Interfacing of DGCL Section 141(e) and the Business Judgment Rule

Professor Stephen Bainbridge, one the nation’s leading corporate law scholars, who is often cited in Delaware opinions, addresses the titular issue in a blog post today, and invites commentary. Specifically, the good professor begins the discussion as follows:

I’m pondering the relationship between the business judgment rule and Section 141(e) of the Delaware General Corporation Law. As I understand it, the business judgment rule is a broader defense than is 141(e). In other words, it is possible for directors to be unable to rely on an expert opinion, thus losing the statutory defense, but still have made a sufficiently informed to get BJR protection. But is the converse true? Imagine a board that was grossly negligent in gather information, but did get expert advice from a properly chosen expert and the board made sufficient inquiry of that expert to satisfy the requirement that they rely in good faith. Would the board be protected by 141(e) even though the business judgment rule would not protect them? Logically, it would seem that the answer must be yes if 141(e) is to have independent role, but the case law I’ve found provides no clear answer. Thoughts?

Chancery Dismisses Claim of Excessive Compensation

thFriedman v. Dolan, C.A. No. 9425-VCN (Del. Ch. June 30, 2015), is a Delaware Court of Chancery decision that should be read by anyone who thinks they should be able to challenge allegedly excessive compensation packages granted to members of a family in a family-controlled company. This ruling granted a motion to dismiss claims related to a quite generous executive compensation package awarded to family members of a family that controlled a publicly traded company. The worth and qualifications of the family members who received the outsized wages were alleged to be have been disproportionate to the amounts they were paid. The court’s reasoning in a 37-page letter ruling was summarized thusly:

compensation decisions are not the expertise of trial judges, and the Court should not second-guess an independent compensation committee’s business decisions that are not irrational. The Court also lacks a principled way to evaluate a director’s decision to accept a position and her performance as a director. Although the amount of compensation and board composition raise some concern, that concern does not justify judicial intervention into that thicket here.

The Court relied on the bedrock Delaware principle that an independent and disinterested compensation committee is entitled to the deference of the business judgment rule. In addition, DGCL section 157(b) supports deference to the board in their valuation of stock options in the absence of fraud.

The Court declined to inquire into the fitness of a director to serve or whether lack of perfect attendance at meetings or less than stellar qualifications were a basis to allow claims to proceed. Predictably, despite the large amount of compensation involved, in part due to evidence of comparable compensation for similarly situated company executives, the claims for waste were also rejected.

Supreme Court Interprets Advance Notice Bylaws

Hill International, Inc. v. Opportunity Partners L.P., , Del. Supr., 305, 2015 (Del. July 2, 2015). This Delaware Supreme Court opinion should be read by anyone interested in the latest iteration of Delaware law on advance notice bylaws. A few bullets points about this decision should help readers decide if they want to read the whole ruling linked above.

  • The original notice of the annual meeting did not provide a precise date; rather, it described the meeting to be held “on or about” June 10.
  • Not until a date certain was made public, were various timetables and deadlines triggered–especially because the actual date certain of June 9 was different than the first date given as “on or about June 10″
  • The Supreme Court based its analysis on contract interpretation principles applied to the applicable provisions of the bylaws, which of course are treated as a contract within the framework of the Delaware General Corporation Law.
  • The procedural posture was an appeal from the Court of Chancery’s grant of a mandatory injunction preventing the company from conducting business at the annual meeting other than adjourning the meeting, which allowed the court to consider more fully the arguments that the company improperly refused to consider nominees for two director positions that the company argued were not timely submitted in accordance with the advance notice bylaws
  • No security was required by the Court of Chancery when the mandatory injunction was imposed and the last footnote of this opinion “dodges” that issue in some respect by finding that the issue was not adequately presented in order for it to be considered on appeal. Nonetheless, in dicta  Delaware’s high court, in a panel decision, observed that, in essence, the Court of Chancery was not in error on that point for reasons explained in the final footnote of the decision.
  • After the June 5 injunction was ordered, based on a complaint and motion for preliminary injunction filed on May 14, the Court of Chancery granted a partial final judgment under Rule 54(b) on June 16, at which time an expedited appeal was filed with the Supreme Court, which held oral argument on July 1. This decision of July 2 affirming the Chancery decision deserves to be exalted as an example of very fast decision making in a formal written opinion, after full briefing, on complicated issues of corporate litigation (by both the Court of Chancery and the Supreme Court.)

