arctic Ease and Summetria.  Together with the Heck Parties, they also asserted third-party claims against Cohen, Weinberger, Costar, and Gawi, LLC, a company involved in the purchase of Arctic Ease and Summetria (the “Cohen Parties”).

Parties’ Allegations: The Cohen Parties moved to dismiss for lack of personal jurisdiction and failure to state a claim upon which relief could be granted.  The Forden Entities and the Heck Parties opposed the motion, arguing that jurisdiction existed under the Delaware Limited Liability Company Act (the “LLC Act”) and the Delaware long arm statute through the conspiracy theory of jurisdiction.  The LLC Act provides for jurisdiction over LLC managers. The conspiracy theory of jurisdiction allows for jurisdiction over an out of state defendant if the plaintiff can show that: (1) a conspiracy to defraud existed; (2) the defendant was a member of the conspiracy; (3) a substantial act or effect of the conspiracy occurred in the forum; (4) the defendant had reason to know of the act; and (5) the act was a direct and foreseeable result of the conduct in furtherance of the conspiracy.

Specifically, the Forden Entities argued that Cohen was a manager of Summetria pursuant to the LLC Act because he was an original member of the board of directors who possessed voting power.  The Forden Entities and Heck Parties together asserted that there was jurisdiction over the remaining Cohen Parties under the conspiracy theory of jurisdiction.

Court’s Analysis: The Court granted the motion to dismiss, finding that it lacked personal jurisdiction over Cohen and the Cohen Parties.

The Court determined that it did not have jurisdiction over Cohen pursuant to the LLC Act, as he was not a manager of Summetria under § 18-109 of the LLC Act.  The Summetria LLC Agreement made clear that Forden was the sole manager of the company.  The LLC Agreement further provided that a board position did not grant membership authority to an individual.  Moreover, Cohen did not control Summetria or have a decision-making role within the company under the LLC Act, even though he was involved in important financial negotiations for Summetria.  In accordance with prior precedent, Cohen’s power was limited to Forden’s decision-making authority, and thus, he did not materially participate in Summetria’s management. Therefore, Cohen was not a manager pursuant to the LLC Act for purposes of finding personal jurisdiction over him.

Additionally, the Court did not have jurisdiction over Cohen under Delaware’s long arm statute because the Forden Entities alleged no facts regarding any act Cohen committed in Delaware, nor any business Cohen transacted in Delaware, either personally or through his agents.  Cohen’s only connection with Delaware was his indirect ownership interest in Summetria through Costar.  Therefore, neither the long arm statute nor the LLC Act provided a basis for jurisdiction over Cohen.

The Court also determined that there were no facts regarding the remaining Cohen Parties’ contacts with Delaware.  The Forden Entities did not allege that Weinberger managed a Delaware entity, and there was no basis to assert jurisdiction under the conspiracy theory of jurisdiction.  The Court explained that personal jurisdiction by conspiracy is not an independent basis for jurisdiction, but instead relies on the agency relationship inherent in a conspiracy and a proper jurisdictional hook for at least one conspirator.  Because neither Cohen nor any of the Cohen Parties were subject to the Court’s personal jurisdiction, the Complaint did not adequately allege jurisdiction over the Cohen Parties under the conspiracy theory of jurisdiction.

 Conclusion: The Court granted the motion to dismiss the Forden Entities’ and the Heck Parties’ third-party complaints for lack of personal jurisdiction.  The motion to dismiss for failure to state a claim was rendered moot.

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