Supreme Court Rejects Claims Against Directors

The Delaware Supreme Court, in a short Order issued not long after oral argument, rejected the arguments on appeal that challenged a decision of the Court of Chancery that dismissed claims that directors were beholden to those that they had business relationships with. Greater Pennsylvania Carpenters’ Pension Fund v. Giancarlo, et al., No. 531-2015, Order issued (Del. Mar. 11, 2016).

Frank Reynolds of Thomson Reuters provides helpful insights and more details on the case in an article. Frank writes that:

… the plaintiffs’ bid for a reversal faced long odds with the Delaware Supreme Court’s recent track record of quickly rejecting emergency appeals in cases such as this that were dismissed for failure to clear procedural hurdles like the pre-suit-demand requirement.

Over the past several months, the high court has summarily affirmed the dismissal of  high-profile shareholder suits in one-page orders often issued the day after oral argument was held. For example, within 24 hours, the justices tossed an appeal in a suit that claimed GM Co.’s directors negligently failed to respond quickly to reports of fatal ignition switch failures. In re GM Co. Derivative Litig., No. 392, 2015, order issued (Del. Feb. 11, 2016).

 

Supreme Court Expands Basis to Sue Directors and Officers in Delaware

The Delaware Supreme Court recently interpreted the statutory basis for imposing jurisdiction over directors and officers of Delaware corporations in a manner that is broader than the interpretation that previously prevailed in Delaware courts for the last 30 years. Hazout v. Tsang, No. 353, 2015 (Del. Supr., Feb. 26, 2016).

Directors and officers of Delaware corporations are deemed to consent to the personal jurisdiction of the Delaware courts by virtue of their agreement to serve as directors and officers of Delaware corporations.  The prevailing interpretation of the applicable statute, Section 3114 of Title 10 of the Delaware Code, for the last 30 years or so, has been to limit personal jurisdiction over directors and officers to claims against them in their capacity as directors and officers only for such things as breach of fiduciary duties or claims by stockholders that they violated sections of the Delaware General Corporation Law.  In essence, for reasons related to concern over minimum contacts required by due process under the U.S. Constitution, the case law over the last three decades has, in the words of the Supreme Court, “excised” a phrase in Section 3114 that allows the imposition of jurisdiction where a director or officer was merely a “necessary or proper party.”

This opinion has now rejected more than a generation of cases interpreting Section 3114 to the extent that the Delaware courts (until a few days ago), did not enforce the provision of the statute that allowed for the imposition of jurisdiction over directors or officers when they were merely “necessary or proper parties,” even if there was no breach of fiduciary duty or related claim.

Delaware’s high court based its thorough analysis on statutory construction principles and the intent of the General Assembly.  The holding also acknowledged the benefit, and likely legislative intent, of efficiency and avoiding piecemeal litigation.

The Supreme Court reasoned that there is no constitutional impediment to its conclusion because the statute requires that there be a close nexus between the claims against the corporation and those against the officer and director, and “that the claims against the officer and director involved conduct taken in his official corporate capacity.  In other words, this safeguard ensures that the implied consent mechanism of Section 3114 only applies when a director or officer faces claims that arise out of his exercise of his corporate powers.”

The court explained that the defendant in this case satisfied the statutory language because he was a “necessary or proper party to a civil action brought in this State against the corporation of which he is an officer and director.”  Moreover, he consented to suit in Delaware for certain types of lawsuits by virtue of his service as an officer and director of a Delaware corporation, and, moreover: (i) the dealings that gave rise to the suit were focused on a change of control of the Delaware corporation based on an infusion of capital or loan, and (ii) the parties to those dealings agreed to Delaware law as their common language of commerce.  Thus, the defendant had no basis to complain that his due process rights would be offended by Delaware’s exercise of personal jurisdiction over him.

The court’s conclusion was also bolstered by underscoring the public policy reason why “Delaware has a legitimate interest in providing a forum for efficient redress of claims against a Delaware corporation and a fiduciary whose actions are at the heart of those claims.”

