Mere Act of Forming Delaware Entity Not Basis for Personal Jurisdiction

A recent decision from the Delaware Court of Chancery provides practical insights into the requirements for imposing personal jurisdiction in Delaware over non-residents involved in the formation of a Delaware entity. The act of forming a Delaware entity only, without more, is not sufficient to impose personal jurisdiction in Delaware over a non-resident involved in the formation.

The case of Baier v. Upper New York Investment Company LLC, C.A. No. 6896-VCS (Del. Ch. April 16, 2018), involves lengthy litigation among siblings over the division of the inheritance from their parents’ estate.  The estate involved assets in many foreign countries and some of those assets were titled in Delaware entities.  A prior decision addressed more detailed factual background in the matter, in an opinion styled: de Adler v. Upper New York Inv. Co. LLC, 2013 WL 5874645 (Del. Ch. Oct. 31, 2013).

Mere Formation Not Enough:

The most noteworthy statement of law in this case with the most widespread application to corporate and commercial litigators (although not a new statement of the law), is the court’s ruling that the “mere formation of a Delaware entity, without more, is insufficient for this Court to exercise jurisdiction. Rather, the act of formation must be ‘an integral component of the total transaction to which [the] cause of action relates.’” See footnotes 88 to 92.

Single-Act Long-Arm Statute:

The court refers to Delaware’s long-arm statute, at Section 3104(c)(1) of Title 10 of the Delaware Code as a “single act” statute. This requires that the non-resident defendant’s act of transacting business in Delaware must have a nexus to the claim against that non-resident defendant.

Also notable was the court’s description of the slightly different standard that applies when a motion to dismiss based on personal jurisdiction is analyzed prior to any jurisdictional discovery–in which case only a prima facie showing is necessary.  Once, however, jurisdictional discovery is completed, one must allege specific facts to support personal jurisdiction. See footnotes 76 and 77.  The court then discussed the familiar two-step personal jurisdictional analysis where the court first assesses whether there is a statutory basis for personal jurisdiction, and then, secondly, determines whether its exercise of personal jurisdiction over a non-resident defendant is consistent with the Due Process Clause of the Fourteenth Amendment to the United States Constitution. See footnotes 81 and 82.

Jurisdiction over Managers of LLC:

The court also discussed the concept of when a manager of an LLC is subject to personal jurisdiction under Section 18-109 of the Delaware LLC Act. See page 26.

Latches:

Latches as an equitable defense was also discussed in connection with the general rule that due to the factual nature of the requisite analysis of the applicability of latches, a ruling on that argument is generally not suitable for a motion to dismiss–but this case was an exception to that rule. See pages 28 and 29.  Thus, laches was a separate basis to dismiss the claims even if personal jurisdiction were appropriate.

Law of the Case

The court also discussed the “law of the case” doctrine, which equally applies to decisions of courts from other countries involving the same issues between the same parties, in which case the principle of comity also militates against re-litigation of issues previously decided.

Delaware Choice-of-Law Provision Upheld

Delaware case law is replete with decisions upholding provisions in contracts that choose Delaware as the governing law for any disputes related to an agreement. A recent Delaware decision adds to the large body of Delaware jurisprudence on this topic. See, e.g., selected decisions on choice-of-law enforceability from the Delaware Supreme Court and Delaware Court of Chancery, highlighted on these pages over the last decade or so. Similar reasoning has been applied by the Delaware courts to uphold forum selection clauses requiring that suits relating to a contract be filed exclusively in state or federal courts located in Delaware. See, e.g., selected cases on forum selection clauses highlighted on these pages over the last ten years-plus, including reference to a recent update of Delaware statutes validating such provisions in corporate bylaws. These two related topics are of widespread applicability that extend beyond the corporate and commercial litigation fare, and legal ethics topics, typically covered on this blog.

The recent decision in Change Capital Partners Fund I, LLC v. Volt Electrical Systems, LLC, et al., C.A. No. N17C-05-290-RRC (Del. Super. April 3, 2018), by the Delaware Superior Court (Delaware’s trial court of general jurisdiction that does not hear the equitable claims filed in Chancery), provides an excellent overview of the doctrinal underpinning for the longstanding position of the Delaware courts that choice-of-law provisions in agreements are generally enforceable.

