Voluntary Corporate Financiers Cannot Seek Fee Awards

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

A recent Delaware Court of Chancery ruling clarified that only parties or counsel have standing to seek legal fees as an award for a successful result in certain cases. Judy v. Preferred Communication Sys., Inc., C.A. No. 4662-VCL (Del. Ch. Sept. 19, 2016)

Background:  Preferred Spectrum Investments, LLC (“PSI”) sought the recovery of attorneys’ fees and expenses totaling $20 million from Preferred Communication Systems, Inc. (the “Company”) for the funding of Michael Judy’s (“Judy”) litigation against the Company.  After a long and tortuous history that resulted in several federal prison sentences, PSI approached the Company in an attempt to transfer control to PSI from its current management.  When that offer was refused, PSI sought to initiate a lawsuit to obtain a court-ordered meeting of the stockholders where PSI would seek to replace the Company’s leadership and take over control.  However, PSI was not a stockholder of the Company.  Therefore, PSI used Judy as the plaintiff.  No formal agreement between PSI and Judy regarding litigation funding was ever formed.  Yet, PSI was funding the litigation.  The court entered its final decision on the merits in March 2013, which was upheld by the Delaware Supreme Court that following May.  Two-and-a-half years later, PSI moved through Judy to reopen the case and intervene so it could file a fee application.  In its application, PSI sought approximately $20 million, which is based on the value of the Company’s licenses, or alternatively, $4,958,056.43, representing expenses PSI claims to have incurred.

A prior decision in this case highlighted on these pages, related to the right of an attorney to retain a file of a client who has not paid

Analysis: The court began its analysis by stating the well-known maxim that, generally, parties are responsible for paying their own legal fees unless a contractual or statutory right, or other exception, otherwise exists.  One such example is the common benefit doctrine, which dictates that those who have benefited from litigation should share in the expense.

To prevail under the common benefit doctrine, a party must show: (1) the action was meritoriously filed; (2) an ascertainable group received a substantial benefit; and (3) a causal connection existed between the litigation and the benefit.  Importantly, since the common benefit doctrine is rooted in the court’s power to do equity, the court can deny the application of the doctrine even when a litigant has satisfied all of the elements.

First, the court determined that PSI lacked standing to assert such a claim for fees.  PSI was not a plaintiff nor its counsel.  Instead, PSI was a gratuitous financier that funded the litigation without any formal agreement with Judy.  And Delaware law is clear: “only a litigant or its counsel has standing to seek a fee award.”

Second, PSI lacked standing to seek a fee award under the common benefit doctrine because the litigation it funded was part of an effort to take over the Company.  Here, the primary goal was the advancement of PSI’s personal interests in obtaining control of the Company.  This objective is at odds with the purpose of the common benefit doctrine, because the primary purpose for the litigation was self-serving.  Therefore, any benefit bestowed upon the Company and its shareholders is purely incidental.

As a secondary argument, PSI claimed that it was entitled to recover the fees and expenses it spent under the doctrine of quantum meruit.  A claim of quantum meruit, as the court explained, is quasi-contract claim that allows a party to recover the value of its services if: (1) the party performed the services with the expectation of payment; and (2) the recipient should have known that payment was expected.

First, the court found that PSI could not satisfy the first element—that the services were performed with the expectation of payment.  PSI failed to document any repayment scheme with Judy.  Instead, PSI simply paid the fees and costs without first protecting itself by entering into a contract.

Second, neither PSI nor any of its stockholders had any reason to believe that PSI was expected to pay for the litigation.  On several occasions PSI represented to the Company’s shareholders that the litigation it was pursuing through Judy would be “free of cost to [them].”  Therefore, the Company and its investors could not realistically be considered to have known that payment was actually expected.


Chancery Provides Practice Tip

In a recent letter ruling, the Delaware Court of Chancery provided a practice tip for those engaged in litigation before the court who seek an extension of the word-limit for briefs: Don’t present the court with a “Morton’s Fork.” That is, don’t make the court choose between two equally unappealing alternatives by waiting until the last business day before the brief is due. In a prior opinion in the Hermelin case highlighted on these pages, at the famous footnote 19, the court explained the difference between other somewhat similar expressions, like Hobson’s Choice, that can easily be conflated. Kandell v. NivC.A. No. 11812-VCG (Del. Ch. Oct. 14, 2016).

