Request for Interim Fee Award Denied and Representative Plaintiff Disqualified

In a pair of related decisions issued on the same day, June 29, 2016, the Court of Chancery in Smollar v. Potarazu (here and here) made the unusual move of disqualifying a derivative plaintiff and his counsel, and granting a motion to intervene brought by another stockholder who sought to become the representative plaintiff.

Key Issues Addressed

The memorandum opinion denied an interim fee request made by Smollar’s counsel and granted a motion to disqualify Smollar and his counsel made by other stockholder objectors.

Overview

The interim fee request followed what the Court termed a “botched settlement” proposal by Smollar in which he would have obtained benefits not shared by others in the class, which was rejected by the Court. Despite having his proposed settlement rejected, Smollar’s counsel made a motion for an interim fee award, anticipating withdrawal from the matter. In rejecting that request, the Court emphasized that Smollar had not conferred upon the class any lasting benefit that was not capable of reversal, examining both the standard for granting an interim fee award and the Sugarland factors. The Court also found that counsel for a derivative plaintiff who has lost standing to serve as the class representative is not entitled to an award of fees.

Other stockholder Objectors opposed the motion for an interim fee award, and moved to disqualify Smollar as a representative plaintiff, arguing that his attempt to secure a personal benefit through the rejected settlement rendered him an inadequate representative. The Court granted the Objectors’ motion, and discussed the eight factors it considers to assess whether a proposed derivative plaintiff will adequately represent the class:

Factors to Determine Adequacy of Plaintiff

(1) economic antagonisms between the representative and the class;

(2) the remedy sought by plaintiff in the derivative litigation;

(3) indications that the named plaintiff was not the driving force behind the litigation;

(4) plaintiff’s unfamiliarity with the litigation;

(5) other litigation pending between plaintiff and defendants;

(6) the relative magnitude of plaintiff’s personal interests as compared to her interest in the derivative action itself;

(7) plaintiff’s vindictiveness toward defendants; and

(8) the degree of support plaintiff was receiving from the shareholders she purported to represent.

Chancery Imposes Penalties for Not Saving Text Messages and Bad Faith Litigation

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

Key Issue Addressed: Fees imposed for bad faith litigation as well as for failure to preserve text messages and other mishandling of ESI. In re: Shawe & Elting LLC, C.A. Cons. No. 9661-CB (Del. Ch. July 20, 2016).

Background: This decision is the latest in a series of decisions involving a deadlock between 50/50 owners Elizabeth Elting (“Elting”) and Philip Shawe (“Shawe”), who are also co-CEOs of TransPerfect Global, Inc. (“TPG” or the “Company”). Previous decisions involving this litigation have been highlighted on these pages.

With facts that seem to spring from a John Grisham novel, Shawe was accused of surreptitiously monitoring Eltings phone calls, emails and communications between her and her counsel, hacking into her computer, and hiring a former employee to break into her office to take photographs and steal documents. The two co-CEOs were former sweethearts who met in college before forming their global company that has annual revenue of a few hundred million dollars per year.

Elting also accused Shawe of deleting files from his laptop, and otherwise failing to preserve ESI; “accidentally” destroying his phone; and lying in interrogatory answers, and while giving deposition and trial testimony.

Analysis: The court first reiterated that Delaware follows the “American Rule” and courts do not generally award attorneys’ fees for the prevailing party in litigation. However, an exception to that rule exists when the losing party acted in bad faith. The court clarified that the purpose of the award is not to provide the prevailing party with a fee award as a matter of right, but instead to avoid abusive behavior in the future and preserve the integrity of the judicial process. And any claims of bad faith must be based on clear evidence and is normally “only applied when the party in question displayed unusually deplorable behavior.”

First, the court found that Shawe intentionally sought to destroy evidence he was judicially ordered to make available. The expedited discovery order that the court entered explicitly gave Elting the right to conduct forensic discovery on Shawe’s computers, phones, and other devices. Instead of complying with the order, Shawe twice, and without counsel’s knowledge, deleted files from his laptop. First, a total of 19,000 files were deleted prior to Shawe creating a mirror image of it—all but 1,068 were recovered. Those deleted files were directly relevant to the litigation. Second, Shawe deleted 22,000 more files from his laptop. However, the court found that Shawe did not intend on deleting those files permanently because he deleted them after creating the mirror image. However, the court still found that the deletion of those 22,000 files was improper, because it was an attempt to “sneak one past his computer expert, who had just been hired.”