Dispute on Advancement of Fees to Corporate Directors; Court Requires Discussion During a Meal

Advancement of fees to corporate directors has been the focus of many decisions of Delaware’s Supreme Court and Court of Chancery that have been highlighted on these pages over the last ten years. Both the statute and the cases that interpret them are often counterintuitive and one of the more vexing aspects of corporate litigation.

The point of this post is to feature a recent Order from the Court of Chancery that presented a novel approach to advancement disputes which one member of the Court referred to as the bane of his existence. Courtesy of The Chancery Daily, a highly respected subscription service that covers every aspect of activity in the Delaware Court of Chancery in an unparalleled manner, we have an Order in the matter of Colaco v. Cavotec Inet US, Inc., C.A. No. 10925-VCL, Order (June 1, 2015), which required counsel to meet and confer over “lunch or dinner” in order to try to resolve any disputes regarding the fees to be advanced. Brilliant idea in my view. That Order also provides for a procedure that the lawyers and parties need to follow to “tee up” and otherwise refine and clarify issues that arise in connection with the amount of fees that are payable.

A major issue that often arises, even when advancement has been ordered, is what fee amounts are payable when work performed may not be easily allocated, for example when some parts of litigation are covered by advancement and some are not.

The Chancery Daily reported today that the Court entered another Order in this case on June 29, 2015, requiring the parties, if they could not agree on the amount of fees to be paid, to follow the procedure outlined in the June 1 Order (including meetings over a meal), and failing that, to submit the dispute over the amount of fees to a Special Master to be suggested by the parties.

In addition to the court rulings that I have outlined on this blog, and the chapter I recently wrote on the topic for a book published by the ABA, last year I presented a PowerPoint on the topic at the American Bar Association’s Business Law Section meeting in Los Angeles, as the Chair of the Indemnification and Advancement Committee.

Supplement: In reply to this post, Kevin LaCroix, author of the highly-regarded and widely-read blog called The D & O Diary, sent me the following anecdote about the value of a “meet and confer over a meal” that a federal judge he clerked for often “ordered” in business disputes before him, which often resulted in a negotiated resolution:

… a lot of things could be worked out if people just talked to each other. I clerked for a federal district court judge after law school, Richard L. Williams in the Eastern District of Virginia, based in Alexandria, Virginia. Whenever he had a business case in his court, he would ask the parties whether the principals had spoken to each other about the case without their lawyers present. Everyone would look stunned and say no. He would then order the principals to go around the corner to Portner’s, a local restaurant, to tell the hostess that they had been sent there by Judge Williams to meet there, and that they required a private room. (The people at Portner’s were very accustomed to this.). The judge would then adjourn the court until after lunch. Nine times out of ten the principals would come back after lunch with big smiles on their faces and with the news that they had managed to settle the case. The lawyers hated it but everyone else, including the principals (and the folks at Portner’s) loved it.

 

Judicial Comportment

For my regular ethics column for The Bencher, the national publication of the American Seal of the United States District Court for the Eastern District of PennsylvaniaInns of Court, I wrote about the recent investiture ceremony for The Honorable Mark Kearney‘s elevation to the bench of the U.S. District Court for the Eastern District of Pennsylvania. The article describes highlights of his exemplary background and how that should serve as a sound basis to suggest an exemplary judicial tenure.

The article does not focus on formal standards of judicial conduct, but is more akin to an anecdotal observation. His Honor was a former law clerk for the Delaware Court of Chancery and practiced corporate litigation in both Delaware and Pennsylvania during his years in private practice.

Supreme Court Addresses Direct v. Derivative Claim in Contractual Context

NAF Holdings, LLC v. Li & Fung (Trading) Limited, Del. Supr., No. 641, 2014 (Del. June 24, 2015). This Delaware Supreme Court decision held that a party has a direct claim to pursue a breach of contract action for a contract to which it is a party in order to enforce its own contractual rights.  The claim does not become a derivative claim simply because there may be a related injury to a corporation as well.