Court Imposes Costs and Fees, Sua Sponte, in Connection with Motion to Compel

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

A recent Chancery decision provides practical tips for litigators regarding the use of general objections in response to interrogatories and document requests. In addition to striking numerous objections, the seller of a company (“Seller”) was recently awarded, sua sponte, costs and fees incurred in connection with a motion to compel discovery, as well as costs and fees incurred for the meet and confer prior to the motion. The court cautioned parties against using broad general objections to discovery requests and provided guidance on how to properly identify documents in replying to interrogatories when using Rule 33(d).Glidepath Ltd. v. Beumer Corp., C.A. No. 12220-VCL (Del. Ch. Oct. 6, 2016) (TRANSCRIPT)(Order). [N.B. Eckert Seamans represented the Seller that filed the motion.]

Background: Seller filed a cause of action against the buyer of a company (“Buyer”) for breach of an earn out agreement relating to a joint venture. During discovery, Buyers raised several general objections to Seller’s document requests. Buyers also utilized Rule 33(d) to incorporate documents into their interrogatory answers.

I. Replies to Document Requests
The court reviewed each contested response and gave detailed instructions to Buyers’ counsel. The court noted that general objections that lack any specificity are unhelpful. For example, according to the Court, a party objecting to a document request must explain why “something is ‘improper,’ why you think it is ‘overly broad as to time and content,’ why you think it is ‘unduly burdensome or oppressive,’ why you think something is ‘vague or ambiguous’ . . . and why you think it’s not relevant, immaterial, or otherwise not reasonably calculated to lead to admissible evidence.” Simply listing those general objections without further explanation is not enough.
Similarly, the Court explained that when a party objects to a document request because it believes the documents sought are publicly available or already in the possession of the seeking party, those documents must be “specifically” identified so that the opposing party knows which documents are being referred to.
Along the same lines, when a party is objecting to answers that are outside of a specific time period, it is important for the objecting party to explain why it thinks the chosen time period is appropriate and to specify a time period that is acceptable.

II. Replies to Interrogatories
In addressing the objected-to interrogatories, the Court explained specificity is also important when a party invokes Rule 33(d) as part of a reply. Rule 33(d) allows a party to answer an interrogatory by referencing business records that the requesting party could inspect when the burden of review is equal on the parties.. By way of example, the court stated, “No. 14 stated: ‘Identify all communications, including, but not limited to solicitations or negotiations You had with any third-party from 2014 to the present relating to . . . systems and/or services.”’ Buyers answered, ‘“[Buyer] will produce its non-privileged, responsive documents within its custody, control, or possession; the remainder of the interrogatory is objected to.”’

The court explained that it is not enough state that a party will produce everything in its possession, because that is a more proper rely to a document request. Instead, when relying on Rule 33(d) to answer an interrogatory, the party must identify, with greater specificity, the documents it is relying on.

Practice Tips from Court’s Ruling
1. Rule 33(d) requires some measure of specificity when referring to documents to answer interrogatories. Simply referring generally to the documents to be produced is not enough; and
2. General objections to discovery requests that lack any specificity or fail to inform the requesting party as to which discovery requests are subject to the general objections, and which are not, are not helpful to the parties or the Court and should be discouraged as they may be stricken. .

The following general objections to document requests and interrogatories were stricken by the court:

1. The Defendants object to the Interrogatories to the extent the Interrogatories, or the instructions and definitions incorporated therein, are contrary to or purport to impose obligations on and to require procedures of the Defendants beyond those required by the Delaware Court of Chancery Rules, or the case law interpreting them;
2. The Defendants object to the Interrogatories to the extent the Interrogatories, or the instructions and definitions incorporated therein: (a) are improper; (b) are overly broad as to time and content; (c) are unduly burdensome or oppressive; (d) are vague or ambiguous; (e) are unreasonably cumulative or duplicative; or (f) seek information that is not relevant to the claim or defense of any party, is immaterial, or is otherwise not reasonably calculated to lead to the discovery of admissible evidence;
3. The Defendants object to the Interrogatories to the extent the Interrogatories, or the instructions and definitions incorporated therein, call for the production of documents or information that are publicly available, previously provided to the Plaintiffs by the Defendants, or otherwise already in the Plaintiffs’ possession, custody, or control or are available from sources that are more convenient, less burdensome, or less expensive, or from sources that are as readily available to the Plaintiffs as to the Defendants;
4. The Defendants object to the Interrogatories to the extent the Interrogatories, or the instructions and definitions incorporated therein, are duplicative and repetitive of each other.
5. The Defendants object to the Interrogatories to the extent the Interrogatories, or the instructions and definitions incorporated therein, call for the identification of “all” persons with knowledge or “all” documents of a broad classification or pertaining to a specific subject, to the extent such language is overly broad, unduly burdensome, oppressive, vague, and ambiguous;
6. The Defendants object to the Interrogatories to the extent the Interrogatories, or the instructions and definitions incorporated therein; and
7. The Defendants object to the absence of a defined time period for the Interrogatories as being overbroad, unduly burdensome, and not reasonably calculated to lead to the discovery of admissible evidence. Subject to an agreed upon ESI Production protocol, and an agreement regarding appropriate custodians and search terms, the Defendants will produce documents generated or dated during the agreed upon time period that are responsive to the portions of the Interrogatories to which the Defendants do not otherwise object.

The following Responses to Interrogatories were rejected by the court:


Identify all communications, including, but not limited to solicitations or negotiations You had with any third-party from 2014 to the present relating to baggage handling systems and/or services.
Subject to the General Objections and in accordance with Rule 33(d), Defendant . . . will produce its non-privileged, responsive documents within its custody, control, or possession; the remainder of this Interrogatory is objected to on the ground that it is not reasonably calculated to lead to the discovery of admissible evidence.


Identify all other companies in which [Buyer] acquired an ownership interest (e.g., through a stock or membership purchase agreement, merger, etc.), which contained an Earnout provision.
The Defendants object to this Interrogatory on the ground that it is not reasonably calculated to lead to the discovery of admissible evidence.

Court Dismisses Buyer’s Claims Against Seller of Business

Justin M. Forcier, an associate in the Delaware office of Eckert Seamans, prepared this post.
The Delaware Court of Chancery recently dismissed counterclaims for fraud brought by a buyer of a business for failure to satisfy Rule 9(b)’s requirement of pleading fraud with particularity and to state a claim upon which relief can be granted. Glidepath Ltd. v. Beumer Corp., Glidepath LLC, Thomas Dalstein and Finn Pederson, C.A. No. 12220-VCL (Del. Ch. Oct. 10, 2016). [N.B. Eckert Seamans represents the seller in this case].

Background: Glidepath Limited (“Seller”) sold a 60% stake in Glidepath LLC (the “Company”) to Beumer Corporation (“Buyer”). Following the transaction, the Seller brought suit against the Buyer for numerous claims relating, among other things, to the Seller’s failure to honor the earn out provision set forth in the parties’ agreements. After the Seller brought suit, the Buyer filed Counterclaims for fraud and breach of contract, alleging that the Seller provided false information about the Company’s finances in order to fraudulently induce the Seller into closing the deal. The Seller moved to dismiss the Counterclaims under Rule 9(b) and 12(b)(6).
The Court ultimately dismissed the counterclaims, noting that they were too general and conclusory, and lacked the specificity needed to allege fraud. For example, although the Buyer alleged that the Seller provided false projections regarding the Company’s outlook, the Buyer failed to set forth exactly what false information was provided. The Court also noted that certain supposedly fraudulent statements were made after the deal closed, and thus, could not form the basis of a fraudulent inducement claim.
Count II, in which the buyer claimed a breach of contract was also rejected because it did not state a reasonably conceivable basis for breach. The Court observed that the Buyer did not allege which specific representations and warranties were breached nor how.

Court Describes Board Duty of Oversight

The Delaware Court of Chancery recently provided an exemplary explanation of Delaware law on the requirements that must be met before directors can be found liable for breaching their duty of oversight. Reiter v. Fairbank, C.A. No. 11693-CB (Del. Ch. Oct. 18, 2016).

Key Background Facts: This case involved a claim that the board of directors of Capital One Financial Corporation breached its fiduciary duties of oversight in connection with its alleged failure to adequately monitor the bank’s activities in connection with check cashing services, and in particular, allegedly failed to monitor compliance with the federal laws and regulations regarding money laundering.

