New Chapter on Advancement and Indemnification of Directors

As we have written on these pages for several years, in my capacity as the Chair of the American Bar Association’s Advancement and Indemnification Subcommittee of the Business Law Section’s Corporate Litigation Committee, yours truly co-authors a chapter each year that highlights the most noteworthy court decisions on advancement and indemnification of directors and officers, as part of an annual publication of the American Bar Association entitled: Recent Developments in Business and Corporate Litigation. The 2017 edition was recently published, and the chapter this year is co-authored by yours truly along with the following litigators who work with me in the Delaware office of Eckert Seamans: Gary Lipkin, Aimee Czachorowski, Justin Forcier and Alexandra Rogin. Even though we do a survey of cases on this topic from around the country, the majority of the decisions have been from Delaware and typically are highlighted on these pages as well.

Thank You Justice Holland

The Honorable Randy Holland retired on March 31 after 30 years as a Justice on the Delaware Supreme Court. He deserves praise and gratitude for this 30 years of service on Delaware’s high court. He was the author of many important corporate law opinions, in addition to authoring many opinions, books and articles on a wide range of other topics. His Honor also has had a leadership position for many years in the American Inns of Court. This short post can’t do justice to the many accomplishments of this exemplary jurist, but the formal announcement of his retirement on the Supreme Court’s website provides an overview of his many accomplishments. A dinner last night at the Hotel duPont featured a distinguished roster of luminaries who sung the praises of Justice Holland. We join in that chorus of praise and wish him all the best in the next chapter of his life. His photo from the court’s website follows.Justice Randy J. Holland Announces Retirement

Chancery Orders Company to Supplement Disclosure Statement in Connection with Proposed Merger Transaction

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

In a recent letter opinion in the case styled Vento v. Curry, C.A. No. 2017-0157-AGB, Chancellor Bouchard granted the plaintiff’s motion to preliminarily enjoin a stockholder vote until information regarding the company’s financial advisor’s interests had been fully disclosed.

Background: Consolidated Communications Holdings, Inc.’s (the “Company”) sought to acquire FairPoint Communications, Inc. (“FairPoint”) through a stock-for-stock merger. Morgan Stanley & Co. LLC (“Morgan Stanley”) served as the lead financial advisor to the Company and provided a fairness opinion in connection with the transaction.  An affiliate of Morgan Stanley, “MSSF,” was to provide $935 million in debt financing for the merger.

Because the merger agreement called for issuance of more than 20% of the Company’s common stock to FairPoint stockholders, as a NADSAQ listed company, the Company’s stockholders were required to vote to approve the proposed transaction.  After learning that a special meeting would be held to consider approving the share issuance, the plaintiff (a Company stockholder) filed a complaint against Company board members alleging that they breached their fiduciary duties by failing to disclose information relating to Morgan Stanley’s conflicts of interest with respect to the proposed transaction.

Although the Court mentioned that the plaintiff waited an inordinate amount of time to file the motion for preliminary injunction, the Court determined that the issue had not been barred by laches, and therefore, the Court considered the merits of the motion.

Parties’ Contentions: Plaintiff asserted that although the Company’s Amended Registration Statement (the “Statement”) provided that Morgan Stanley or its affiliates would receive fees from financing the merger, the Statement failed to disclose details concerning the amount of such expected compensation. The Company argued that it provided enough information in its Statement for the stockholders to adequately quantify the amount.

Court’s Analysis: The Court explained that full disclosure of investment banker compensation and potential conflicts are required under Delaware law. Relying on David P. Simonetti Rollover IRA v. Margolis, 2008 WL 5048692 (Del. Ch. June 27, 2008), the Court determined that resolution of the disclosure claim depended on whether Morgan Stanley’s interest in the transaction was material and, if so, whether that interest was quantifiable.

As an initial matter, that MSSF was a separate entity from Morgan Stanley did not change the analysis. As an affiliate of Morgan Stanley, a potential conflict of interest remained.

In evaluating the disclosure claim, the Court found that information related to the magnitude of the fees to which MSSF was potentially entitled was material. With respect to the adequacy of the disclosure, the Court determined that the “buried facts” doctrine—whether information is “buried” in the proxy materials—was particularly applicable.  In accordance with the buried facts doctrine, because the stockholders would be required to piece together all the information in the 248-page Statement, to then “guess” what the compensation arrangement was, the Court held that disclosure was inadequate.