The agreement involved was for the purchase of accounts receivable. The unsuccessful argument made was that either New York or Texas law should apply, despite the choice-of-law provision selecting Delaware as the governing law, because (i) either of those states would be the “default state” in the absence of a choice-of-law provision; (ii) enforcement of the agreement would be contrary to the public policy of either Texas or New York; and (iii) both New York or Texas have a materially greater interest in the determination of the issues between the parties to the agreement.

Delaware’s Public Policy Upholding Freedom of Contract

Part of the court’s introductory summary of its conclusion provides a preview of the more detailed reasoning that the scholarly decision provides: “Delaware courts are generally reluctant to subvert parties’ agreed-upon choice-of-law provisions.” In the context of a motion to dismiss, this opinion provides many eminently quotable statements of Delaware law that are perfectly suitable for use in future briefs. For example, the court started with the basic public policy of Delaware regarding contracts in general, separate from the choice-of-law issue:

Delaware courts are ‘strongly inclined’ to respect the widely recognized and fundamental principles of freedom of contract. This Court will not interfere unless ‘upon a strong showing that dishonoring the contract is required to vindicate a public policy interest even stronger than freedom of contract.’ With very limited exceptions, Delaware courts will enforce the contractual scheme that the parties have arrived at through their own self-ordering, both in recognition of a right to self-order and to promote certainty of obligations and benefits. Upholding freedom of contract is a fundamental policy of this State. (internal footnotes omitted)

Delaware Choice-of-Law Policy and the Exception in Restatement (Second) of Conflicts, Section 187(2)(b)

It remains well-settled that:

Delaware courts will honor a contractually-designed choice-of-law provision so long as the jurisdiction selected bears some material relationship to the transaction. The existence of a choice-of-law clause establishes a material relationship between the chosen state and the transaction. Title 6, section 2708(a) of the Delaware Code recognizes that a choice-of-law clause is a significant, material and reasonable relationship with this State and shall be enforced whether or not there are other relationships with this State (citing Oak Private Equity Venture Capital Ltd. v. Twitter, Inc., 2015 WL 7776758, at *9 (Del. Super. Ct. Nov. 20, 2015)).

If an agreement has no choice-of-law provision, Delaware applies the “most significant relationship” test from Section 188 of the Restatement. Where such a provision does exist, however, Section 187(2)(b) of the Restatement provides for exceptions to enforceability, which were the arguments made unsuccessfully as noted at the beginning of this synopsis. Those exceptions may apply if: (i) the “default state’s” law would apply absent a choice-of-law provision; (ii) Delaware law would be contrary to a fundamental public policy of the default state; and (iii) the default state has a materially greater interest in the enforcement of the agreement.

Importantly, a “mere difference between the laws of two states will not necessarily render the enforcement of a cause of action arising in one state contrary to the public policy of another.” (citing Vichi v. Koninklijke Philips Elecs. N.V., 62 A.3d 26, 45 (Del. Ch. 2012)). The Vichi case was highlighted on these pages. The Superior Court distinguished several mostly Chancery decisions involving covenants not to compete, in which the public policy of California and Delaware on that topic is substantially different. See, e.g., EBP Lifestyle Brands Holdings, Inc. v. Boulbain, 2017 WL 3328363, at *7 (Del. Ch. Aug. 4, 2017); Kan-Di-Ki, LLC v. Suer, 2015 WL 4503210, at *18 (Del. Ch. July 22, 2015); Ascension Ins. Holdings, LLC v. Underwood, 2015 WL 356002, at *3 (Del. Ch. Jan. 28, 2015).

Notably, the Superior Court found that New York and Delaware do have different public policy on the topic of usury laws, which were relevant to the agreement at issue in this case. New York has a strong policy against interest rates higher than 25%. See footnote 30. Delaware, by contrast, has no cap on interest rates. See footnote 31 for statutory and case law citations.