Key Legal Principles Addressed: The Court of Chancery found that the standard under Delaware law for imposing oversight liability, sometimes referred to as Caremark liability, requires evidence of bad faith, meaning that “the directors knew that they were not discharging their fiduciary obligations.”

The court reasoned that this type of claim, often described as one of the most difficult to prevail upon in corporate litigation, failed to allege facts from which it reasonably may be inferred that the defendant directors consciously allowed Capital One to violate the federal requirements so as to demonstrate that they acted in bad faith.  Specifically, the plaintiff failed to plead with particularity that a majority of the directors of Capital One faced a substantial likelihood of liability.

It would take more space than typically allocated for a blog post to recite the excellent recitations of the law by the court regarding the nuances and prerequisites of both: (1) the duties of oversight of the board of directors, which is part of the duty of loyalty, a subset of which is the duty of good faith; and (2) the prerequisites for a plaintiff to successfully allege a breach of the duty of oversight such that it will survive a motion to dismiss under either Rule 23.1 or 12(b)(6).

Several gems can be found on pages 14 and 15 of the slip opinion, in which the court explains that the Rales test applies in this context as opposed to the Aronson because in connection with a Caremark claim, it is the lack of action by a board or an alleged violation of the board’s oversight duties that must be examined as opposed to an allegedly improper decision.

In addition, the prerequisites that must be satisfied by a plaintiff alleging a Caremark claim are usefully enunciated in page 17 through 20 of the slip opinion.

I will provide a few selected excerpts, but those needing to know the nuances of Delaware law on this topic need to read the whole opinion.The court explained that in order to establish a breach by the directors of their fiduciary duty by failing to adequately implement controls and monitoring procedures, plaintiffs would need to show either:

“(1)  That the directors knew, or (2) should have known that violations of law were occurring and, in either event, (3) that the directors took no steps in a good faith effort to prevent or remedy that situation, and (4) that such failure approximately resulted in the losses complained of.”

The opinion referred to the Delaware Supreme Court’s reinforcement of the Caremark framework for director oversight liability by clarifying that:  “To impose personal liability on a director for failure of oversight requires evidence that the directors ‘knew that they were not discharging their fiduciary obligations.’”  See footnote 48 and accompanying text.


Chancery Dismisses Challenge to Board’s Dissolution Plan

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

A recent Chancery opinion held that stockholder approval and the business judgment rule barred fiduciary duty claims against a board that dissolved the company. The Huff Energy Fund, L.P. v. Gershen, C.A. No. 11116-VCS (Del. Ch. Sept. 29, 2016)

Background: The Delaware Court of Chancery recently dismissed a stockholder’s breach of contract and fiduciary claims against a dissolving company. This action stems from Defendant Longview Energy Company’s (“Longview”) decision to dissolve Longview after the company sold a significant portion of its assets.  Plaintiff, The Huff Energy Fund (“Huff”), was the largest Longview stockholder, holding approximately 40% of Longview’s common stock. Huff brought suit to challenge the dissolution.

A Shareholders Agreement (the “Agreement”) between Huff and Longview required a unanimous vote of the Board for any act having “a material adverse effect on the rights of [Longview’s stockholders], as set forth in” the Agreement. The Agreement also provided Longview with the right of first offer if Huff were to transfer any shares, and provided that the company would continue to exist and remain in good standing under the law.

The sale and dissolution plan at issue was approved by the Longview Board and shareholders, over the abstention of one Huff board designee.

Huff’s Allegations: Huff alleged that Longview breached the Agreement because the dissolution had “a material adverse effect” on its right to transfer its Longview stock to Longview. Accordingly, Huff alleged that the Board’s decision was subject to the unanimity requirement. Additionally, Huff asserted that dissolution violated the obligation to “continue to exist.” Finally, Huff brought a fiduciary claim against the Board for adopting the dissolution plan without exploring more favorable alternatives in violation of Revlon, and as an unreasonable response to a perceived threat in violation of Unocal.

Court’s Analysis: The court first held that the individual Board defendants could not be liable for breach of contract because they signed the Agreement as company representatives, and not in their individual capacities. Additionally, Huff failed to adequately plead a tortious interference claim, as the allegations were improperly raised for the first time in briefing.

