Any lawyer involved in litigation about issues surrounding an LLC member’s withdrawal from an LLC should become familiar with the recent decision in 5high LLC v. Feiler, C.A. No. 2022-0108-LWW (Del.Ch. Aug. 5, 2022).

Issue Addressed

Whether one of the original 50/50 members of an LLC resigned despite no written LLC agreement and no written resignation.

Essential Background Facts

Two members formed an LLC without a written LLC agreement but agreed orally that each would have a 50% ownership interest, each would co-manage the LLC, and each contributed an equal amount of capital. Shortly after the formation, one of the 50/50 members orally resigned and took several public actions to notify vendors, customers, employees, and others that he was resigning. The other 50% member orally accepted the resignation and the parties began exchanging draft formal documents–but they never signed a formal, written agreement to memorialize the resignation.

Important Legal Principles From Court’s Opinion

  • The Delaware Declaratory Judgment Act was an appropriate vehicle to present the issue for the Court to decide if one of the original 50/50 members remained as the sole member. Slip op. at 15-16 and n. 84.
  • The LLC Act allows an LLC agreement to be written, oral or implied. Slip op. at 18. See Section 18-101(9) of LLC Act.
  • The court defines an implied agreement and explains how one can be formed by conduct of the parties. Slip op. at 18-19.
  • Subjective intent is not relevant to determining if an implied contract was formed, and silence or failure to object can be treated as acceptance. Id.
  • Based on the circumstances of this case, it was not necessary to invoke the magic word “resign”, and there was ample evidence presented at trial on a paper record, to permit an objective observer to conclude that the departing member’s behavior demonstrated his intent to sever all ties with the LLC–and the remaining member accepted that offer to sever ties.
  • The LLC Act provides default provisions, but the parties’ implied contract modified those default provisions. Slip op. at 20-21.
  • The LLC Act’s default provisions would otherwise have prevented the resigning member from withdrawing prior to dissolution or winding up of the LLC. Id. and n. 104. See Section 18-603 of LLC Act.
  • The implied agreement was not conditioned on a formal, written agreement being signed, and efforts to memorialize the implied agreement did not alter the implied agreement. Slip op. at 21.
  • The court’s statement of the law and its reasoning highlighted above might possibly be applied to other situations where, for example, parties may agree–in an implied contract–to settlement terms in other contexts without signing a formal, written agreement.

This post was prepared by Frank Reynolds, who has been following Delaware law and writing about it in various publications for over 30 years.

Delaware’s Court of Chancery recently dismissed a shareholder challenge to The Trade Desk Inc. (TTD) charter amendment that extended the advertising software company’s dual stock class structure and its CEO’s control, finding TTD met all six qualifications of the Delaware high court’s seminal MFW ruling, entitling it to deferential business judgment review in City Fund for Firefighters and Police Officers in the City of Miami v. The Trade Desk Inc.,et al. opinion issued, (Del. Ch. July 29, 2022).

In his July 29 memorandum opinion, Vice Chancellor Paul Fioravanti threw out the breach of duty charges that the City Fund for Firefighters and Police Officers in the City of Miami had brought against TTD officers and directors for allegedly helping CEO and controlling shareholder Jeff Green trick common shareholders into approving Green’s self-interested stock scheme.  He said the plaintiffs failed to show that investors were duped into voting for an amendment to delay the end of a dual stock class or were uninformed about Green’s supposed hidden urgency to dispose of his many Class B shares that carried ten votes per share.

The ruling called on the Chancery Court to apply the Delaware Supreme Court’s milestone MFW opinion, which set out the six conditions that could exempt a controller’s transaction from the heightened scrutiny of review under the exacting entire fairness standard announced in Kahn v. M & F Worldwide Corp., 88 A.3d 635 (Del. 2014) (commonly referred to as MFW.)  Since the TTD amendment fit the MFW framework, it only faced examination under the more lenient business judgment rule, the vice chancellor said.

Background

According to the court record, Jeff Green co-founded TTD, a Ventura, California, technology company that markets “a software platform to provide data-driven digital advertising campaigns” and has served as its President, Chief Executive Officer, and as chairman of the Delaware-chartered company’s board of directors.  Green controlled a majority of TTD’s stock through his ownership of most of its Class B stock but that was due to change when the number of those non-public shares shrank.

After lengthy negotiations and the creation of a three-director special review committee, the TTD board company endorsed an extension of the projected sunset of the Class B shares and their conversion into the common Class A stock and that continued Green’s control at a crucial juncture.

After the pension fund filed its complaint, defendants moved to dismiss based on failure to plead a claim and the case focused on whether the disputed transaction fit the MFW framework by complying with six elements:

  • the controller conditions the procession of the transaction on the approval of both a Special Committee and a majority of the minority stockholders;
  • the Special Committee is independent;
  • the Special Committee is empowered to freely select its own advisors and to say no definitively;
  • the Special Committee meets its duty of care in negotiating a fair price;
  • the vote of the minority is informed; and
  • there is no coercion of the minority.

Plaintiffs focused on elements two and five, arguing that the independence of the special committee was tainted by director Lisa Buyer and the vote was uninformed because shareholders were kept in the dark about the scheduled end of the Class B stock and Green’s need to unload his shares.