The court explained that the defendant was “obviously a proper party because he has a tangible legal interest in the matter” that is separate from the interest of the corporation involved and because the claims against him arise out of the same facts and occurrences as the claims against the corporation involved.

In sum, the court declined to “excise” the provisions in Section 3114 that allow for the imposition of personal jurisdiction over directors and officers who are either “a necessary or proper party,” even though Delaware cases have been excising that phrase in the statute for many years as a result, apparently misplaced, of due process concerns.  Moreover, the court emphasized that it was not enough to make that “necessary or proper party” determination, but rather the court must also find that the exercise of personal jurisdiction, as in this case, was also consistent with constitutional expectations of due process.

By becoming a director and officer of the corporation involved, the defendant purposely availed himself of certain duties and protections of Delaware law.  The claims against him involved his actions in his official capacity of negotiating contracts that involved the change of control of the Delaware company.  The defendant executed written agreements which chose Delaware law to govern the disputes that formed the basis of the claims.

To make the point about choosing Delaware law more colorful, the court observed that other parties in the case were from Hong Kong and Canada, but the court found that all the parties “understood that as to the course of their respective actions relevant to this case, the jurisdiction that was their focus was the home of the fried oyster sandwich, and not the home of poutin or dim sum.”  Therefore the court concluded that requiring him to defend the lawsuit in this state does not “offend traditional notions of fair play and substantial justice.”

Delaware Allows Claims Based on Extra-Contractual Statements About Merger

Allegations are commonly made that representations outside the four corners of the parties’ agreement about a merger or similar deal were untrue, and the buyer relied to his detriment on them. A recent decision from the Delaware Court of Chancery addresses the types of provisions in an agreement that could bar such claims for misrepresentation based on extra-contractual statements or omissions. In FdG Logistics LLC v. A&R Logistics Holdings, Inc., C.A. No. 9706-CB (Del. Ch. Feb. 23, 2016), the court allowed claims to proceed based on the absence in the parties’ agreement of a provision that restricted the representations on which the buyer relied only to those contained in the agreement.

Key Takeaways:

  • The starting point of an analysis about whether claims based on extra-contractual statements or omissions will be barred, must be the precise wording of the representation clauses and the integration clause in the applicable agreements. This starting point explains why the recent decision in Prairie Capital barred fraud claims based on alleged extra-contractual statements, but the instant opinion allowed such claims to proceed.
  • Another factually determinative aspect of an analysis of the issue is whether the promises about relying only on the warranties in the agreement are expressed from the point of view of the buyer. That is, in order to bar claims based on statements outside the four corners of the agreement, the provision in the agreement must “reflect a clear promise by the buyer that it was not relying on statements made to it outside of the agreement to make its decision to enter into the agreement” (citing Anvil, 2013 WL 2249655, at *8) (emphasis in original).
  • The court in the instant opinion recognized that an opposite conclusion was reached in dismissing fraud claims based on extra-contractual representations in the Prairie Capital case. But unlike in a similar case called Anvil, the court in Prairie found that the provisions at issue in that matter: “reflected an affirmative expression by the aggrieved buyer that it had relied only on the representations and the warranties in the purchase agreement.” Slip op. at 27. See also n. 55 (quoting exact language of the agreement).
  • In the instant opinion, the court distinguished Prairie Capital, and found the critical language was similar to the Anvil case to the extent that key language was missing from the integration clause and the representation provisions that did not include an affirmative expression by the buyer of: (1) specifically what it was relying on when it decided to enter the merger agreement or (2) that it was not relying on any representation made outside of the merger agreement. Instead, the representations in the instant matter were disclaimers by the selling company of what it was representing and what it was not representing. Moreover, in the instant opinion the court determined that the integration clause did not contain a clear statement by the buyer disclaiming reliance on extra-contractual statements.
  • The court relied heavily on the reasoning in the Abry case which underscored the strong public policy against fraud and the unwillingness of the court to bar a contracting party from asserting claims for fraud unless that contracting party “unambiguously disclaims reliance on such statements.”
  • The court referred to the point made in the Prairie Capital case that the disclaimer language need not include any “magical words,” but the disclaimer must be made from the perspective of the party who is making the claim in order to preclude fraud claims for extra-contractual statements.
  • The court noted the important fact that the buyer in the Abry case did not seek relief based on extra-contractual representations, but instead amended its complaint to premise its claims solely upon alleged misrepresentations in the agreement itself.