Ultimately, the Court explained that a stockholder should not have to “go on a scavenger hunt to try to obtain a complete and accurate picture of a financial advisor’s financial interests in a transaction.” The amount of fees MSSF stood to receive from the proposed transaction was both material and quantifiable.  Thus, there was “simply no excuse for [the Company’s] failure to disclose that information in a clear and transparent manner along with related information bearing on its financial advisor’s potential conflict of interest.”

Conclusion: Because disclosure was inadequate, the Court held that the plaintiff satisfied each of the requisite preliminary injunction elements: (1) a reasonable probability of success on the merits; (2) irreparable harm from an uniformed stockholder vote; and (3) that the need for protection outweighed any harm to the Company—a slightly delayed vote—if the Court granted the injunction.

Therefore, the Court preliminarily enjoined the stockholders’ special meeting until five days after the Company had supplemented its disclosures to include a direct explanation of the amount of financing fees Morgan Stanley or its affiliates might receive in connection with the merger.

Delaware Supreme Court Addresses Contractual Fiduciary Standard

Last week the Delaware Supreme Court reversed its prior decision interpreting a master limited partnership agreement that provided what Delaware’s high court described as a contractual fiduciary standard.  The Court’s opinion is necessary reading for anyone who drafts or litigates alternative entity agreements that waive fiduciary duties but provide other contractual replacement standards.  In Brinckerhoff v. Enbridge Energy Company Inc., Del. Supr., No. 273, 2016 (Mar. 20, 2017; revised Mar. 28, 2017), Delaware’s high court was candid enough to describe the contract provisions in this case as “complex,” and the Court’s precedent on the controlling issues as “confusing.” (Four of the five members of the Court on the bench in 2013, the year of the decision reversed in this case, are no longer on the bench.  Next month, no member of the Court sitting in 2013 will still be on the bench.)

Background: There were three prior Chancery decisions involving the master limited partnership agreement (LPA) in this matter, and two prior Delaware Supreme Court rulings.  Some of these decisions, which provide more factual background, were highlighted on these pages: here, here and here. In this fifth Delaware decision in this matter, to be known hereafter as Brinckerhoff V, the Court reversed the Chancery decision which had dismissed a claim by a unitholder in a publicly traded master limited partnership (MLP).  The Court’s opinion included a chart to distinguish the alphabet soup of related entities involved, including the general partner and other entities affiliated with the master limited partnership.  For purposes of this short blog post, the important facts are that the LPA waived all fiduciary duties and substituted a contractually defined standard of conduct.  A unitholder challenged an affiliated transaction that the unitholder claimed was in violation of the contractual substitute standard, in part because it was unfair to the unitholders and favored the general partner.

The MLP in this case was involved in the oil and gas industry and the transaction related to a project for a proposed $1.2 billion pipeline.  Despite declining oil prices and a nearly 20% decrease in projected EBITDA during the intervening period, the partnership paid $200 million more for the rights in the project that it had sold several years earlier. 

Although the Court of Chancery followed the Supreme Court’s pleading standard announced in the Supreme Court’s 2013 decision in this matter, known as Brinckerhoff III, this ruling changed course and reversed the standard announced by the Supreme Court in its 2013 decision in Brinckerhoff III. 

Delaware’s high court acknowledged the confusing precedent in this area, and cited in footnote 1 to no less than ten decisions of the Delaware Supreme Court within the past few years alone, not including the several decisions by the Court of Chancery addressing similar issues, on the topic addressed in this opinion.  See, e.g., Dieckman v. Regency GP LP, Del. Supr., No. 208, 2016 (Jan. 20, 2017), highlighted on these pages. 

Legal Analysis:

In connection with its analysis, the Court noted that in light of the statutory authorization allowing expansive variations on standards of contract, the general principles interpreting such contractual standards need to be nuanced. In this writer’s view, it turns out that attorneys are often not exemplary in their drafting of clearly defined contractual standards of conduct when fiduciary duties are waived.

The high court explained that the Court of Chancery confused the general standard of care in the LPA with more specific requirements in other sections, and observed that the trial court also violated settled rules of contract interpretation requiring that courts prefer specific provisions over more general ones.

Although the general partner was exculpated for actions taken in good faith, good faith was not a defined term in the LPA.  Rather, a general standard of conduct allowed actions to be taken by the general partner if the general partner reasonably believed that its action was in the best interest of, or not inconsistent with, the best interest of the partnership.  The Supreme Court treated this standard as a contractual fiduciary standard similar to the entire fairness standard.