Second, the court found that Shawe recklessly failed to safeguard information on his cell phone. Shawe frequently communicated with TPG employees through text messages. Although the court was less than convinced that Shawe’s phone was “accidently” submerged in a plastic cup of Diet Coke, it found absolutely zero credibility in Shawe’s explanation the his assistant (Campbell) threw the phone away innocently. The court stated, “Campbell’s story of having such a ‘visceral’ reaction to seeing rat droppings in his office desk drawer that he spontaneously threw out the phone is so preposterous that it is not even recounted in Shawe’s own brief.”

Furthermore, the court observed that Shawe is the co-CEO of a company that specializes in e-discovery. He had a wealth of resources available to him that could attempt to fix his phone. Instead, he trusted it with Campbell, whose only experience with data recovery is that his own phone fell in a toilet once and worked fine after it dried. Once Campbell was unsuccessful in his attempt, the phone sat in his desk drawer and was then thrown away. The court found that this action by Shawe at least amounted to a reckless failure to safeguard information.

Finally, the court found that Shawe knowingly provided false testimony. The court found that Shawe provided perjurious testimony at least four separate times. Shawe provided false testimony: (1) in his sworn interrogatory responses; (2) during his deposition; (3) on the witness stand during the trial on the merits; and (4) in an affidavit submitted post-trial.

As a remedy, the court considered three factors: “(1) the culpability of the spoliating party; (2) the degree of prejudice suffered by the aggrieved party; and (3) the availability of lesser sanctions that could both avoid unfairness to the aggrieved party and serve as an adequate penalty to deter such future conduct.”

To start, the court shifted all reasonable attorneys’ fees and expenses (including experts) Elting incurred in bringing the motion for sanctions to Shawe. However, the court found that an additional sanction was appropriate because Shawe’s behavior “significantly complicated and permeated the litigation.” Therefore, 33% of Eltings attorneys’ fees and expenses that were incurred until the decision was rendered for the trial on the merits were also shifted to Shawe.

Firm Disqualified Based on Representation of Two Adverse Subsidiaries

In my latest ethics column for The Bencher, the national publication of the American Inns of Court, I highlighted a recent decision by a federal district court in which a law firm was disqualified based on its representation of two adverse subsidiaries of a parent company. The court’s useful application of Rule 1.7 and Rule 1.9 should be of interest to those engaged in corporate and commercial litigation for subsidiaries of large companies, whether in Delaware or elsewhere.

Chancery Upholds Ability of Managers to Waive Fiduciary Duties

In my most recent article for the publication of the National Association of Corporate Directors called Directorship, I provide an overview of a recent decision of the Delaware Court of Chancery that upheld the waiver of fiduciary duties for managers of a limited partnership. The name of the case is Employees Retirement System of the City of St. Louis v. TC Pipelines GP, Inc., decided in May 2016. This is a hot topic in corporate and commercial litigation.

 

Chancery Addresses “Commercially Reasonable Efforts” and Denies Request to Enforce Deal

In an expedited deal litigation matter, in The Williams Companies, Inc. v. Energy Transfer Equity, L.P., C.A. No. 12168-VCG (Del. Ch. June 24, 2016), the Court of Chancery denied a request to enjoin Energy Transfer Equity, L.P. (“ETE”) from evading a deal based on its inability to obtain a tax opinion that was a condition precedent to closing on a deal with The Williams Companies, Inc. Although the facts of this case are somewhat sui generis, the legal principles addressed should have broader application, not only for deal litigation but contract litigation in general.

The court’s discussion of the concept of “commercially reasonably efforts” and “reasonable best efforts” is useful to remember. The court distinguished the two prior Chancery opinions in Hexion, highlighted on these pages previously, and WaveDivision Holdings, highlighted on these pages, in part because, on a factual level, in both of those cases the Court of Chancery found, unlike in the instant case, that a party took affirmative steps, in violation of the relevant cooperation clause, to thwart a condition to closing such as using commercially reasonable efforts, or reasonable best efforts, to obtain financing or to obtain the consent of a third party to the deal.

Short Overview of the Basic Facts

After the merger agreement between the parties was entered into, the energy market, and the value of the assets in the transaction, experienced a precipitous decline. Since a part of the consideration for Williams was $6 billion in cash, which ETE would have to borrow against its devalued assets to obtain, the proposed transaction quickly because financially unattractive to ETE as the buyer. Thus, ETE was looking for an exit from the merger agreement, although initially it had been an ardent suitor of The Williams Companies.