But, it is not enough for the public policy of two states simply to be conflicting. In addition, a party seeking to avoid a choice-of-law provision pursuant to Section 187(2)(b) of the Restatement, must demonstrate that the other state has a “materially greater interest in the enforcement or non-enforcement” of the agreement at issue. In this case, the Superior Court found a sufficient connection to Delaware because: (i) one of the parties was a Delaware entity; and (ii) both parties agreed to choose Delaware law to control their agreement.

Delaware Public Policy to Uphold Contracts Generally is Stronger than Public Policy of Other States to Enforce This Particular Agreement Under Other State Law

Several prior Delaware decisions were cited to support the reasoning in this opinion that when the court must choose between the law of other states that arguably may apply, the choice of Delaware law typically prevails. See, e.g., footnotes 40 and 47. For example, in Abry Partners V, L.P. v F & W Acquisition, LLC, 891 A.2d 1032, 1048, n.25 (Del. Ch. 2006), the Court of Chancery needed to choose among different choice-of-law provisions in several interlocking agreements that provided for different state laws to apply, and reasoned that no rational businessperson would intend that the law of multiple jurisdictions would apply to a single controversy having its origin in a contract-based relationship. In Abry, therefore, the agreement calling for Delaware law prevailed.

Additional reasoning to support the conclusion in this Superior Court opinion was based on the recognition that there is an inherent difficulty in avoiding the terms of a contract based on allegedly contrary public policy of another state. In part, this is due to the fundamental, strong Delaware public policy of freedom of contract and the inclination of the Delaware courts to enforce otherwise valid contracts. Stated another way, “Delaware courts regularly express their reluctance to allow avoidance of the contractual choice-of-law provision” and are “strongly inclined to respect [a] parties’ agreement….” See footnotes 36 to 39 and accompanying text.

In sum, this opinion should be included in the toolbox of every litigator who needs to know the latest iteration of Delaware law on the enforceability of choice-of-law provisions selecting Delaware law to govern issues that arise in connection with an agreement.

Supreme Court Clarifies Requirements for Whistleblower Protection

The U.S. Supreme Court’s recent decision in Digital Realty Trust v. Somers, explained that in order for a whistleblower to be protected from retaliation, in some circumstances, the employee must complain directly to the SEC. I provide a summary of the decision in my latest article for the magazine of the National Association of Corporate Directors, called Directorship.

Chancery Addresses Scope of Director Consent Statute and Civil Conspiracy Claims

In the context of cross-claims of fraudulent inducement by parties to a merger, the Court of Chancery discussed several principles of Delaware law that serve as useful references for those involved in corporate and commercial litigation.  The opinion in LVI Group Investments, LLC v. NCM Group Holdings, LLC, C.A. No. 12067-VCG (Del. Ch. Mar. 28, 2018), provides useful iterations of the following principles of Delaware law:

·     The extended scope of the director consent statute which allows for the imposition of personal jurisdiction on officers and directors of Delaware entities even when the claims are not for breach of fiduciary duty.  This opinion amplifies the Delaware Supreme Court’s recent Hazout decision which reversed decades of prior precedent on this topic, highlighted on these pages, interpreting Section 3114 of Title 10 of the Delaware Code.

·     The court also discusses the general rule that a civil conspiracy may not be formed between a director and the corporation that she represents, however, there are exceptions to this rule which are explored in this opinion.  For example, the court noted that it was unaware of any Delaware authority in support of a per se rule that a private equity firm and its principal cannot conspire with a company controlled, but not wholly owned, by them.  The court cited to several decisions addressing this issue including Prairie Capital III, L.P. v. Double E Holding Corp., 132 A.3d 35, 60 (Del. Ch. Nov. 24, 2015), which was highlighted on these pages.  The court also cited Prairie Capital for the principle that a corporate officer can be held personally liable for the torts he commits and cannot hide behind a corporate shield when he is a participant in the tort.