In explaining the reversal of its decision in the 2013 Brinckerhoff III decision, the Court in this opinion announced the following pleading standard:  In order to plead a claim that the general partner did not act in good faith, the facts must support an inference that the general partner did not reasonably believe that the [challenged] transaction was in the best interest of the partnership.  Importantly, the Court emphasized that:  “as our prior cases established, the use of the qualifier ‘reasonably’ imposed an objective standard of good faith.”  See footnote 63 (citing the cases referring to a subjective good faith standard where the LPA at issue did not require a “reasonable” belief).

The Court provided seven specific reasons why the claims challenging the transaction at issue in this matter were sufficient at the pleading stage.  The Court also explained why a claim that the fairness opinion used should not be entitled to a conclusive presumption of good faith, also satisfied pleading standards.  For example, the Court found that the “financial terms were fully baked” by the time the author of the fairness opinion appeared on the scene. 

Equitable Remedies:

An important principle reiterated in this opinion was that even if the LPA exculpated a general partner from monetary damages based on good faith behavior, that language did not insulate the general partner from equitable remedies for breaches of the contract.  A key ruling in this matter was that based on what the Court regarded as a “contractual fiduciary standard similar if not identical to entire fairness,” the general partner was subject to equitable remedies if the trial court, after remand, found contractual violations even if such actions were take in good faith.

Supreme Court Defines “Commercially Reasonable Efforts”

The Delaware Supreme Court recently analyzed, for the first time, a common contractual standard in business agreements.  The legal meaning of the phrase “commercially reasonable efforts” does not enjoy clarity in the law. Lawyers and jurists alike should be excused if they view the law on this topic as not entirely self-evident.  The split decision of the Delaware Supreme Court in the case styled The Williams Companies, Inc. v. Energy Transfer Equity, L.P., Del. Supr., No. 330, 2016 (Mar. 23, 2017), proves the point. The Delaware high court decision in this matter featured a vigorous dissent from the Chief Justice in opposition to the majority’s affirmance of the Court of Chancery’s decision. The majority opinion was based on different reasoning than the trial court applied.

The background facts were included in the Court of Chancery’s opinion in this matter that was highlighted on these pages previously. The foregoing hyperlink also features links to scholarly commentary on this topic by the esteemed Professor Stephen Bainbridge. (The dissent of the Chief Justice will not be covered in this modest blog post, although those interested in this topic may want to read it, because it may provide ideas for opposing arguments on the topic, and in the future when a new majority exists on the Delaware Supreme Court, perhaps the reasoning in the dissent will garner a majority of votes.)

For now, the majority’s restatement of the latest Delaware law in connection with interpreting the meaning of the phrase “commercially reasonable efforts” includes the following important principles.  

Important Legal Principles Explaining the Legal Meaning of “Commercially Reasonable Efforts”:

Although the Delaware Supreme Court affirmed the post-trial opinion of the Court of Chancery, based on different reasoning, Delaware’s high court explained three errors in the Chancery decision, and in doing so the Supreme Court elucidated the correct principles of law applicable to an understanding of the phrase “commercially reasonable efforts.”

First, the Supreme Court explained that the Court of Chancery took an “unduly narrow view” of the decision in Hexion Specialty Chemicals, Inc. v. Huntsman Corp., 965 A.2d 715 (Del. Ch. 2008).  The Delaware Supreme Court emphasized in this opinion that it agreed with Chancery’s Hexion decision, which was highlighted on these pages. The Supreme Court quoted extensively from the Hexion opinion, and described that the buyer in the Hexion case required financing to complete a transaction.  The Court of Chancery in Hexion held that the agreement required action to the extent that such action was “both commercially reasonable and advisable to enhance the likelihood of consummation of the financing . . ..”  (Hexion, 965 A.2d at 749.) The Supreme Court in Williams quoted with approval the reasoning in the Hexion case even though the Hexion case involved a standard of “reasonable best efforts”–and not commercially reasonable efforts. See footnote 16 and accompanying text in the Williams decision for related analysis.

The Supreme Court in Williams also observed that in the Hexion case, after the buyer developed a more substantial concern about the solvency of a combined entity after the deal closed, the buyer “was then clearly obligated to approach the seller’s management to discuss the appropriate course to take to mitigate the solvency concerns.” Instead, the buyer in Hexion chose not to approach the seller’s management, and the court in Hexion reasoned that such a “choice alone would be sufficient to find that the buyer had knowingly and intentionally breached its covenants under the merger agreement.”  Hexion, 965 A.2d at 750.