One of the key facts of the case was that a condition precedent to consummation of the merger was the issuance of an opinion by the tax attorneys for ETE at the law firm of Latham & Watkins. The firm was specified in the agreement, and in its sole discretion, was to issue an opinion as a prerequisite to closing, to the effect that the transaction “should” be treated as a tax free exchange under Section 721(a) of the Internal Revenue Code. Although Latham initially, at the time the agreement was signed, expected to be able to issue that opinion, after the agreement was signed something changed. Based on the effect of changing market conditions and reduced value of the stock on the tax impact, Latham disclosed that it was no longer able to issue such an opinion. One of the claims that Williams maintained against ETE was that it failed to use “commercially reasonable efforts” to secure the Latham opinion and, therefore, materially breached its contractual obligations.

The court approached the inability of ETE to obtain the Latham opinion with skepticism, amid claims that it was a ruse to allow it to back out of the deal in light of the downturn in the energy market which made the deal financially problematic. Another important fact is that the court found that the person at ETE in charge of tax issues did not accurately read or understand the terms of the deal at the time the agreement was signed, and both he and the Latham firm only realized there was a problem in issuing a the tax opinion after the agreement had been signed. Curiously there were six different tax opinions presented at trial by independent experts and tax experts connected with the deal. Some of those opinions were contradictory.

Money Quote

Notwithstanding the court’s initial skepticism and the motive that ETE had to avoid the closing, a few money quotes from the court have application far beyond this case. For example, the court reasoned that:

“Just as motive alone cannot establish criminal guilt, however, motive to avoid a deal does not demonstrate lack of a contractual right to do so. If a man formerly desperate for cash and without prospects is suddenly flush, that may arouse our suspicions. Nonetheless, even a desperate man can be an honest winner of the lottery.”

Court’s Holding

The court explained in its 58-page post-trial opinion, issued the same week that the trial ended, that Delaware is a contractarian state, and recognizes and respects provisions in contracts that favor specific performance in case of breach. But conditions precedent to a transaction must be enforced as well. The request of Williams to force the court to consummate the deal with ETE would force ETE to accept the risk of substantial tax liability which the parties did not contract for.

Key Issues

Among the key issues the court had to consider was whether the Latham firm determined “in good faith” that it was unable to issue the tax opinion. Williams argued that Latham reached a conclusion that it could not issue the opinion in bad faith and for reasons other than its best legal judgment, in order to please its client. That relates to the argument that ETE persuaded Latham not to issue the necessary opinion, which, if true, would be a breach by ETE of the requirement that it use commercially reasonable efforts to obtain the opinion.

The court articulated the issue as whether Latham determined in “subjective good-faith” that it could issue the necessary opinion which was a condition precedent to closing. The court observed that Latham was a law firm of “national and international repute” and that is was at the very least a blow to the reputation of the firm and its tax partners that they had preliminarily advised that the deal would qualify for certain tax treatment, but had to backtrack in a way that “caused the ‘deal to come a cropper.’”

Among the six different tax experts who testified at trial about the ability to issue the necessary tax opinion that was a condition precedent, one tax law professor testified that “no reasonable tax attorney could agree with Latham’s conclusion,” but another professor testified that the conclusion of Latham that it could not issue the opinion was appropriate. Other law firms argued that although the conclusion of Latham was correct, the reasoning for that conclusion was different.

In its analysis of subjective good-faith, the court observed that it was a “substantial embarrassment to Latham” that it was not able to issue the opinion despite its initial view that it could do so, and that the reputational effects outweighed any benefit of an unethical deference to the interests of its client because “while this deal is, certainly, a lunker, Latham has even bigger fish to fry.” The court also noted a blog post from one of the Wall Street Journal’s blogs that Latham & Watkins had been a clear loser on the deal regardless of who won the litigation. See footnote 122.

Legal Principles Discussed

The court observed that the phrase “commercially reasonable efforts” was not defined in the agreement, and that even though the phrase has been addressed in other cases – – “the term is not addressed with particular coherence in our case law”. The phrase has also been articulated as “reasonable best efforts” which has been described as “good-faith in the context of the contract at issue.” Citing Hexion Specialty Chemicals Inc. v. Huntsman Corp., 965 A.2d 715 (Del. 2008), the court found that the phrase “commercially reasonably efforts” in the agreement in this case required the purchaser, ETE, to submit itself to a “objective standard to ‘do those things objectively reasonable to produce the desired’ tax opinion in the context of the agreement reached by the parties.”