Free Supplemental Commentary: A complete understanding of this opinion and the key issue it addresses, requires a familiarity with and a comparison of the recent Chancery opinion that dealt with an identical issue in Prairie Capital III, L.P. v. Double E Holdings Corp., 2015 WL 7461807 (Del. Ch. Nov. 24, 2015), highlighted on these pages. Also, in order to master this issue, one needs to be familiar with two other cases listed in this post. The only practical way to distinguish between the cases is the precise wording of the integration clauses and the representation clauses in the agreements considered by these cases, regarding whether the provisions sufficiently and specifically expressly disclaimed reliance on extra-contractual statements, or if the agreement confined the universe of reliance in an affirmative manner to the four corners of the agreement. See Abry Partners V, L.P. v. F & W Acquisitions LLC, 891 A.2d 1032 (Del. Ch. 2006); and Anvil Hldg. Corp. v. Iron Acquisition Co., Inc., 2013 WL 2249655 (Del. Ch. May 17, 2013). See also cases cited at footnotes 47 and 48 of the FdG opinion.

Other Noteworthy Principles of Law for Corporate and Commercial Litigation:

  • The court rejected claims based on the Delaware Securities Act because the buyer did not establish the requisite factual nexus between the challenged merger and Delaware, needed to trigger an application of the Act. The court rejected as unreasonable the arguments that the Act applied in this case because to do so would lead to the “bizarre result” of converting a blue-sky statute intended to regulate intrastate securities transactions into one that would regulate interstate securities transactions. In addition, the court rejected the use of a statute allowing for the parties to agree that Delaware law would apply as a way to bootstrap an application of the Act.
  • That statute referred to is useful to know about – – independent of this case: Section 2708 of Title 6 of the Delaware Code allows parties to choose Delaware law to govern their agreement to provide certainty to the parties who are subject to jurisdiction in Delaware, to ensure their choice of Delaware law will be respected. The statute was intended to preempt the analysis in the Restatement (Second) of Conflict of Laws, that there exists a substantial relationship between the state and the parties, and that the application of the law of Delaware would not be contrary to any fundamental policy of the state. A prerequisite for the application of the statute is that the contract must involve $100,000 or more.
  • As part of this opinion, the court also granted summary judgment to the seller based on the terms of the agreement for payment of a tax refund that was earned prior to the merger, but received by the buyer after the merger. The court did not address, and apparently none of the parties raised the issue of, whether a claim for payment of money was outside the scope of the equitable jurisdiction of the Court of Chancery.

Chancery Determines Rights to Books and Records Under LLC Act

The Court of Chancery just decided a case that elucidates the rights of members and managers of an LLC to books and records of the LLC. A few bullet points will extract the nuggets of this decision. You should read the whole thing if you need to know the latest Delaware law on this topic. RED Capital Investment LP v. RED Parent LLC, C.A. No. 11575- VCN (Del. Ch. Feb. 11, 2016).

  • First, this ruling should be compared to the recent ruling in the Yahoo opinion highlighted on these pages. Although this decision did not address electronically stored information (ESI), readers are likely aware that decisions regarding demands for the books and records of an LLC often apply the rationales in rulings interpreting the analogous DGCL provisions (however different they may be)–therefore, you read it here first that the reasoning in the Yahoo decision that ESI must be produced in a Section 220 demand under the DGCL, will also be applied in the future to demands for books and records under Section 18-305 of the Delaware LLC Act, to require ESI to be produced when there otherwise is an entitlement to books and records under the LLC Act.
  • The money quote, which underscores the additional rights of managers of LLCs (and directors of corporations) to books and records:

    Managers are entitled to all information falling within Section 18-305(a)(1)-(6) that is “reasonably related to the position of manager.”40  This language is tantamount to that used in 8 Del. C. § 220 with respect to director requests for corporate information.41  As such, LLC managers should be afforded similar “unfettered”42  access to company books and records, absent restrictions in an applicable LLC agreement. With this context, the Court is unwilling to deprive an LLC holding company’s manager of books and records of the company’s wholly-owned operating entities…. (footnotes omitted)

  • One big difference between DGCL Section 220 and Section 18-305 of the LLC Act, is that LLC operating agreements can limit the rights that a member or manager may otherwise have to demand books and records. The LLC Act expressly says so. Section 220 does not expressly say so, but in a teleconference for a relatively recent Section 220 case, one member of the Court of Chancery informed the parties that a contract that purported to limit rights under Section 220 was not likely to be enforced. The name of the case was Brazil Mining. That case comes to mind readily, but I expect that there are similar cases, some of which have been featured on these pages over the last 10 years.
  • This opinion is also helpful in how it addresses issues involving the interface between the rights of members or stockholders in affiliated entities relating to access to records of subsidiaries and parent entities in the corporate context and LLC context.

UPDATE: In a Law 360 article, Jeff Montgomery reports that subsequent to this decision, the company indicated in a letter that it would not produce the documents until the appeal period ended, which apparently was on or about March 15, as it had not yet decided whether to appeal. Vice Chancellor Noble, who previously set the end of February for his retirement from the bench, responded to that position, described by the opposing side as a self-granted unilateral stay, by ordering that the data be produced by March 3.

RIP Justice Scalia

U.S. Supreme Court Justice Antonin Scalia has gone to his eternal reward. The front page of The New York Times today quoted Court of Appeals Judge Richard Posner as writing in 2011 that Justice Scalia was “the most influential justice of the last quarter century.” Whether you agreed with his views or not, he was in my estimation the best writer of legal opinions that I have ever read. Period.

I had the pleasure of meeting and speaking with Justice Scalia when he attended a reception prior to speaking at a dinner in Wilmington sponsored by the St. Thomas More Society about a decade ago. More recently, I met him again at a book signing in Wilmington where he signed one of his latest books for a group of Delaware lawyers that included yours truly. Over the last 24 hours or so since his passing, much has been written, and more will continue to be written about his towering intellect and the lasting impact he will have on American jurisprudence. I agree with Professor Bainbridge’s observation that his death is a national tragedy.

I extend my prayers and sympathies to his family. May he rest in peace.

Delaware High Court Rejects Claims Against GM Directors

Frank Reynolds of Thomson Reuters reports on the Delaware Supreme Court’s recent affirmance of a Chancery ruling which dismissed claims against GM directors. He reports that:

Dissident General Motors investors have failed to persuade the Delaware Supreme Court to give them another chance to prove the automakers’ directors negligently relied on a defect reporting system that failed to alert them to deadly ignition switch flaws for five years. In re Gen. Motors Co. Derivative Litig., (Del. Feb. 11, 2016)(Order).

After holding a special oral argument session at the Widener University Delaware Law School in Wilmington on Feb. 10, the justices [decided to] uphold a Chancery Court judge’s dismissal of charges that GM’s directors were asleep at the wheel and missed a fatal vehicle flaw. In re Gen. Motors Co. Derivative Litig., No. 9627, 2015 WL 3958724 (Del. Ch. June 26, 2015)

The rest of the article is available at this hyperlink. If Delaware’s high court had issued an extensive Opinion instead of a one-page Order, they would be hard pressed to provide a more scholarly legal analysis for their holding than provided by Professor Bainbridge, with his citations to prior cases and published commentary, explaining the doctrinal underpinnings for the decision to reject claims against the GM directors.