The second error that the Supreme Court determined that the Court of Chancery made in the Williams case was the trial court’s focus on the absence of any evidence to show that Energy Transfer Equity, L.P. (ETE) caused the law firm to withhold the opinion that was a condition precedent to closing.  This is so, explained the Supreme Court, because there was evidence recognized by the Court of Chancery from which it “could have concluded that ETE did breach its covenants,” including evidence that ETE did not direct the law firm to engage more fully with counsel for the opposing party in the transaction in an attempt to negotiate any issues.

The third error the Supreme Court found with the Chancery opinion involved shifting of the burden of proof.  The Supreme Court in Williams ruled that “once a breach of a covenant is established, the burden is on the breaching party to show that the breach did not materially contribute to the failure of a transaction.”  See footnote 54. (Of course, one might note that an adjudication that a party was in breach is not usually made until after trial).  Moreover, the Supreme Court emphasized that a plaintiff “has no obligation to show what steps the breaching party could have taken to consummate the transaction.”

Nonetheless, the Supreme Court affirmed the decision of the Court of Chancery (just barely), because the end result in its post-trial opinion would have been the same even if the Court of Chancery applied the proper burden of proof – – in light of a footnote in the Chancery opinion noting that Williams did not present sufficient facts at trial to prevail even if the burden of proof were correctly applied.

Bottom Line: If you have a case that involves an issue of the meaning or application of the phrase “commercially reasonable efforts,” your first step is to read this opinion.  The next step is to determine how the facts of your case compare to the facts in this decision.

SUPPLEMENT: Scholarly commentary on this decision and the topic of “commercially reasonable efforts” in general, is provided by friend of the blog, Professor Stephen Bainbridge, whose scholarship is often cited in Delaware court opinions.

Chancery Applies Fitracks Procedures to Challenged Advancement Award

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

Last month, in a comprehensive advancement decision captioned White v. Curo Texas Holdings, LLC, C.A. No. 12369-VCL (Del. Ch. Feb. 21, 2017), the Delaware Court of Chancery applied what has become known in Delaware as the “Fitracks Procedures” to determine the appropriate amount of an advancement award when the exact amount of fees for covered and uncovered claims is unclear.  In the decision, the Vice Chancellor touches on apportionment of expenses and discourages parties from making premature objections to the details of advancement during the summary stage of the proceedings.  This ruling provides practical guidance on a frequent topic of Delaware corporate litigation.

Background: The plaintiffs sued to enforce advancement rights stemming from a contractual agreement with the defendant company (“Curo”).  In a prior ruling, the Court denied Curo’s motion to dismiss and granted summary judgment in the plaintiffs’ favor.  The Court held that the plaintiffs were entitled to advancement, and the Vice Chancellor directed the parties to determine the appropriate advancement amounts pursuant to Danenberg v. Fitracks, Inc. (the “Fitracks Procedures”).  The Fitracks Procedures have been previously outlined in detail on these pages here and here.

The Fitracks Procedures: Under the Fitracks Procedures, senior Delaware counsel for the party seeking advancement should oversee the preparation of a detailed submission and personally certify the correctness of the amount of the advancement request.  The submission must meet specific requirements related to its contents and timing.  Senior Delaware counsel for the opposing party may then oversee preparation of an analogous submission, objecting to the amounts requested, and including a personal certification detailing the reasons why the amounts sought are not advanceable.

Parties’ Contentions: The parties followed the Fitracks Procedures, and the plaintiffs provided the requisite submissions and certifications in support of a total advancement award of $5,121,651.73.  In response, Curo argued that 83% of the amounts sought were not subject to advancement.  Accordingly, Curo only paid the undisputed 17%, even though the Fitracks Procedures require a minimum payment of 50%, with the excess to be held in escrow pending a final disposition.  After reviewing Curo’s objections, the plaintiffs agreed to produce additional invoices and to reduce their demand by approximately $8,500 to account for clerical errors.  The plaintiffs then moved to recover the remaining amounts, plus interest.

Court’s Analysis: The Court largely granted the plaintiffs’ motion.  The Court also cautioned that Curo’s “serial and multitudinous” objections could substantiate a finding of bad faith, such that Curo should bear 100% of the enforcement expenses.