Highlights:

This en banc decision was presented as a question of law certified by the U.S. Court of Appeals for the Second Circuit arising out of an appeal from a decision by the U.S. District Court for the Southern District of New York.  The very lengthy articulation of the issue presented by the Second Circuit was summarized by the Supreme Court as a question of Delaware law answered in the following formulation:  “A promisee-plaintiff may bring a direct suit against a promisor for damages suffered by the plaintiff resulting from the promisor’s breach, notwithstanding that: (i) the third-party beneficiary of the contract is a corporation in which the promisee-plaintiff owns stock; and (ii) the promisee-plaintiff’s loss derives indirectly from the loss suffered by the third-party beneficiary corporation.”

The Supreme Court determined to be inapplicable the decision in Tooley v. Donaldson, Lufkin & Jenrette, 845 A.2d 1031, 1039 (Del. 2004), which the District Court for the Southern District of New York misapplied, according to the Supreme Court.  Some of the nuggets from the decision of the Delaware Supreme Court include the following:

●          “A party to a commercial contract may sue to enforce its contractual rights directly, without proceeding by way of a derivative action.  Tooley and progeny do not, and were never intended to, subject commercial contract actions to a derivative suit requirement.”

●          An important initial question for these issues is:  “Does the plaintiff seek to bring a claim belonging to her personally or one belonging to the corporation itself?”

●          The District Court for the Southern District of New York misconstrued Delaware law and applied Tooley in a “decontextualized manner.”

●          The opinion is replete with citations to cases that support the important principle in Delaware law of freedom of contract, and the fundamental principle of contract law that parties to a contract bound by its terms have a corresponding right to enforce them.  The court also added that Delaware law “seeks to promote reliable and efficient corporate laws in order to facilitate commerce.”  See generally State v. Tabasso Homes, Inc., 28 A.2d 248, 252 (Del. Gen. Sess. 1942) (“. . . the right to contract is one of the great, inalienable rights accorded to every free citizen . . ..”)

●          The Supreme Court concluded its opinion by clarifying its holding as follows:  “. . . a suit by a party to a commercial contract to enforce its own contractual rights is not a derivative action under Delaware law.”

Delaware Insiders Give Insights on Delaware’s New Fee-Shifting Legislation

An insider’s view of the recent Delaware legislation banning fee-shifting bylaws is provided by Professor Lawrence Hamermesh and Norman Monhait as published in this post from the Institute of Delaware Corporate and Business Law. This is must reading for anyone who seeks to understand the nuances of this new legislation. In sum, the good professor co-authors the article with one of deans of the corporate litigation bar in Delaware, both of whom played a lead role in drafting the fee-shifting legislation that was just signed by the governor. They explain why this new law does not address the issue of fee-shifting bylaws in the context of claims based on the federal securities laws.

About the authors: Mr. Monhait is the immediate past chair, and Professor Hamermesh a prior chair and a member, of the Council of the Delaware State Bar Association’s Corporation Law Section. The Council each year proposes legislation to update the Delaware corporate and related statutes, including the recently passed fee-shifting and forum selection bills. The views expressed here, however, are solely those of the authors, and do not necessarily represent the views of the Association, the Section, or its Council.

Supplement: Professor Stephen Bainbridge has written an article which takes the position that Delaware made a mistake in passing the legislation described above.

New Law Signed to Limit Fee-Shifting and Enforce Delaware Forum Selection

The Delaware Governor today signed legislation discussed on these pages previously, that: (i) limits the ability to provide, in bylaws or a corporate charter, for the imposition of fee-shifting on plaintiffs who sue corporations or their directors/officers; and (ii) validates the selection of Delaware as a forum for litigation involving internal affairs, and prevents the selection of any other forum exclusively. That is, Delaware must also be allowed as a forum even if another forum is also selected. The synopsis of the Senate Bill provided by the Delaware General Assembly has a thorough summary of the legislation.