 

Chancery Determines that Electronically Stored Information and Personal Emails of Directors Must Be Provided to Stockholders

The Delaware Court of Chancery published an opinion this week that includes electronically stored information as part of the “books and records” that a stockholder can demand from a corporation and its directors and officers. Amalgamated Bank v. Yahoo!, Inc., C.A. No. 10774-VCL (Del. Ch. Feb. 2, 2016). It also addresses the duties of directors in connection with reviewing and approving executive compensation packages. (Plus: it features quotations from a law review article I co-authored on Section 220, as noted below.)

The treasure trove of corporate law jewels in this opinion, weighing in at 74 pages, can easily justify commentary of similar length. Those who want to keep abreast of key Delaware corporate law principles need to make the time to read the opinion in its entirety, but for present purposes I will provide bullet points with highlights.

  • Although this decision includes a comprehensive analysis of the prerequisites for demands under Section 220 of the Delaware General Corporation Law (DGCL) regarding the right of a stockholder to obtain books and records of a company, a fuller understanding of this opinion can be be obtained by comparing it to other recent decisions on Section 220, including the recent Delaware Supreme Court ruling in Abbvie which rejected a Section 220 request based on an exculpatory clause in the corporate charter in that case, and which was highlighted on these pages. The Yahoo decision should also be juxtaposed with a decision a day earlier by Vice Chancellor Noble which limited the scope of records that were demanded by a director. See Chammas v. NavLink, Inc., C.A. No. 11265-VCN (Del. Ch. Feb. 1, 2016). The Chammas opinion directly addresses the rights of a director to books and records but is not as expansive in ordering emails or records of individual officers, and does not address ESI as the parties appear to have agreed on that issue. The Yahoo opinion should also be contrasted with the Supreme Court decision in the Wal-Mart case, highlighted on these pages, which required the production of extensive information regarding board deliberations, including an exception to the attorney/client privilege.
  • One of the most important reasons why this case is destined to be often cited, and deserves a prominent position in the pantheon of seminal Delaware decisions, is because, to my knowledge, it remains the first Delaware opinion to directly interpret DGCL Section 220 in a manner that explicitly requires the production of electronically stored information (ESI) based on the statutory language. Although the court lists quite a number of Delaware decisions in footnote 42 that have ordered the production of emails in connection with Section 220 requests based on the facts of those cases, as far as I am aware, this is the first Delaware opinion that expressly addresses the obligation of a company pursuant to Section 220 to produce ESI as compared to requiring the production of just emails. But I don’t think that prior cases explicitly interpreted the statute to require ESI production (which is broader than emails).
  • This opinion, consistent with it statutory interpretation, rejected the argument by Yahoo that inspection rights under Section 220 are limited to paper records. See page 20. In doing so, I am happy to say that the court in this opinion quoted from a law review article co-authored by yours truly which argued that the court should include ESI as part of the obligation to produce records under Section 220. See 37 Del. J. Corp. L. 163, 165 (2012), highlighted on these pages here.
  • Although the Wal-Mart decision referred to above required the production of various emails, that decision as I recall, is fact specific and did not expressly include in the same direct and comprehensive fashion as this opinion, with the detailed analysis and supportive reasoning that this opinion did, an interpretation of Section 220 as requiring ESI (which is broader than email only) to be included in a production of “books and records.”
  • Importantly for those needing to understand the scope of Section 220, this opinion also required the production of relevant personal emails by officers and directors to the extent that they were responsive to the demand (i.e., emails on a non-business, personal email account). See footnote 43.
  • Although there are hundreds of Delaware decisions interpreting Section 220, many of them highlighted on these pages over the last ten years, this opinion describes the prerequisites of Section 220 and the nuances and scope of Section 220 demands more thoroughly than any other Section 220 opinion that I can recall. If a person interested in learning about Section 220 were to read only one opinion on Section 220, in an effort to understand all of its nuances as requirements, this should be that opinion.
  • In connection with its discussion of Section 220, the court also provides advice to directors regarding their fiduciary duties when reviewing and approving an executive compensation proposal. See pages 42 and 43.
  • The court also clarifies that the prerequisite of needing a credible basis to allege mismanagement as a threshold requirement for Section 220 is not the same as requiring or assuming that one will prevail on such a claim, nor is the Section 220 standard whether it is reasonably conceivable that one could prevail on such a claim, as in a Rule 12(b)(6) motion.
  • Lastly, the court imposed a condition on the production that all the documents that the court ordered Yahoo to produce in this opinion will be incorporated by reference into any plenary complaint that is filed by the plaintiffs.