In making its ruling, the Court reiterated the well-established principle of Delaware law that the party seeking advancement “bears the burden of justifying” the amounts sought.  Citadel Hldg. Corp. v. Roven, 603 A.2d 818, 823-24 (Del. 1992).  With that principle in mind, the Court employed the Fitracks Procedures and factors set forth by the Delaware Rules of Professional Conduct to determine the amount of a reasonable and appropriate advancement award.

The Court advised that a detailed, granular review of fees is not warranted at the advancement stage. Thus, counsel should defer “fights about details” to the final indemnification proceeding.  The Court will not “perform the task of playground monitor” at this summary stage of the proceedings to parse through bills for fees and review each line item of costs.

Despite these guidelines, Curo advanced voluminous objections to the plaintiffs’ submissions. The Court found that contrary to the teachings of Delaware precedent, Curo sought to litigate the particular details of individual expenses – without merit.  The Court determined that the plaintiffs’ billing entries provided adequate detail, and because advancement is not the proper stage for comprehensive review of fees, the certification from responsible Delaware counsel was sufficient.  Additionally, because there was no credible evidence of “clear abuse” in the filings, the plaintiffs had satisfied the Fitracks Procedures.

The Court further determined that although Curo was correct that some fees sought may fall outside the scope of advancement, the majority of Curo’s objections regarding scope were without merit. For example, while a question remained as to which claims out of the multiple underlying actions were advanceable, it was premature for the Court to undertake the burdensome task of apportioning those fees at the current juncture.

The Court cited prior precedent that addresses these situations where some claims in a case are subject to advancement, but others are not: “In actions where only certain claims are advanceable, the Court generally will not determine at the advancement stage whether fee requests relate to covered claims or excluded claims, unless such discerning review can be done realistically without significant burden on the Court.”  Holley v. Nipro Diagnostics, Inc., 2015 WL 4880418, at *1 (Del. Ch. Aug. 14, 2015).  Because the fees could not be apportioned with rough precision (with one small limited exception), the Court determined that the fees should be advanced in whole.  Moreover, as there was no clear demarcation between covered and non-covered claims, the Court was required to err on the side of advancement.

The Court also rejected Curo’s interpretation of the parties’ advancement agreement, finding that in reading the parties contractual obligations as a whole, there existed no cap on the amount of awardable expenses.  Even if a cap provision applied, the decision to extend advancement rights is not dependent on the amount of ultimate potential liability; rather, “the advancement decision is essentially simply a decision to advance credit.”  Advanced Mining Sys., Inc. v. Fricke, 623 A.2d 82, 84 (Del. Ch. 1992).

Fees on Fees: Finally, the Court determined that the plaintiffs were entitled to “fees on fees” for their success on the merits in seeking to enforce their advancement rights.  The amount of such an award should be reasonably proportionate to the level of success achieved.  Therefore, the Court ordered the parties to determine the amount of advancement that should be awarded in accordance with its ruling, and to use that amount to compute the percentage of the enforcement expenses to which the plaintiffs were also entitled.  Additionally, while the Court reserved an ultimate decision as to bad faith, the Court warned that a strong argument could be made that Curo should be forced to bear 100% of the plaintiffs’ costs for its extensive challenges to the plaintiffs’ motion.

Conclusion: In accordance with the Fitracks Procedures, the Court ordered Curo to advance reasonable expenses, attorneys’ fees, interest, and fees on fees to the plaintiffs.  Curo was admonished for its inappropriate objections at the summary stage of the advancement proceedings.

Court Rejects Post-Closing Adjustment Claim

The Court of Chancery recently explained in a post-trial opinion why a post-closing adjustment claim seeking a milestone payment was rejected in light of a careful examination of the meaning of an ambiguous term in the milestone trigger provision. This opinion is helpful for those who want insights into how a Delaware court applies contract interpretation principles to extrinsic evidence to determine the meaning of a disputed term in a post-closing earn-out dispute. Shareholder Representative Services, LLC v. Gilead Sciences, Inc., C.A. No. 10537-CB (Del. Ch. Mar. 15, 2017).

Basic Background: The background facts of this case involve a merger of two pharmaceutical companies. Calistoga Pharmaceuticals, Inc. was purchased by Gilead Sciences, Inc. in 2011 pursuant to a merger agreement which included milestone payments based on certain triggers.  After considering the evidence presented at trial, the court held that Gilead is not required to pay a $50 million milestone payment under the terms of the merger agreement.  The court provided an extensive discussion of esoteric medical and pharmaceutical terms, and aspects of FDA approval for products that either ameliorate or cure a particular disease.