·     The court also considered the extent to which a fraud claim can be pursued in the presence of a non-reliance clause and an integration clause.  The court explained that this was not a bar to claims that representations within the agreement itself were fraudulently made.  See Abry Partners V, L.P. 891 A.2d at 1064 (“To the extent that the stock purchase agreement purports to limit the Seller’s exposure for its own conscious participation in the communication of lies to the Buyer, it is invalid under the public policy of this State.  That is, I find that the public policy of this State will not permit the Seller to insulate itself from the possibility that the sale would be rescinded if the Buyer can show either:  (1) that the Seller knew that the Company’s contractual representations and warranties were false; or (2) that the Seller itself lied to the Buyer about the contractual representations and warranty.”)  See also Prairie Capital III, L.P., 132 A.3d at 61. 

·     The court also explained that equitable fraud claims, also known as negligent misrepresentation claims, require a special relationship, such as a fiduciary relationship, as a prerequisite in order for the scienter requirement of common law fraud to be waived.

Supreme Court Addresses Forum Non Conveniens

A recent Delaware Supreme Court decision should be required reading for anyone involved with a forum non conveniens case in Delaware. Aranda v. Philip Morris USA Inc., Del. Supr., No. 525, 2016 (March 27, 2018), provides an overview of the Delaware law on forum non conveniens and clarified that even if it is a minority view among the 50 states, Delaware only requires that the trial court “consider” whether an alternative forum is available as part of its analysis, but the trial court is not required to find that an alternative forum is available before making its determination whether to dismiss a case based on forum non conveniens.  The court reviewed the three general categories of forum non conveniens cases.  The first type of case under that general category is referred to as:

(1) a first-filed Delaware case with no case pending elsewhere (the Cryo-Maid test);

(2) a second-filed Delaware case with another first-filed case pending elsewhere (the McWane test); and,

(3) a hybrid recently addressed by the Delaware Supreme Court in Gramercy Emerging Markets Fund v. Allied Irish Banks, P.L.C., 173 A.3d 1033 (Del. 2017), which involves a later-filed Delaware case pursued after another jurisdiction had dismissed the first-filed case based on forum non conveniens.  All three of the foregoing types of cases require some application of the forum non conveniens factors.  The difference is the presumptions applied in each category to the applicable factors.  See Slip op. at 11-12.

The court was aware of the competing arguments, and the majority of other states who approached the issue differently. The court also addressed the public policy issue involved.

In sum, Delaware’s high court was satisfied that the trial court did consider the availability of an alternative forum before dismissing the case on forum non conveniens grounds, but it concluded that whether an alternative forum was available is not a deciding factor.  Rather the trial court is only required to consider it as one of many factors.

Delaware Contract Interpretation Principles

Recent decisions of the Delaware courts have provided arguments for considering a broader approach to the more traditional “four corners of the document” view of contract interpretation for so-called unambiguous agreements.  The recent Chancery decision in Plaze, Inc. and Apollo Aerosole Industries LLC v. Callas, C.A. No. 2017-0432-TMR (Del. Ch. Mar. 29, 2018), addresses contract interpretation in the context of post-closing issues arising from Plaze’s purchase of Apollo Aerosole Industries pursuant to a stock purchase agreement which included provisions for non-competition, non-solicitation, indemnification and post-closing adjustments. This decision refers to recent Supreme Court decisions that suggest a fresh approach to the traditional theory of contract interpretation of unambiguous agreements being typically limited to the four corners of the document. 

Highlights of Decision

The court began its analysis with the still applicable bedrock principle that Delaware applies to the objective theory of contracts, i.e.: “A contract’s construction should be that which would be understood by an objective, reasonable third party.”  See footnote 14.  The court acknowledged the traditional approach that provides for interpreting a contract based on the:  “parties’ intentions as reflected in the four corners of the agreement, construing the agreement as a whole and giving effect to all its provisions.”  See footnote 15.

But, citing to a recent Delaware Supreme Court decision, the most recent statement of Delaware law regarding contract interpretation provides for a more holistic approach expressed in the following quote:  “In giving sensible life to a real-world contract, courts must read the specific provisions of the contract in light of the entire contract.”  (citing Chicago Bridge & Iron Co. N.V. v. Westinghouse Elec. Co., 166 A.3d 912, 913-14 (Del. 2017)). 