The court found that the argument by Williams regarding burden of proof was wrong, and that the buyer, ETE, did not have the burden to “prove a negative.” That is, it did not need to show that its lack of more forceful action, or that a specific action taken, was the reason that Latham did not render a tax opinion. The court similarly distinguished the holding in WaveDivision Holdings, LLC v. Millennium Digital Media Sys., LLC, 2010 WL 3706624 (Del. Ch. Sept. 17, 2010). See footnote 130.

Regarding the court’s reasoning about why ETE did comply with its obligation to use commercially reasonable efforts, the court explained why the arguments of Williams were rejected. Williams argued that ETE:

“. . . generally did not act like an enthusiastic partner in pursuit of consummation of the Proposed Transaction. True. The missing piece of Williams’ syllogism is any demonstration that the Partnership’s activity or lack thereof, caused, or had a materially effect upon, Latham’s current inability to issue the [tax opinion].”

Thus, one may read the above quote as suggesting that “not being enthusiastic about closing a deal” is insufficient to breach a duty to use commercially reasonable efforts. The missing part of Williams’s syllogism described by the court is a key fact that distinguished both the Hexion case and the WaveDivision case because the non-performance allegation and the lack of best efforts allegation – – even if true – – did not contribute materially to the failure of the goal to which the “efforts clause” was directed. See footnotes 122 and 123 and accompanying text.

Postscript: Courtesy of The Chancery Daily, we understand that this decision has been appealed to the Delaware Supreme Court. The Court of Chancery facilitated this option by noting in an Order that accompanied the opinion that pursuant to Rule 54(b), this ruling was appealable although it did not conclude all issues at the trial court level.

Supplement: The venerable Professor Bainbridge provides professorial commentary on the use of the phrase “commercially reasonable efforts” and variants, and observes how common it is to use this phrase, and its variations, without definition and without precision. We are also grateful that the good professor links to yours truly and this post in his discussion.

Second Supplement: In a more recent transcript ruling, in a separate case, another vice chancellor addressed the standard of “commercially reasonable efforts” in the context of a motion to dismiss, as opposed to the post-trial findings in the Williams case. In the matter styled:WP CMI Representative LLC v. Roche Diagnostics Operations Inc.,  C.A. No. 11877-VCL (transcript)(Del. Ch. July 14, 2016), the money quote is found at page 56 of the above-linked transcript ruling when the court explains that a reasonable inference that the parties’ interests are aligned can be defeated when the party with the duty to act in a commercially reasonable manner, does “… something that wasn’t originally contemplated and which has the effect of causing the milestone not to be hit….” In that context, it might be “reasonably conceivable” [under Rule 12(b)(6)] that the change in behavior that was  not originally contemplated or not consistent with past practice, may be a change that was not commercially reasonable.

Chancery Approves Sale of Deadlocked Company Proposed by Custodian

This post was prepared by Justin Forcier, an associate in the Wilmington office of Eckert Seamans.

Why This Case is Noteworthy: The Court of Chancery approved, with certain modifications, the recommendation of an appointed custodian for the proposed sale of a company as a going-concern in light of the company’s two directors being deadlocked. In Re TransPerfect Global, Inc., C. A. No. 9700-CB (Del. Ch. June 21, 2016).

Background: On August 13, 2015, the Court appointed a custodian, in light of a deadlock, to oversee a judicially ordered sale of TransPerfect Global, Inc. (“TPG”). That 104-page memorandum opinion was highlighted on these pages. Although there are three stockholders in TPG, they are deadlocked because two of the stockholders, Philip R. Shawe (“Shawe”) and his mother, Shirley Shawe (“Ms. Shawe” and collectively “the Shawes”), own 49% and 1% respectively, and the other 50% is owned by Elizabeth Elting (“Elting”).

Analysis: The August 2015 opinion required the custodian to present the Court with a proposed plan to sell TPG as a going concern in order to maximize stockholder value. Although the company was profitable, the Court found in the 2015 opinion that the requirements of both § 226(a)(1) and § 226(a)(2) were satisfied and, therefore, the appointment of a custodian to break the deadlock was appropriate. The opinion also directed the custodian to evaluate several different options for the sale, including: (1) limiting the possible bidders to only Shawe and Elting in a “Texas shoot out” auction format; (2) an open auction that would allow any interested bidder to participate; or (3) any other option that the custodian felt was appropriate to achieve maximum value.