The core dispute in this case according to the court: “boils down to the meaning of essentially one word – – ‘indication’ – – as used in an 84-page merger agreement.”  The court explained in its 80-page opinion why Gilead’s interpretation of that word prevailed.

Key Principles and Takeaways:

In order to determine the correct meaning of the word in dispute, and the parties’ intent pursuant to the agreement, the court considered extrinsic evidence such as draft merger agreements, emails among the negotiators on opposite sides of the negotiating table, and emails among colleagues for each party, both before and after the closing, which provided an insight into how each party viewed the meaning of the disputed term.

The court includes a recitation of basic contract interpretation principles such as a reminder that Delaware follows the objective theory of contracts. Also useful to commercial litigation practitioners is the court’s discussion of what type of extrinsic evidence is allowed when provisions in an agreement are deemed ambiguous. See slip op. at 43-45.

Especially notable is a contract interpretation principle of Delaware law that is not commonly known, explained by the court as follows: There is no need for a party to convince the court that “its position is supported by every provision or collection of words in the agreement.” See footnote 175.

Although it did not play a role in its decision, the court observed that the phrase “commercially reasonable efforts” was defined in the agreement. Few Delaware opinions have authoritatively discussed commercially reasonable efforts, as explained in a Delaware decision that was highlighted on these pages.

The court explained that “in considering extrinsic evidence, the court should uphold, to the extent possible, the reasonable shared expectations of the parties at the time of contracting. In giving effect to the parties’ intentions, it is generally accepted that the parties’ conduct before any controversy has arisen is given ‘great weight’”

In addition, the court emphasized that “ascertaining the shared intent of the parties does not mandate slavish adherence to every principle of contract interpretation.” Instead, the following instruction was provided: “Contract principles that guide the court – – such as the tenet that all provisions of an agreement should be given meaning – – do not necessarily drive the outcome.  Sometimes apparently conflicting provisions can be reconciled . . ..”

Practical Guidance in Opinion:

The burden of proof that must be satisfied at trial was described, see slip op. at 42, and the decision provides practical guidance for litigators to the extent that it discusses the type of extrinsic evidence that the court found persuasive for purposes of determining the intent of the parties in their use of one word in this case that would have triggered a milestone payment.  The court observed that both parties used the word “indication” as synonymous for “disease” during their negotiations.  An interpretation of the word “indication” was the determining factor in the case.  The court described and relied on emails between the key executives for each side exchanged during the negotiations, as well as emails among executives for each party after the closing took place.

Anecdotally, I often make the observation that any merger agreement or agreement for the sale of companies that includes a post-closing adjustment or other milestone payment will almost invariably lead to litigation. This decision is good evidence supporting that anecdotal observation.  Those litigating such a case will find this opinion a helpful guide for how the court approaches these issues in a post-closing adjustment dispute.

Chancery Enforces Key Litigation Rules

Why this ruling is noteworthy: All those who litigate in the Delaware Court of Chancery need to read an important opinion issued yesterday that enforces key litigation rules by way of granting a motion to compel discovery replies. The court, in the case styled In Re Oxbow Carbon LLC Unitholder Litigation, Consol. C.A. No 12447-VCL (Del. Ch. March 13, 2017), deemed waived a multitude of “non-substantive, generic” objections made to providing discovery responses, based on the deficiencies the court found in those objections. Although prior rulings of the court have similarly enforced the same discovery standards, see, e.g., recent case highlighted here, and synopsis of earlier decision here, this opinion provides comprehensive and formal additional guidance regarding the doctrinal underpinnings of the court’s conclusions and the reasons for striking the objections, with copious citations to Delaware case law and scholarly articles. The opinion includes reference to federal cases and commentary that are instructive because the Chancery Rules of Procedure are based on the federal rules of civil procedure.

Bottom line: This decision provides clear “step by step” instructions for litigators who want to avoid waiver of objections to discovery requests, and waiver of claims of privilege and work product. Nonetheless, as an anecdotal observation, it remains less than unequivocally certain that all members of the Delaware judiciary will strictly enforce the standards explained in this opinion–with the same vigor or rigor as applied in this decision–even though the same rules involved in this case and the same cited authority are applicable in other trial courts in Delaware. I’m also willing to bet that a large percentage of practitioners do not follow religiously the standards enforced in this decision–and are never challenged via a motion to compel.