Another recent Delaware Supreme Court decision also supports the view that the current approach that Delaware courts are taking even for unambiguous contracts allows for one to “step back” to view the context in which the parties reached an agreement.  See Heartland Payment Systems, LLC v. InTeam Assoc., LLC, 2017 WL 3530242, at *10 (Del. Aug. 17, 2017)(quoting Chicago Bridge & Iron Co. N.V. v. Westinghouse Elec. Co., 2017 WL 2774563, at *1 (Del June 27, 2017)). See also E. Norman Veasey & Jane M. Simon, The Conundrum of When Delaware Contract Law Will Allow Evidence Outside the Contract’s “Four Corners” in Construing an Unambiguous Contractual Provision,  72 Bus. Law. 893 (Fall 2017). The Court of Chancery very recently issued an Order with its findings on remand in the Heartland case.

The referenced article co-authored by former Chief Justice Veasey was published in the same year as two above Delaware Supreme Court decisions which arguably support the view that when construing even unambiguous agreements, the larger context in which the parties negotiated the agreements should be taken into account. 

The stock purchase agreement involved in this case provided for indemnification as the sole remedy for breach of representations or warranties, and also included several restrictive covenants and confidentiality provisions.  One of the issues was whether a post-closing separation agreement involving one of the executives superseded the indemnification provision.  That argument was unsuccessful and the court reasoned that the extensive indemnification provisions for breach of representations and warranties was not impacted by the post-closing separation agreement with one of the executives who allegedly violated the restrictive covenants and other provisions.

Chancery Discusses Revlon in Context of Granting Option to Sell Company

The Delaware Court of Chancery addressed a bevy of basic corporate litigation principles in the context of claims challenging the actions of directors, and determining which standards of review apply, and which procedural prerequisites need to be satisfied. In Carr v. New Enterprise Associates, Inc., C.A. No. 2017-0381-AGB (Del. Ch. Mar. 26, 2018), claims for breach of fiduciary duty and related claims challenged a series of transactions, the net result of which was to substantially dilute the ownership of one of the original co-founders of the company, who alleged also that the investor who caused the dilution was able to acquire control of the company for less than fair value, and then the new controller granted an option to a party doing business with the controller to allow the company to be sold at less than the best price–in order to benefit the controller in a separate transaction.

Basic Facts

Carr was a co-founder of Advanced Cardiac Therapeutics, Inc. (ACT). ACT’s controlling stockholder is New Enterprise Associates (NEA). The less than optimum price for the sale of ACT pursuant to an option to be exercised in the future, it was alleged, was in exchange for the buyer (or the person with the option to buy) agreeing to invest in another unrelated company that NEA, the controller, had a need for an investment in–and a quid pro quo connected the option to sell and the separate investment.

Highlights of Key Legal Principles Addressed

Among the highlights of the statements of law in this 60-page decision that will be useful for corporate and commercial litigators include the following:

            Revlon Duties

  • Most noteworthy about this decision is its consideration of applying the Revlon standard to a set of facts to which Revlon has not previously been applied directly in Delaware. The challenged transaction involved selling an option for a third-party to acquire the company, ACT, as opposed to a decision to sell the corporation outright. The court reasoned that the application of Revlon to an option transaction likely would “turn on the conditionality and other specific features of the option in question.”
  • The court discussed several lines of cases applying Revlon which taken together, suggest that the board of directors of a controlled company may have Revlon-like duties when deciding to approve the sale of an option to a third party to purchase the entire company. The court ultimately held that it need not determine whether the board’s approval of the warrant transaction in this matter is subject to enhanced scrutiny because the court concluded that even under the business judgment rule, the plaintiff stated a claim for relief against the directors.

           Step-Transaction Doctrine

  • The court explained the “step-transaction doctrine” which may apply when multiple transactions or a series of agreements are treated as part of a single unitary plan even if not necessarily taking place on the same date. In order for a series of transactions to be treated as a unitary plan, one of three tests must be met. See footnotes 41 and 42 and related text.