The custodian presented five options for a sale. Those recommendations were: (1) a division of TPG into two distinct entities with Elting retaining 100% ownership in one of the entities and the Shawes retaining 100% ownership in the second; (2) conducting an initial public offering; (3) the purchase of one stockholder’s shares by the other stockholder; (4) a board auction process involving strategic bidders and financial bidders; and (5) a modified board auction process led by the existing stockholders where third-party investors would be solicited to either partner with the current stockholders or purchase TPG.

The custodian recommended that the fifth option, the modified board auction, would be most likely to produce the greatest value for the stockholders, because it would allow each stockholder to bid for control of TPG, and also allow third parties to participate.

Elting did not object to the proposal of a modified board auction. Shawe, however, objected to the proposal for two reasons. First, the Shawes asserted that a better option would for each stockholder to prepare a range of values of what TPG is worth, and then limit the bids in the first round of the auction to the existing stockholders. Then, if neither bid fell within the predetermined range of value, a “go-shop” process would be implemented to allow third parties to bid in a second round. However, the “winner” of the first round would retain a matching right that could be exercised in the second round.

The Court rejected the Shawes’ proposed alteration. Observing the fact that TPG has not historically had an annual budgeting process and the Shawes and Elting have submitted vastly divergent estimates of TPG’s value, the Court stated that the “proposal appears designed to cause needless delay and to suppress rather than to maximize stockholder value.”

Second, Shawe opposed non-competition and non-solicitation provisions the custodian proposed to include in the modified board auction plan. Shawe objected to this proposal because he argued that unless a stockholder has engaged in wrongdoing, these restrictive covenants would improperly deprive the stockholder of property rights without compensation. Specifically, the selling stockholder would be deprived of the right to pursue the occupation of his or her choice. And, Shawe argued, that since the current stockholders are not restricted from competing with TPG or soliciting any of its business or employees once they have left, placing such a restriction on post-ownership opportunities would not maximize stockholder value

The parties identified three cases where the Court considered imposing non-competition restrictions in a judicially ordered sale. In two cases the Court declined to include such restrictions, citing the same concerns raised by Shawe. In the third, a non-competition restriction was put in place to address specific threats by a 50% stockholder made while that stockholder was a member of the board and were viewed as undermining the sales process in order for the stockholder to avoid paying the amount that a fair bidding process would obligate him to pay.

The Court agreed with Shawe that the added restrictions should not be included in the proposed plan. The Court stated:

I agree with Shawe that it would not be appropriate to impose non-competition or non-solicitation restrictions on a selling stockholder as a condition of the sale of [TPG] absent evidence of wrongdoing. It stands to reason that TPG would be worth more to a buyer if Shawe and Elting were subject to post-employment restrictions on their ability to compete or to solicit customers and employees than it would be without those protections, but the purpose of the sale process is to maximize the value of [TPG] as it is and not to derive a hypothetically higher value based on contractual protections [TPG] may not currently possess.

Finally, Ms. Shawe contended that a third-party sale would create “‘a thorny allocation issue’ concerning the derivative claims Shawe previously pressed against Elting, which were dismissed with prejudice in the August 2015 post-trial memorandum opinion.” The Court rejected this objection because while derivative claims are corporate assets that are relevant in determining value, any hypothetical value those claims possess here “can be considered and taken into account by anyone who bids to acquire [TPG] and the incremental value attributable to such claims, if any, would be shared by the stockholders in proportion to their ownership interest in TPG.”.

Conclusion: The Court accepted a modified board auction that allows third-party bidders to participate in the judicially ordered sale of TPG over objections that advocated for a two-tier auction process and valuation concerns. However, the Court refused to impose non-competition and non-solicitation provisions on a selling stockholder because there was no evidence of any wrongdoing.

Chancery Examines Good Faith Corollary to Duty of Loyalty in Short-Form Merger

This post was prepared by Justin Forcier, an associate in the Wilmington office of Eckert Seamans.