Key principles/takeaways from this decision:

  • Chancery Court Rule 26(b)(1) is the starting point for an analysis about what is “discoverable”. The “spirit of Rule 26(b) calls for all relevant information, however remote, to be brought out for inspection not only by the opposing party but also for the benefit of the Court….”
  • When a party objects to discovery, “the burden is on the objecting party to show why and in what way the information requested is privileged or otherwise improperly requested.”
  • Once the requesting party provides “some minimal” justification for the request, the burden shifts to the responding party to demonstrate why discovery should be limited or foreclosed. See footnote 2 for cases cited.
  • Three requirements for a valid objection to discovery requests: (i) The objection must be specific; (ii) it must explain why it applies on the facts of the case to the request being made; (iii) if a party is providing information subject to the objection, the party must articulate how it is applying the objection to limit the information it is providing. Moreover, objections must be “plain enough and specific enough so that the Court can understand in what way the discovery is claimed to be objectionable.” (citing Van de Walle, 1984 WL 8270, at *2.)
  • Each of the challenged objections was reviewed, and “generic, non-substantive objections” such as assertions that the requests were “overly broad”, excessive or “unduly burdensome” or not relevant, were overruled. Rather, in order for such objections to be valid, the objecting party needs to “submit affidavits” or “offer evidence” revealing the nature of the burden.
  • Likewise, objections asserting “vague or ambiguous” questions were overruled because “they should have explained in what way the terms were giving them trouble, interpreted the terms in a reasonable and constructive way, and set our in their responses how they were interpreting them.”
  • A bare assertion of privilege will not suffice. Privilege cannot be properly asserted unless a party provides “sufficient facts as to bring the identified and described document within the narrow confines of the privilege.” Separately, privilege in this case was also waived because the facts sought to be discovered were “at issue” in the litigation, and the “truthful resolution of [those facts] requires an examination of the confidential communications.”
  • Work product likewise cannot be protected by invoking “in anticipation of litigation” as a “formulaic set of magic words” without specifying the litigation involved and satisfying the following requirements on a privilege log: 

(a) the date of the communication, (b) the parties to the communication (including their names and corporate positions), (c) the names of the attorneys who were parties to the communication, (d) [a description of] the subject of the communication sufficient to show why the privilege applies, as well as [the issue to which] it pertains…. With regards to this last requirement, the privilege log must show sufficient facts as to bring the identified and described document with the narrow confines of the privilege. Slip op. at 11 (citation omitted).

  • Work product was waived in this case because the log did not satisfy the foregoing requirements. In addition, “routine investigations” are not generally protected by work product.

In sum, many examples recited in this opinion of “non-substantive, generic” objections (that I know are commonly used by many litigators), were overruled as invalid, such as objections based on relevance, and unspecified assertions that the requests were overly broad, overly burdensome, or ambiguous.

SUPPLEMENT: The court issued a supplemental opinion on March 30, 2017 denying the motion for reargument (notwithstanding the attempt by the movant to categorize it as a “request for clarification”).  In re Oxbow Carbon LLC Unitholder Litigation, Consol. C.A. No. 12447-VCL (Del. Ch. March 30, 2017). Although the Memorandum Opinion of five pages is important for an understanding of the foregoing original court opinion, one part of the decision denying the motion for reargument is especially noteworthy: On page 4, the court explained that a privilege was waived for those documents on the privilege log “for which no attorney is identified.” 

The court also was not persuaded that one might discern that an attorney was involved if one “dug into the documents that corresponded to the entries on the log.”  The court explained that it previously considered and rejected that argument.  It added that the requirements for a privilege log are clear and the prior “discovery-obstructing” stances did not allow the movant to receive the benefit of the doubt.  The court also cited to a prior decision on privilege logs and waiver in Klig v. Deloitte, 2010 WL 3489735, at * 3 (Del. Ch. Sept. 7, 2010), highlighted on these pages.

Chancery Determines Rightful LLC Manager and Awards Fees

A recent Delaware Court of Chancery opinion is notable for its post-trial analysis, based on a summary proceeding, of who the rightful manager of an LLC was. The court also shifted attorneys’ fees based on the bad faith exception. Ensing v. Ensing, C.A. No. 12591-VCS (Del. Ch. March 6, 2017)

Background: The introduction to the opinion begins with the idyllic observation of a couple who “made the dream of many a reality: they acquired a picturesque vineyard in Italy and moved there with their two children to operate a winery and boutique hotel on the property.”  The businesses operated indirectly through two Delaware limited liability companies.  The wife was both sole manager and member of one of the entities, and “through that entity, was manager of the other.”  Her husband was neither a member nor a manager of either entity.