Chancery Addresses Conflicting Representation of Director by Counsel for Adverse Party


Partners Healthcare Solutions Holdings, L.P. v. Universal American Corp., C.A. No. 9593-VCG (Del. Ch. June 17, 2015). This Delaware Chancery decision provides useful guidance on a situation involving a director who was designated by a major stockholder pursuant to an agreement giving that stockholder the right, but not the obligation, to appoint an independent director.

An issue arose because the major stockholder became adverse to the company in litigation and the company did not want to seat the director designated by that major stockholder unless the director would first agree not to be represented by the same law firm that was adverse to the company in pending litigation, and sign a confidentiality agreeement.  After this suit was filed, the parties settled the specific performance claim which attempted to enforce the terms of the designation agreement.  That partial settlement required the law firms to create an ethical wall to prevent the attorneys representing the stockholder in the litigation against the company from being the same attorneys who represented or provided advice to the director.  (Referring to a George Orwell book, the court suggested that this was an obvious solution to this corporate litigation that started as a Section 225 action.)

The court granted summary judgment to the company on the separate related claim for damages and attorneys’ fees related to the attempt to specifically enforce the director designation agreement–prior to the partial settlement.

See generally J. Travis Laster and John Mark Zeberkiewicz, The Rights and Duties of Blockholder Directors, 70 Bus. Law. 33 (Winter 2014/2015) (addressing issues regarding directors appointed by particular class or series of stock, referred to as “blockholder directors.”)

Bonus: Although this was not a Section 220 case, a useful discussion was included based on an old Chancery decision that prohibited a designated agent for purposes of a Section 220 inspection to review documents when that agent already was adverse to the corporation in pending litigation.  See Henshaw v. American Cement Corp., 252 A.2d 125 (Del. Ch. 1969).

Supreme Court Rejects Malicious Prosecution/Fee-Shifting Claim

Blue Hen Mechanical, Inc. v. Christian Brothers Risk Pooling Trust, Del. Supr., No. 589, 2014 (Del. June 15, 2015). This Delaware Supreme Court opinion has practical application for corporate litigators and civil litigators generally, due to the manner in which it addresses: (i) how to deal with suits filed allegedly in bad faith; and (ii) how to deal with a suit that may have been filed in good faith, but is conducted or continued in bad faith. Some highlights:Little Sisters of the Poor

  • Delaware’s high court rejected an effort to expand Delaware law to allow for malicious prosecution claims to extend beyond the current law that (apparently unlike PA and the Restatement (Second) of Torts) bars such a claim if a good faith basis existed when suit was filed.
  • The court relied on existing law that allows for fee-shifting if litigation is conducted in bad faith (even if there was a good faith basis for the suit being filed initially). For example, at footnote 42, the court refers to Super. Ct. Civ. R. 37(b) as providing a default so that a prevailing party who seeks a motion to compel “is entitled to its fees and costs in securing that order….” But one reading of that rule would suggest a different result: that fees only become mandatory when a prior order granting a motion to compel is violated–although at least one other recent decision has read the rule the same way as Delaware’s high court in this case. But cf. prior Chancery ruling declining to grant fees after second motion to compel.
  • This case involved a separate suit for malicious prosecution instead of the self-described aggrieved party seeking fees when the prior suit complained of was finalized, as part of that same concluded suit. The court’s reasoning is eminently quotable: “Put simply, we see no empty compartment in the tool box that trial judges have to address bad faith litigation conduct that would be filled by usefully extending the malicious prosecution tort.”
  • The court provides public policy commentary about fee-shifting in general and comparisons of the American Rule and the English Rule on fee-shifting, as well as the impact of those two different rules on “the poor”, and access to the courts for redressing grievances. See, e.g., footnote 46.
  • This case was based originally on a breach of contract claim relating to a large air conditioning unit at a nonprofit nursing home called the Jeanne Jugan Residence located in Newark, Delaware, run by a group of Catholic nuns called the Little Sisters of Poor. FULL DISCLOSURE: my youngest brother is a Catholic priest for the Diocese of Wilmington and he is the Chaplain for the Little Sisters of the Poor. I have no involvement in this case. (The photo above shows one of the nuns in one of the nursing homes around the world that they run.)