The Court of Chancery in the case of In re Chelsea Therapeutics International Ltd. Stockholders Litigation, 2016 WL 3044721 (Del. Ch. May 20, 2016), addressed claims of bad faith in connection with a short-form merger of a developmental biopharmaceutical company (“Chelsea” or the “Company”), which researched and developed a drug called NORTHERATM (“Northera”) to treat rapid blood pressure decreases upon standing, (also known as “NOH”). The Court analyzed a claim of bad faith against an independent and disinterested board, and granted a motion to dismiss.

Background:

Chelsea’s main competitor was given notice that it would have to take Midodrine, a drug used to treat the same condition, off of the market. However, after an outcry by physicians and their patients, the FDA allowed Midodrine to remain in stores pending final approval. Chelsea commissioned a study by L.E.K. to determine other potential revenue streams from Northera. That study found, ‘“without adjusting for risk, Northera’s additional applications could represent $860 million in revenue potential in 2030.”’

Lundbeck, a Danish international pharmaceutical company, offered to purchase the Company at a price of $6.44 per share, with earn-out payments of 30%–60%. In reviewing this offer, Chelsea relied on three different models of potential future revenue. The first model assumed only that Northera would be used to treat NOH. The second model assumed the same thing, but also assumed higher net sales through a Midodrine restriction. The third model adjusted the base price to assume an increased demand following the hypothetical removal of Midodrine.

Chelsea agreed to sell the Company for $6.44 per share, plus up to an additional $1.50 per share if certain sales goals were achieved. Chelsea’s stockholders sued, contending that the deal undervalued the Company by $266-$558 million. Plaintiffs alleged: (1) the board knowingly sold Chelsea for an amount substantially below its standalone value; (2) Chelsea 14D-9 disclosures were deficient because it did not contain the projected revenue model that assumed Midodrine would be taken off the market or the model that assumed Northera would later be used to treat other conditions; (3) the board improperly instructed its financial advisors to disregard the model that assumed Midodrine would be removed from the market; and (4) the Board members, who were also equity holders, were able to recoup their losses on the sale through a change-of-control payment. Defendants moved for summary judgment pursuant to Rule 12(b)(6).

Analysis: The Court first addressed Plaintiffs’ failure-to-disclose claim. This same argument was rejected in Plaintiffs’ motion for preliminary injunction. The Court quoted then-Vice Chancellor Parsons’ bench ruling denying Plaintiffs’ earlier motion.

The Court noted that then-Vice Chancellor Parsons acknowledged that the board considered the no-Midodrine and restricted-Midorine scenarios, but rejected them because they were highly speculative. And since Plaintiffs conceded that they had no new evidence or alternative arguments to put forth other than those that were rejected in their motion for preliminary injunction, the Court granted Defendants’ motion to dismiss for this theory.

Analysis of Bad Faith: Next, the Court evaluated Plaintiffs’ bad-faith claim. First, the Court observed that “Defendants here are exculpated from duty-of-care claims under Section 102(b)(7), and the Plaintiffs have not articulated a claim for breach of the duty of loyalty, beyond the narrow bad-faith claim” of directing the board’s advisors to disregard the no-Midodrine model and to complete the transaction without considering the expanded-use-of-Northera model.

Bad Faith Defined: The Court explained that in order to show bad faith by an independent, disinterested board, “a plaintiff must show either ‘an extreme set of facts’ to establish that ‘disinterested directors were intentionally disregarding their duties’ or that ‘the decision under attack is so far beyond the bounds of reasonable judgment that it seems essentially inexplicable on any ground other than bad faith.”’

Holdings: The Court rejected the change-in-control payment as a basis for bad faith, because Plaintiffs failed to include a well-pled allegation that any change-in-control payment exceeded the alleged undervaluation.

Next, the Court analyzed the claims of bad faith for the board’s failure to consider different models. The Court stated, “that it is not without the bounds of reason—in fact, it is readily explicable—that the Board would decline to use the Projections to value the Company, as they are both highly speculative.” The first model that assumed Midodrine would be taken off the market was not reliable because the Company had previously stated that it had no assurances this would come to pass.

The second model, which assumed Northera would be approved to treat other medical conditions, projected revenue more than 15 years out and did not adjust for the added risk. Furthermore, for second model to have potential applicability, those additional uses would have to be proven in clinical studies and then approved by the FDA.

Finally, the Court stated that since the projections were made public prior to the sale of Chelsea, the sale price is an accurate representation of the actual price. Otherwise, another potential bidder would have recognized the extremely low bid and bid slightly higher. Thus, the Court granted Defendants’ motion to dismiss.