Next, the Court held that Huff failed to plead breach of contract against the Board. Huff argued that the unanimity requirement applied to any act effecting any right referenced in the contract. However, the Court found that Huff’s interpretation contradicted common sense. Huff’s interpretation would unreasonably subject all extra-contractual “rights” to the unanimity requirement, solely because they were referenced in relation to another right actually created by the Agreement. Therefore, because the Agreement did not create a “right of transferability” for Huff, but instead allowed Longview the right of first offer, the Court rejected Huff’s argument that the dissolution vote violated the Agreement.

The Court also found that dissolution itself did not breach the Agreement’s provision requiring Longview to “continue to exist and [] remain in good standing under [the law].” The provision was merely a commitment to remain in good standing as a Delaware corporation, and not a “commitment to exist ‘come what may,’” as Huff asserted. Huff’s interpretation was also unreasonable in light of other contract provisions referencing a potential merger or sale.

Next, the Court found that there was no fiduciary violation in approving the transaction. Huff failed to plead that the Board was not disinterested and independent. That the dissolution plan provided severance pay to certain directors, that some members had personal friendships, and that one member acted with alleged “animosity” towards Huff did not indicate that the Board was “interested” in the transaction to a degree that would rebut the business judgment rule. Regardless, despite Huff’s allegations toward individual Board members, Huff failed to plead that a majority of the Board that approved the transaction were not independent. Thus, entire fairness did not apply.

The Court next turned to Huff’s Revlon and Unocal arguments. Revlon did not apply because the applicable policy concerns were absent. Specifically, the adoption of the plan did not constitute a “final stage” transaction or effect a “change of control.” Similarly, Unocal did not apply. The Court noted that Huff “cite[d] no cases…indicating either that (1) the adoption or filing of a certificate of dissolution or (2) the board’s ‘perception’ that a shareholder posed a threat to any individual director’s ‘power’ over the corporation implicates the ‘omnipresent specter’ lingering in those instances where Unocal scrutiny has been invoked.”


Therefore, the Court held that Huff failed to plead any contractual breach or fiduciary violations. The Court also noted the significance of the shareholder vote in addition to Board approval. Even if enhanced scrutiny applied, “the Longview stockholders’ [informed] approval cleansed the transaction thereby irrebuttably reinstating the business judgment rule.” Accordingly, the Court invoked the business judgment rule and dismissed Huff’s complaint in its entirety.

Chancery Reviews Pre-Suit Demand Requirements

A recent Delaware Court of Chancery opinion provides practical instruction for corporate litigators regarding the difference between a direct v. derivative claim as well as an analysis of the requirements under Rule 23.1, and an application of the two-prong test in Aronson v. Lewis to satisfy the prerequisite of pre-suit demand futility.  Chester County Employees’ Retirement Fund v. New Residential Investment Corp., C.A. No. 11058-VCMR (Del. Ch. Oct. 7,2016). This case involves a challenge to a transaction among affiliated entities.

Key Legal Principles Addressed

The Court conducts an educational description of a direct and a derivative claim, as well as recognition that some claims are both direct and derivative.

The Court also reviewed the standard under Rule 23.1 which embodies the pre-suit demand requirement that must be satisfied for a derivative claim.  The Court reviewed the two-pronged test to demonstrate demand futility with particularized facts that allege a “reasonable doubt” that: (1) the directors are disinterested and independent; and (2) the challenged transaction was otherwise the product of a valid exercise of business judgment.  In addition to providing a definition for determining if a director is “disinterested” as well as “independent”, the Court discusses the second prong which involves the rare case in which a transaction can be shown to be “so egregious on its face that board approval cannot meet the test of business judgment, and a substantial likelihood of director liability exists.”

The Court reviewed the alleged conflicts based on relationships involving interlocking directorships, but found that the plaintiff did not allege sufficient facts to excuse demand. The Court also reviewed the requirements for ripeness and the need for an actual controversy before the Court would hear a declaratory judgment action pursuant to 10 Del. C. § 6501.

Chancery Dismisses Claims Challenging Merger; Applies BJR

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

The Delaware Court of Chancery recently held that because a majority of the fully informed, uncoerced, disinterested stockholders voted to approve a merger, the directors were entitled to deferential review under the business judgment rule (“BJR”).  In re OM Group, Inc. Stockholder Litigation, C.A. No. 11216-VCS (Del. Ch. Oct. 12, 2016).