           Direct v. Derivative Claims

  • The court provides a useful explanation of the often difficult distinction between a direct claim and a derivative claim, as well as the rare instance when a claim can be both direct and derivative, but in this case the dilution claims are treated as traditional derivative claims, though the challenge to the warrant transaction is direct. The complaint hedged its bets by pleading all of the claims as direct and derivative in the alternative. See pages 22 and 23.

            When Groups Acting In Concert Equal Control Group

  • The court explains the standards that will apply to determine whether one or more persons acting together will be treated as a “control group” for purposes of applying the standard of a controlling stockholder. See pages 24 and 25.

           Pre-Suit Demand Futility—Aronson and Rales

  • Another useful reference is the court’s explanation of when the Aronson test as compared to the Rales test will be used to determine whether pre-suit demand futility has been established. See pages 31 to 33. The court here explained that Aronson applied because at least half of the board that was in place when the alleged breaches occurred was still in place. The court also explained that the Aronson test was met based on the facts of this case so that pre-suit demand futility was adequately established.
  • By comparison, the court described the three situations principally where Rales will apply:

“(1) Where a business decision was made by the board of a company, but a majority of the directors making the decision had been replaced; (2) Where the subject of the derivative suit is not a business decision of the board; and (3) Where the decision being challenged was made by the board of a different corporation.”

  • The court explained that what is relevant in the end is not whether the board that approved the challenged transaction was or was not interested in that transaction, but whether the present board is or is not disabled from exercising its right and duty to control the corporation.
  • Under the Aronson test, the plaintiff sufficiently plead facts in this case that raised a reasonable doubt as to the disinterestedness or independence of the directors in connection with the challenged decisions.
  • The court noted that in Rales, the question is whether the board that would be considering the demand but which did not make the business decision being challenged, can satisfy the first and second prongs of Aronson. See footnote 80.
  • The court explained why motions to dismiss are rarely granted when the entire fairness test applies in light of the many factual issues that will often be determinative.

           The Business Judgment Rule Articulated

  • The court provides a useful recitation of the well-known business judgment rule which “provides a presumption that the board made a decision on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company.” See footnote 150. Under that standard the plaintiff can survive a motion to dismiss if it has been adequately pled that the directors breached their duty of care or loyalty in coming to their decision. In this case, the court found it was reasonably conceivable that the director defendants breached both of those duties so as to rebut the business judgment rule.

           Breach of Duty of Care to Rebut BJR Presumption

  • The court explained that the duty of care was breached because the directors did not even engage a financial advisor, for example, and as well the board did not implement any formal process in selling the warrant. In addition, the board did not pursue a transaction with another interested party in an attempt to extract a higher price. Taken together, these factors suggest the board may have been grossly negligent.

          Breach of Duty of Loyalty to Rebut BJR Presumption

  • Regarding the duty of loyalty, the court found that the presumption of the BJR was rebutted because facts were pled that showed at least half of the six-person board that approved the transaction was not disinterested or independent. See footnotes 153 and 154.

          Rights and Duties of Controlling Stockholders

  •  Controlling stockholders have the right to act in their own interest when acting solely in their capacity as a stockholder and generally have the right sell control without regard to the interests of the minority as long as the transaction is done in good faith. See footnotes 158 through 160 and accompanying text.
  • But, the right of a controlling stockholder to do so, must yield when a corporate decision implicates a controller’s duty of loyalty. See footnote 160. For example, a controller may not prioritize a return on its own investment over the maximization of value for all of the company’s stockholders if all of the company stock is being sold. See page 56.           

           Non-Exculpated Claims against Directors Fail:

  • The court dismissed certain non-exculpated claims against certain directors based on the recent Supreme Court decision of In re Cornerstone Therapeutics, Inc., Stockholder Litig., 115 A.3d 1173, 1175-76 (Del. 2015), which made clear that a plaintiff seeking only monetary damages must plead non-exculpated claims against the director who was protected by an exculpatory charter provision to survive a motion to dismiss, regardless of the underlying standard of review for the board’s conduct—be it Revlon, Unocal, the entire fairness standard or the business judgment rule. See footnote 166. The Supreme Court explained the reasoning for this as follows:“When a director is protected by an exculpatory charter provision, a plaintiff can survive a motion to dismiss by that director defendant by pleading facts supporting a rational inference that the director harbored self-interest adverse to the stockholders’ interests, acted to advance the self-interest of an interested party from whom they could not be presumed to act independently, or acted in bad faith.”
  • Based on the foregoing, the court dismissed some of the claims against certain of the defendants because there was no argument that they acted in bad faith with respect to the transaction and there were no facts pled that supported a non-exculpated claim.