Court Orders Search Terms To Be Selected Early for E-discovery

This post was prepared by Justin Forcier in the Delaware office of Eckert Seamans.

Why this ruling is notable: The Court of Chancery advised the parties in the context of a Motion to Compel (MTC), after discovery had closed, that the parties should agree on search terms for e-discovery at the beginning of the discovery process. Archer VI, LLLP v. Archer on North, LLC et al. v. Archer Properties, C.A. No. 11237-CB, hearing(Transcript)(Del. Ch. May 2, 2016).

Background: Discovery was complete in this case at the time of the oral argument on the MTC, and dispositive motions were due approximately two weeks later. Search protocols for e-discovery were never exchanged between the parties. In their MTC, the defendants sought communications between the Plaintiff (Archer VI) and the third-party defendant (Archer Properties).

Following the defendants’ filing of the MTC, the plaintiffs made three productions. Those productions satisfied most of the issues briefed in the MTC. However, the defendants were still seeking other communications

The Court Provides Advice on the Timing of and Search Terms for e-discovery: First, the court observed the timing of this motion was later than ideal. It was filed after the close of discovery and after depositions had been taken. The court also reminded the parties of their obligation to meet and confer on discovery disputes before bringing them to the court’s attention. The court ordered all communications between the defendants’ principals be produced with no subject matter limitation on either search.

Search Terms: Then, the parties were ordered to develop search terms for internal communications for the management of the property and it was suggested that this should have been done at the outset of the case. The court also declined to take an in-camera review of the missing pages—which had been redacted because of a claim of privilege. Defendants were advised to file a motion if they felt strongly about such a review, if a “meet and confer” was not fruitful.

The court also declined to impose sanctions on the plaintiffs because it observed both sides were partially at fault for the discovery deficiencies.

Finally, pointing out the small amount in controversy ($35,000) and the fact that much more than that amount was likely spent on this discovery issue alone, the parties were ordered to seek leave of the court if they wish to file a motion for summary judgment.

Chancery Imposes Attorneys’ Fees for Bad Faith Litigation

This post was prepared by Justin Forcier, an associate in the Wilmington office of Eckert Seamans.

In James v. National Financial, LLC, C.A. No. 8931-VCL (Del. Ch. June 3, 2016), the Court of Chancery held that the defendant and its counsel are jointly and severally liable for costs and attorneys’ fees of more than $331,000 as a result of bad faith litigation tactics. The Court held in an opinion dated March 16, 2016, that a cash-advance loan was invalid due to its draconian terms and awarded costs and fees. This latest opinion determined the amount of fees and costs for which National and its counsel were jointly and severally liable.

Key Issue: When will the Court award legal fees for bad faith litigation.

Background: Under the terms of the contract, James was advanced $200, but the total repayments after one year added up to $1,820. The March opinion left the parties to propose a fee schedule. After the parties failed to agree, James made her application for fees.

Court’s Reasoning: First, the Court held that James was entitled to an award for all of her costs and fees for the entire litigation pursuant to the Truth in Lending Act (“TILA”). The Court added, however, that “[a]ssuming for the sake of argument that TILA did not authorize the Fee Award to extend beyond the TILA claim, James remains entitled to all of her fees and costs under the bad faith exception to the American Rule.” Reiterating the narrow exception to the American Rule, the Court stated:

[A]n award of fees for bad faith conduct must derive from either the commencement of an action in bad faith or conduct taken during the litigation, and not from conduct that gave rise to the underlying cause of action. Further, the bad faith exception applies only in extraordinary cases, and the party seeking to invoke that exception must demonstrate by clear and convincing evidence that the party from whom fees are sought acted in subjective bad faith. Our courts have not settled on a single definition of bad faith litigation conduct, but have found bad faith where parties have unnecessarily prolonged or delayed litigation, falsified records, or knowingly asserted frivolous claims. Further, we have recognized the bad faith exception where a party is found to have misled the court, altered testimony, or changed position on an issue.

James, 2016 WL 3226434, at* 1–2 (Del. Ch. June 3, 2016) (quoting RBC Capital Mkts., LLC v. Jervis, 129 A.3d 816, 877 (Del. 2015)) (quotation marks, alterations, and footnotes omitted).

National’s bad faith conduct began at the very beginning of the case when it moved to compel arbitration. National knew James opted out of arbitration because it used the opt-out argument to move for dismissal in an action James brought against National in federal court. For this, the Court issued sanctions.