Background: Plaintiffs are former stockholders of non-party OM Group, Inc. (“OM” or the “Company”).  Plaintiffs filed this action against OM’s former board of directors for what Plaintiffs claimed was a rushed sale to avoid the embarrassment of a prolonged proxy battle.  Essentially, Plaintiffs claimed that Defendants, who were former directors of OM, shut out strategic acquirers in favor of a financial sponsor because the financial sponsor was more interested in acquiring OM as a whole and not its individual business units and this rush to judgment was fueled by a desire to avoid a proxy fight with a dissident shareholder.  Second, Plaintiffs contended that the board failed to manage conflicts with investment bankers who were compensated on a contingency basis.  And finally, Plaintiffs alleged that the board relied on manipulated projects designed to artificially drive down the merger price.

Defendants moved to dismiss under Rule 12(b)(6) on three grounds: First, Defendants claimed that the complaint failed to allege facts that lead to a reasonable inference that the board acted unreasonably under Revlon.  Second, since a majority of the fully informed, uncoerced, disinterested stockholders approved the merger, the board is entitled to the business judgment rule, and Plaintiffs failed to identify any material omissions or misleading disclosures relating to the merger.  Finally, Plaintiffs failed to plead facts that were sufficient to overcome OM’s exculpation clause in its certificate of incorporation.

Analysis: The court explained that when plaintiffs are attempting to hold directors individually liable for a merger that was approved by disinterested shareholders, they must show: (1) the transaction amounted to corporate waste; and/or (2) the stockholders were not truly informed or were actually coerced.  Plaintiffs in this case did not plead corporate waste.  Therefore, the court stated that Plaintiffs were left to show that a material fact was omitted­­––a fact that would have significantly altered the total mix of information––in order to show that the shareholders were approved the merger were not truly informed.

First, Plaintiffs argued that the shareholders were not fully informed because the proxy failed to disclose that Advanced Technology & Materials Co. Ltd. made a competing proposal for $34.00­–35.00, a price slightly higher than the merger price, during the go-shop period.  The court rejected this argument because while the proxy statement did not mention Advanced Technology & Materials Co. Ltd. by name, it did state that OM had received competing bids, but OM was excluded from negotiating with them under the merger agreement.  Therefore, stockholders were informed of the competing bid when they cast their ballots for or against the merger.

Second, Plaintiffs alleged that OM failed to disclose that Steven J. Demetriou, a member of the OM board, was also Chairman and CEO of a company partially owned by Apollo (the acquiring company), and met with Apollo during the sales process, and that such omissions were material.  The court held that no facts in the complaint supported the view that Demetriou’s connection with Apollo was a material omission.  All the complaint stated was: (1) Demetriou was the CEO of Aleris; (2) Apollo owns 18.99% of Aleris; and (3) Demetriou had lunch with a key Apollo employee.  The court held that any alleged omission under these facts is conclusory and would not have been material to a reasonable investor.

Finally, Plaintiffs alleged that stockholders were uninformed about the amount of fees Apollo paid to Deutsche Bank, which served as a third-party advisor, until the day the OM board approved the merger and the proxy failed to disclose that OM initially contemplated hiring Deutsche Bank on a flat-fee basis.

Again, the court rejected that argument because, as it stated, “Plaintiffs have not well-pled facts that allow me to conclude it is reasonably conceivable that any of the omissions regarding Deutsche Bank would have significantly altered the total mix of information available to OM’s stockholders.”

Having decided that the majority of fully informed, disinterested, uncoerced stockholders voted to approve the merger, the business judgment rule applied.  And since Plaintiffs did not allege the merger amounted to corporate waste, they could not overcome the presumption of the business judgment rule.  Therefore, the court granted defendants’ motion to dismiss.


Court Grants Motion to Dismiss Previously Released Claims

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

In Geier v. Mozido, LLC, C.A. No. 10931-VCS (Del. Ch., Sept. 29, 2016), the Court of Chancery granted Mozido, LLC (“LLC”) and Mozido, Inc.’s (“Inc.”) motion to dismiss claims by plaintiff Philip Geier (“Geier”) because Geier released his claims against the entities in a previous settlement agreement.