Supplement: California lawyer Keith Paul Bishop and the venerable Professor Bainbridge, observe that if Nevada law were to apply to this set of facts, the result would likely be much different.

Chancery Awards Fees for Therapeutic Benefit Originating in a Ruling That Bylaw Amendment Not Applicable to Prior Stockholders

In a recent ruling from the bench, the Court of Chancery approved fees for a therapeutic benefit that had its genesis in a ruling from March 2015, that was previously highlighted on these pages in the matter of Strougo v. Hollander, and which determined that a bylaw amendment would not apply to former stockholders when adopted by the board on a date after the plaintiff-stockholder was cashed out in a reverse stock split. When the transcript of the settlement hearing on Feb. 3, 2016, becomes available I will upload it on this blog, but the key aspects of this ruling for future reference include the following bullet points:

  • The common fund that was the result of a negotiated settlement was created in the amount of $127,000 and although the court awarded 15% of that fund for attorneys’ fees, the court first “grossed-up” the amount. The net result of that “gross-up” was more in fees as compared to taking 15% of the $127,000. That is, the court added the 15% of the $127,000 to the amount of the common fund before applying the 15% to calculate the fee.
  • The court also awarded $333,000 for the fees attributable to the therapeutic benefit originating in the winning of a motion last year, highlighted on these pages and hyperlinked above, in which the court invalidated a fee shifting bylaw as applied to the former stockholders, even though no decision was made on the facial validity of that bylaw and no ruling was made regarding the substantive issues in the challenged reversed stock split. The ruling on the applicability retroactively of that bylaw did not depend on the particular type of bylaw it happened to be, but the fact that it was a fee-shifting bylaw brought more attention, and dicta, to that prior decision.
  • The amount of $333,000 is notable by comparison to the much smaller amount of the common fund obtained as a result of a settlement on the merits of the case, which was made possible or more likely by the ruling which allowed the case to proceed in light of the fee shifting bylaw which was held to be inapplicable to the former stockholders.
  • The amount of the fee of $333,000 for a therapeutic benefit appears identical to a fee award that was approved in a case involving the withdrawal of forum selection bylaws. In a case styled In Re Colfax, the transcript refers to that fee award in the other bylaw settlement case. The awkward and circuitous citation results from the fact that the Colfax transcript refers to a stipulated settlement in another case that I only have documented in consolidated stipulations, but those stipulations don’t mention the approved amount of the fee (as compared to a higher stipulated amount.) Refer to the stipulations of settlement in consolidated cases involving the withdraw of forum selection bylaws.
  • One takeaway from this bench ruling of Feb. 3, 2016, in the Strougo matter, is that a fee award for a therapeutic benefit can be several times larger than the amount of the common fund created for stockholders in the same case, and the lack of proportionality between the two amounts is not an impediment to the amount of the fee award for the therapeutic benefit. (Yours truly was one of the defense counsel in the Strougo matter.)

Chancery Sounds Death Knell for Most Disclosure-Only Settlements

The Delaware Court of Chancery recently issued a seminal decision that may signal the end of (at least) most disclosure-only settlements in class action cases that challenge mergers. In Re Trulia Inc. Stockholder Litigation, C.A. No. 10020-CB (Del. Ch. Jan. 22, 2016), is must reading for those interested in class action settlements in general, and disclosure-only settlements in particular.

Michael Greene of Bloomberg BNA published a helpful overview of the case (with a few quotes from yours truly.) Professor Bainbridge also provides scholarly insights. Ted Mirvis provides expert commentary on the case as well.

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