Eventually the marriage ended bitterly, after which the husband purported to remove his former wife and appoint himself as manager of the entities. He then engaged in a series of transactions intended to divest his former wife of her interest in the winery and the hotel.  The wife initiated summary proceeding pursuant to 6 Del. C. Sections 18-110 and 18-111 to obtain declarations regarding the rightful owners and the managers of the entities. (DGCL Section 225 is the corporate analog to Section 18-110.)

Key Principles from the Opinion:

One simplistic way to summarize the legal discussion in this opinion is to make the observation that the husband was never properly documented as a manager or a member of the LLCs involved, and his efforts to remove his ex-wife as a manager, and thereafter attempt to transfer assets, were based on fraudulent documentation which, of course, was ineffective.

Section 18-110 of Title 6 of the Delaware Code provides that any member or manager may apply to the Court of Chancery for a determination of the validity of any removal of a manager of a limited liability company and the right of any person to continue as a manager. The ex-wife in this former business venture sought a declaration under Section 18-110 that the following actions taken by her ex-husband were void:  (1) his removal of her as a manager and appointment of himself as a manager; (2) his transfer of 70% interest; and (3) his transfer of voting control.  She won on all three counts.  First, the court rejected summarily the argument that, notwithstanding a clear and unambiguous operating agreement, there was some relevance to the fact that a non-manager provided the “financial impetus behind the acquisition and operation of the vineyard” or that he was a “de facto manager.”

In addition, a tardy attempt to request judicial notice of foreign law under Rule 202(e) of the Delaware Rules of Evidence was unsuccessful in part because the rule was not complied with. The rule requires that a party wishing to rely on foreign law needs to satisfy its burden of proving the substance of the foreign law and providing adequate notice to the opposing party, neither of which was done in this case.

The court also observed that an effort to schedule a meeting was ineffective. Instead of sending a notice of the meeting where the other party was residing, the notice was sent to a registered agent in Delaware, and the other party did not receive the notice prior to the meeting.  Therefore, the actions taken at the meeting, among other reasons, were void as a matter of law for failure to give proper notice of the meeting.

The court shifted fees for two thirds of the fees incurred by the plaintiff based on the bad faith exception to the American Rule. The court found that the defendant engaged in subjective bad faith conduct both prior to and during the litigation.  For example, the court found that frivolous positions were repeatedly advanced and documents were presented and relied on that were not authentic.  Motions to compel discovery were necessary and status quo orders of the court and discovery orders were not complied with on more than one occasion.

Notably, the court referred to what has been described in prior cases as the “pizza principle.” As outlined in connection with prior decisions highlighted on these pages, in essence, the principle provides that if a party challenges the amount of fees awarded to the other side, it will be required to produce its own billing records and fee amounts for purposes of comparison.

Chancery Orders Predictive Coding to Assist E-Discovery Process

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

The Chancery Daily recently reported on the Court’s order in OSI Restaurant Partners, LLC v. United Ohana, LLC, C.A. No. 12353-CB (Del. Ch. Jan. 27, 2017) (Order), requiring the parties to use predictive coding to assist the plaintiff in expeditiously producing responsive documents.

As is often the case, the OSI parties were faced with sorting through voluminous documents during the discovery phase of litigation.  The plaintiff had belatedly produced a large volume of documents without adequately reviewing for relevancy and confidentiality.  As a remedy in connection with the defendant’s motion to compel, the Court ordered use of predictive coding, which the parties had suggested, to ascertain relevancy.

It was apparently relayed to the Court that no party in Delaware had yet used predictive coding, so the parties would be the first to go through the process.  Not so.  However, the parties would need to undergo training and extensive collaboration before making use of this technology.

Contrary to the belief that the use of predictive coding is a rarity in Delaware, at least some firms, including Eckert Seamans, have been using this discovery aid for quite some time.  Indeed, our firm has been using this tool (also called computer or technology assisted review) to help sort through hundreds of thousands of documents with accuracy, in far less time, and resulting in less cost to our clients.  A 2012 decision where Vice Chancellor Laster suggested the use of computer assisted review was covered on this blog here.

Technological advances bring opportunities to better serve our clients.  BNA Bloomberg published an article late last year regarding the benefits of technology assisted review in its Digital Discovery & e-Evidence section here.  As discussed by the article, predictive coding, a new but not unheard of technology, can help attorneys to provide more efficient and quality representation to their clients.

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