Next, National failed to comply with a discovery order when it turned over a spreadsheet containing loan information that was incomplete and inaccurate. National failed to include all of the loan history information in the spreadsheet as it was required to do.

James then had to move for an emergency temporary restraining order because she alleged the CEO of National appeared at her home and threatened her. Although National contested the factual allegations, it stipulated to the temporary restraining order.

Five months later, National again disregarded a second discovery order by again failing to produce accurate loan information. As a remedy, the Court deemed the disclosed APRs “were incorrect and fell outside of the tolerance permitted by TILA.”

Through a pre-trial conference and trial testimony, it became clear to the Court that National concealed even more evidence during discovery. During discovery, James requested all of the documents that related to her loan. National failed to identify as a source of information an electronic loan management system it used to keep a record of all its loans, including James’s loan. It also failed to produce the requested records from that database. Nor did National ever produce its records of James’s payment history.

Finally, after National’s witness testified about a system used to keep notes on its loans, James specifically requested those notes. National produced a printout. The printout was not marked to indicate that it had been redacted, but it contained occasional odd white spaces. One week before trial, National produced a second printout of the same notes. However, the second printout contained the names of the employees who entered the notes—something that had been secretly redacted on the first printout. The Court observed that the first printout contained other information that was not contained in the second printout and vice versa.

After three separate, inconsistent attempts to explain the second printout, the Court stated that it “was a false record that National submitted with the apparent intention to mislead the tribunal.”

Conclusion: The Court held that James was entitled to the full amount sought. And in light of the seriousness of the misconduct by National and its counsel, the two were held to be jointly and severally liable for the fee award.

 

Another Recent Chancery Opinion Fuels Skepticism About Section 220’s Usefulness

Why this Case is Noteworthy: The Court of Chancery’s opinion in Laborers’ District Council Construction Industry Pension Fund v. Bensoussan, C.A. No. 1123-CB (Del. Ch. June 14, 2016), is the second decision from the Court of Chancery in two months that provides a reasonable basis for skepticism about whether, as a practical matter, plaintiffs’ attorneys should wait for the results of a Section 220 action before filing a plenary derivative suit. This case involves the popular Lululemon brand of athletic apparel, and allegations of insider trading at the company.

Overview: This opinion needs to be viewed in the context of a Chancery opinion issued last month styled In Re Wal-Mart Stores, Inc. Delaware Derivative Litigation, in which the court found that Delaware derivative litigation was barred due to a prior dismissal in another state of a derivative suit that was filed involving similar claims. The plaintiffs in that related litigation in another state, that was dismissed with prejudice, did not use Section 220. In the Wal-Mart case, as in the instant case, the Delaware plaintiffs waited until their Section 220 claims were litigated before filing their plenary action. By that time however, the litigation that was filed earlier in another jurisdiction, and which was not delayed by Section 220 demands, was dismissed. The Court of Chancery in this case found that the additional information that was obtained through the Section 220 action was not a sufficient reason to avoid the principles of issue preclusion, and claim preclusion, that prohibited the Delaware case from proceeding.

Readers should closely review the 40-page decision, but among several highlights include the following:

Procedural Background:

This litigation was preceded by two separate Section 220 actions. In one of those actions, after trial, the court largely rejected the request for books and records under Section 220. In the other Section 220 action that preceded this litigation, the court ordered the production of some documents but still a motion to compel was required because of a dispute about attorney/client privilege. That dispute resulted in a written opinion that was highlighted on these pages here. See In Re Lululemon Athletica Inc. 220 Litigation, Cons. C.A. No. 9039-VCP (Del. Ch. Apr. 30, 2015).

That decision on Section 220 issues was rendered approximately two years after the first Section 220 litigation was filed in Delaware as a prelude to the instant decision in the plenary case. My comments at the above link regarding the Section 220 opinion, and the shortcomings of Section 220 in general, apply here as well.

Key Takeaway:

The court found that simply because the plaintiffs and their counsel in the New York litigation did not first file a 220 action, or wait for a 220 action to conclude, that fact alone did not, ipso facto, make the plaintiffs in that derivative case inadequate representatives for that litigation. See page 32 and footnote 69 – 70 and accompanying text. See also footnote 75 referring to the Delaware Supreme Court opinion in Pyott, highlighted on these pages, which held that not using Section 220 prior to a derivative action does not create an irrebuttable presumption of inadequacy of representation.

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