Background: In March 2012, after several courting attempts, Geier agreed to join the LLC board of directors. As an incentive, Geier acquired 1% of the outstanding membership units (the “Options”). After resigning from the board a year later, Geier loaned LLC $3 million through the Philip H. Geier Irrevocable Trust (the “Geier Trust”) and The Geier Group, LLC (the “Geier Group”). LLC defaulted on that loan and the Geier Trust and Geier Group filed a suit to recover. An LLC board member repaid the loan and filed an action in Florida against a member of the LLC (“Liberty”) for reimbursement. In the settlement agreement for that action, Liberty and LLC sought the release of any claims Geier, the Geier Trust, and the Geier Group could assert. In that agreement (the “General Release”), the Geier Group and the Geier Trust were named as releasers, but Geier was not.

In 2013, LLC assigned all of its rights and interests to Inc. However, Inc. did not assume LLC’s liability for the Options. Geier made a formal demand in 2014 to exercise his rights to the Options, but both LLC and Inc. have refused.

Analysis: The court reviewed this motion under the well-known Rule 12(b)(6) standard; however, the court noted that the release was governed under New York law. Geier made two separate arguments for why the release did not bind him: First, he argued that reading all of the documents surrounding the release together, the release was only meant to bind the Geier Trust and the Geier Group; and second, the terms of the release show that he was not a releaser.
The court rejected both of these theories. First, the court observed that the release was captioned “General Release” and did not contain any carve outs or limitations on who was bound by its terms. Furthermore, no parol evidence could have been considered since there was no ambiguity. Citing New York law, the court declined to consider the other documents because the General Release was executed separately from the other releases in the settlement documents. The court stated that the different agreements contained separate assents and there was no indication that the General Release was not meant to stand on its own.

Therefore, it had to be interpreted within its own four corners and no extrinsic documents could be considered.
Second, the court observed that the General Release expressly named the Geier Trust and the Geier Group as releasers, but it also stated that it applied to any claims the releasors’ “affiliates, subsidiaries, and parents . . . ever had, now have or hereafter can have” against the releasees. The court found that Gieir is an affiliate of the Geier Group and the Geier Trust because the complaint shows that he is in control of both entities—Geier is a co-trustee of the Geier Trust and Chairman of the Geier Group.

Finally, the court found that Geier also released his claims against Inc., even though it was not explicitly named in the General Release. Simply stated, the General Release contained broad language defining a “releasee” to mean those entities that were named as well as any subsidiaries of the LLC. Since Inc. is a subsidiary of LLC, Geier had no recourse against either entity.

Chancery Awards Injunctions and Damages for Breach of Non-Compete and Non-Solicitation Agreements

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

The Delaware Court of Chancery recently granted injunctive and monetary relief based on the parties’ contractual agreements and obligations. This case involves two Delaware entities that own school meal management software: inTEAM Associates, LLC (“inTEAM”), and Heartland Payment Systems, Inc. (“Heartland”). The action stems from a transaction in which Heartland bought substantially all of the assets of inTEAM’s predecessor, School Link Technologies, Inc. (“SL-Tech”). inTEAM Associates, LLC v. Heartland Payment Systems, Inc., C.A. No. 11523-VCMR (Del. Ch. Sept. 30, 2016).

Background: In the sale, Heartland acquired WebSMARTT, a program categorized by the USDA as Nutrient Analysis Software. Heartland did not acquire inTEAM’s Decision Support Toolkit (“DST”) program. Three agreements, the Asset Purchase Agreement, the Co-Marketing Agreement, and the Consulting agreement, govern the transaction. The collective agreements contain non-competition, non-solicitation, and cross-marketing provisions.

The Asset Purchase Agreement prohibited the parties from providing competitive products or soliciting customers in competition with Heartland’s business. However, inTEAM’s consulting, eLearning, and DST portions of the business were explicitly excluded from the scope of the provision (the “inTEAM carve-out”). Thus, inTEAM could still competitively pursue those aspects of its business.

The Co-Marketing Agreement also contained reciprocal non-competition provisions. Additionally, it contained a provision obligating Heartland to provide inTEAM with marketing support with respect to particular products. Heartland was allowed to terminate the Co-Marketing Agreement if inTEAM did not meet specified sales targets.