Chancery Addresses Breach of Fiduciary Duty Without Measurable Damages

The practical problem of proving a breach of fiduciary duty without being able also to prove damages was recently addressed by the Delaware Court of Chancery in a post-trial opinion styled The Ravenswood Investment Company, L.P. v. The Estate of Bassett S. Winmill, et al., C.A. No. 3730-VCS (Del Ch. Mar. 22, 2018). Several of the many prior decisions in this matter over the last decade have been highlighted on these pages and provide factual and procedural history. In this short blog post, I’ll highlight the key points that may be most useful for those interested in the nuances of corporate and commercial litigation discussed by the court in this decision:

Standard of Review Applicable

  • The challenged executive compensation decisions of the board were subject to the entire fairness test. The presumption of the business judgment rule’s applicability was rebutted because the defendant directors stood on both sides of the transaction. See, e.g., cases cited at footnote 125. Thus, the directors needed to establish both fair dealing and fair price in connection with the challenged compensation decisions.  The 68-page opinion analyzes the interfacing between the two parts of the test. See, e.g., cases cited at footnote 161. The court found that the board failed the entire fairness test, and that they breached their fiduciary duty of loyalty.
  • Although in the past the company had traded on NASDAQ, a father and his two sons constituted the entire board and they alone voted on their own compensation including the disputed stock options. They did not use a compensation consultant and the documentation relating to the “process” and analysis supporting their compensation was, in the court’s description: “thin”. Some of the options exercised were paid with promissory notes that were later forgiven.

Remedies Available

  • The court found no evidentiary basis for compensatory damages, despite finding a breach of the duty of loyalty in connection with the compensation decisions relating to the stock options. See footnote 174 and accompanying discussion.
  • The court considered rescission, rescissory damages, equitable rescission and “cancellation” of the stock options (and the nuanced comparison with that concept and rescission.) The court also grappled with the doctrinal dissonance of fashioning a practical and fair remedy in the context of a derivative action when the corporate benefit would be enjoyed to a large extent by the defendants who are major stockholders, for example. See, e.g., footnotes 180 to 188.
  • Nominal damages, in the end, were the only damages that the court determined to be available under the circumstances of this case. See footnotes 215-216.
  • Notably, the court acknowledged that the plaintiff was still requesting attorneys’ fees and that it would consider that issue separately. There is precedent in Delaware for a court to award attorneys’ fees when there has been a breach of fiduciary duty but no measurable damages. See, e.g.,William Penn Partnerships v. Saliba, C.A. No. 111 (Del. Supr. Feb. 9, 2011), highlighted on these pages here. The award of attorneys’ fees in such a situation may be slim solace for the plaintiff, and of primary interest to the lawyers, but at the very least it “levels the field” somewhat to the extent that if the plaintiff is not “in the hole” for any attorneys’ fees, then that plaintiff is not disadvantaged by bearing the cost of proving the defendants’ breach of fiduciary duty.

The Business Judgment Rule and DGCL Section 144

A recent decision of the Delaware Court of Chancery discusses the interplay between the business judgment rule and section 144 of the Delaware General Corporation Law (DGCL). Section 144 provides some defenses to what would otherwise be easily challenged, conflicted transactions involving directors.

Professor Stephen Bainbridge, well known to readers of this blog and often cited by Delaware courts for his corporate law scholarship, discusses the decision in Cumming v. Edens, and provides an in-depth analysis with reference to many of his prior articles and treatises as well as explaining comparisons with other court decisions on this nuanced topic of Delaware corporate law that should be of interest to corporate litigation practitioners.

Court Allocates Amount of Fees Due Per Indemnification

The Delaware Court of Chancery in a recent opinion allocates the precise amount of fees payable, as a result of a prior indemnification ruling, in light of the total amount of fees incurred by various parties and proceedings that were not all subject to indemnification obligations. The decision in Meyers v Quiz-Dia LLC, et al., C.A. No 9878-VCL (Del. Ch., Mar. 16, 2018), needs to be read by anyone who wants to know how, according to Delaware law, the exact of amount of fees will be allocated when indemnification is owed to less than all the parties, and for fewer than all of the underlying lawsuits, for which fees have been incurred and that may not be easily separated for purposes of determining what amounts are covered by an indemnification obligation. Several of the many prior Chancery decisions in this case have been highlighted on these pages and should be referred to for detailed background facts and procedural history.

After 13 years of highlighting Delaware decisions on indemnification and advancement rights of officers and directors, and publishing an annual book chapter on those cases for several years, this is the most helpful decision that I recall for its analysis of how to determine the allocation and exact amount of fees incurred and payable among multiple parties and different lawsuits, when not all the parties and not all the underlying litigations are covered by indemnification.

Noteworthy Aspects of Indemnification Law from This Decision

  • The court addresses the rare issue of a subrogation right to indemnification pursued by one of the companies involved that paid the fees for the officers and directors based on secondary liability for indemnification. [The company with the primary indemnification obligation initially refused to pay.] This opinion explains the prerequisites that need to be satisfied for one seeking reimbursement via subrogation of fees paid pursuant to a secondary obligation to indemnify. One of the requirements for subrogation in this context is that the payor not be a “volunteer” though that term in this context is not strictly defined and may be satisfied by the desire of a company to support its management.
  • Chancery Rule 88 was the procedural mechanism that the parties resorted to, in connection with the motion to quantify the exact amount of fees, because the prior opinion in June 2017 establishing the right to indemnification, highlighted on these pages, did not determine the amount of fees due–and the parties could not agree on the amount or allocation. A total of about $552,000 (out of a total of about $785,000) was sought for the underlying litigations, and about $820,000 for “fees on fees” out of a total of about $1.9 million was sought in this latest ruling. [Yes, the “fees on fees” amount exceeded the total of fees incurred, and now sought, for the underlying lawsuits.]
  • Allocation of fees payable for the two indemnitees in this matter was  determined by the court to be controlled by a prior agreement among the parties to share the fees for the underlying litigations. See footnotes 56 to 59. The court reasoned that the two persons entitled to indemnification pursuant to the prior ruling of the court, Smythe and MacDonald, had previously agreed that they would be allocated 20% of the fees in the underlying lawsuits. The company seeking subrogation on their behalf in this instant decision, therefore, was not entitled to seek reimbursement for more than the 20% that Smythe and MacDonald had previously agreed to be apportioned to them in a separate allocation agreement. The net amount awarded in this decision was about $145, 00o, therefore, instead of the more than $700,000 sought.
  • The allocation of “fees on fees” was based on a slightly different analysis. Citing to prior decisions that applied the principle of “reasonably proportionate to the level of success” to an award of “fees on fees”, and in light of the request in this matter for about $820,000 out of the $1.9 million in “fees on fees” incurred for both covered and uncovered parties, or 39% of the total, the court explained that based on the total number of initial claims and the amount of work on the successful claims, 50% success was the appropriate starting point for allocation of fees on fees in this case. The court then used the 20% allocation explained above for the underlying litigation and: “Multiplying the two percentages results in a fees-on-fees percentage of 10%.” Applying that percentage to the “base amount”, results in a fee award of $125,000.
  • The court compared that award with what the court described as “its experience” that briefing on summary judgment in this case “likely would have cost between $100,000 and $200,000”, and because the success achieved in this case could have been achieved via summary judgment motion, the court determined that the amount awarded was reasonable.
  • Pre-judgment interest was also awarded and the discussion about the date when that interest starts is worth reading verbatim. See footnotes 67 to 70 and accompanying text.
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