The Consulting Agreement provided that Goodman was to act as an advisor to Heartland. It also contained non-competition and non-solicitation provisions.

The parties later agreed that inTEAM could develop a new program based on DST technology: KidsChoose. Heartland was to share beneficial information in exchange for a portion of the resulting revenue. After KidsChoose failed to meet expectations, inTEAM was allowed to develop a new version of the product. Thereafter, Heartland terminated its support obligations under the Co-Marketing Agreement.

In 2014, inTEAM employees emailed a potential customer about providing an inTEAM alternative to Heartland’s WebSMARTT program. Although WebSMARTT contained POS features, inTEAM was interested in adding a POS feature to its current software. inTEAM later sent two additional emails to a school district to obtain information about their current POS software.

In 2015, Heartland and an inTEAM competitor, Colyar Technology Solutions, Inc. (“Colyar”) submitted a joint proposal to Texas for the development of meal management software. After Texas declined Heartland’s proposal, Heartland promised to “ramp up efforts with Colyar[ ]” to bid in other states.

inTEAM then revealed a new program, CN Central, which combined prior DST technology. The USDA classified CN Central as Menu Planning Tool software, as opposed to Nutrient Analysis Software, such as WebSMARTT.

Parties’ Allegations: inTEAM alleges that Heartland breached its non-competition, cross-marketing, and support obligations by partnering with Colyar and failing to support inTEAM’s software development with respect to KidsChoose. Heartland asserts that inTEAM and Goodman breached their non-competition obligations by developing CN Central in competition with WebSMARTT. Additionally, Goodman breached his non-solicitation obligations by participating in inTEAM’s efforts to solicit business from schools.

Court’s Analysis: The court found that inTEAM did not breach its non-competition obligations, as CN Central was based on DST technology covered by the inTEAM carve-out. The carve-out contemplated future versions of DST software, like CN Central, with greater functionality. The Court did not consider Heartland’s extrinsic evidence on this matter because the agreement unambiguously described the carve-out. The agreement documents plainly discussed the “future release” of DST technology, and anticipated the development of a product with functionality that did not exist at closing.

Heartland also argued that CN Central competed with WebSMARTT because both programs had the ability to analyze nutrients. However, CN Central, a Menu Planning Tool, could only perform a subset of the abilities of Nutrient Analysis Software, such as WebSMARTT. Heartland argued that the USDA’s software classifications were not dispositive, as the programs had overlapping functionality. However, the Court explained that the USDA classifies the various software according to their functionality. Thus, CN Central did not compete with WebSMARTT.

With respect to Heartland, the Court found that it breached its non-competition obligations when it collaborated with inTEAM’s competitor, Colyar, to produce software covered by the scope of inTEAM’s business. It did not matter that the anticipated technology never came to fruition. However, Heartland did not breach its support obligations relative to KidsChoose. KidsChoose was a brand of Heartland’s software, and Heartland validly terminated those obligations in 2013. Regardless, inTEAM did not point to any evidence that Heartland failed to provide adequate cross-marketing aid. Moreover, there was no evidence Heartland caused any problems with the unsuccessful version of the program.

Finally, with respect to Goodman, the Court found that he did not breach his non-competition obligations as a result of the inTEAM carve-out. As discussed, CN Central did not compete with WebSMARTT, despite similar functionality. Additionally, an email evidencing inTEAM’s interest in developing POS features was not proof that inTEAM was actively engaging in selling POS software. However, the Court found that Goodman did breach his non-solicitation obligations when he encouraged a school district to adversely modify its existing relationship with Heartland by proposing an alternative tool to WebSMARTT.

Conclusion: In finding that no equitable defenses applied, the Court granted inTEAM an injunction because: (1) it showed actual success on the merits; (2) breaching a covenant not to compete is an irreparable injury; and (3) the balance of equities favored inTEAM because Heartland agreed to the non-compete covenant, and inTEAM would continue to suffer harm contemplated by the agreements if the behavior continued. However, inTEAM was not entitled to costs and fees pursuant to the language of the agreements.

Similarly, Heartland was entitled to an injunction regarding Goodman. The parties contractually agreed that an injunction was the appropriate remedy for the specified violations. In balancing the equities, the court limited the injunction to six months from the execution date. Unlike inTEAM, Heartland was entitled to damages pursuant to the agreement language.