The Special Committee’s independence

Plaintiff charged that the Chair of the committee, Buyer, had been a consultant for  Green during TTD’s initial public offering and received a large compensation for her services that compromised her neutrality.

But the vice chancellor noted that the MFW opinion requires an inquiry before such a determination. “This court is hesitant to infer materiality of compensation absent well-pleaded facts. The determination of whether a director’s compensation from the Company is sufficient to raise a reason to doubt her independence is a fact intensive inquiry. See In re MFW S’holders Litig., 67 A.3d at 510–13.

Plaintiff contended that Buyer caused the other two independent directors to function under a “control mindset” that skewed the committee’s decisions.

The decision

The court determined that, “Even assuming that Buyer’s TTD compensation creates a reasonable inference that her director compensation was material to her and that she was, therefore, not independent, the Plaintiff has not alleged facts that create a reason to doubt that a majority of the committee lacked independence or that Buyer so dominated the committee process that it undermined its integrity as a whole.”

“Plaintiff has not pleaded sufficient facts alleging that Buyer’s conduct dominated or subverted the Special Committee process so as render the entire committee defective, even if she was determined to be lacking in independence,” Vice Chancellor Fioravanti added, noting that the controlled mindset theory is not part of the MFW analysis.

Was the vote uninformed?

The court concluded that none of six alleged material non-disclosures altered the “total mix of information” available to the investors who needed to consider whether to vote for the extension amendment.

  • Green’s desire to sell Class B stock;
  • the Company’s expectations as to when the Dilution Trigger would likely be tripped;
  • advice that Centerview provided to the Special Committee;
  • Green’s counsel’s acknowledgement that a business rationale would be needed to justify any amendment to the Dilution Trigger;
  • the Special Committee’s efforts to obtain stockholder support for the Dilution Trigger Amendment; and
  • the Compensation Committee’s consideration of an equity grant to Green in December 2020

The court concluded that as Defendants aptly put it, “anyone reading the Proxy would understand both that Green desired to retain control through the Trigger Amendment and that the amendment would enable him to continue his (disclosed) historical practice of selling shares without losing that control.”

The Delaware Court of Chancery recently published a post-trial decision involving the officer of a company who breached his fiduciary duties by, among other things, competing against the company for which he served as president. Metro Stores International LLC v. Harron, C.A. No. 2018-0937-JTL (Del. Ch. May 4, 2022), is a 128-page opinion that warrants a plenary review, but for purposes of this short blog post I am only highlighting a few gems of Delaware corporate and commercial law that every Delaware litigator should know.

Brief Overview

The first 34 pages or so of the opinion describe in extensive detail the factual background. A basic outline of the facts includes an existing U.S. company that was a large player in the self-storage facility business.  They brought on a person who was assigned the job of growing the business in Brazil.  The court’s decision goes into great detail about how this person, in his capacity as president of the LLC that was responsible for the business in Brazil, in violation of his contractual and fiduciary duties, competed against the company and took confidential information from the company when he left.

Selected Key Principles of Delaware Law

  • The Court reviewed the elements that must be established in order to successfully pursue a breach of fiduciary duty claim, with a special emphasis on such a claim against the officer of a company, as compared to a director. Slip op. at 36-39.
  • The opinion describes the three potential levels of review that the court uses to determine if a fiduciary duty was breached. In this case, the court determined that the “entire fairness standard” applied.
  • The court explained that the state of the law in Delaware regarding the analysis of the duty of care of an officer applies the “Director Model”. Slip   at 40–47.
  • The court highlighted the important difference between the provisions in an LLC Agreement that:

(i)  waive or limit the scope of fiduciary duties – – as compared with;

(ii)  an exculpation cause which merely limits liability for certain actions.  Slip op. at 47–48.

  • Notably, a clause limiting liability for certain actions does not limit fiduciary duties–and would merely bar money damages but not other potential remedies.
  • In an extensive footnote, the court explains that an officer is an agent of the company, and like all agents is a fiduciary–but not all fiduciaries are agents. See footnote 18.
  • The court expounded on the duty of loyalty and its various nuances. Slip op. at 40.
  • The court also described in great detail the duty of disclosure that an agent has. Slip op. at 55–57.
  • The court explained the very useful distinction between behavior that could be either a breach of contract and/or a breach of fiduciary duty – – and when both claims may proceed in the same case to the extent that they are not overlapping.
  • The court found that the unauthorized access to the former employer’s computer system, without authority, was not only a breach of confidentiality obligations but also a breach of a federal statute called the Stored Communications Act.  Slip op. at 120–122.
  • In particular, the court found that the federal statute involved, the Stored Communications Act, was violated because the former officer accessed an electronic communication while it was being stored, by either intentionally accessing the computer system without authorization or exceeding his authorization.  See 18 U. S. C. §2701.

The Delaware Supreme Court recently provided guidance to corporate litigators regarding the nuances of DGCL Section 220, which most readers recognize as the statute the allows stockholders to demand certain corporate records if the prerequisites in the statute–and those imposed by countless court decisions–have been satisfied. In NVIDIA Corp. v. City of Westmoreland Policy and Fire Retirement System, Del. Supr., No. 259, 2021 (July 19, 2022), a divided en banc bench of Delaware’s High Court explained in a 54-page decision why the “credible basis” requirement may be satisfied in some circumstances by “reliable hearsay”.

Regular readers of these pages will be forgiven if their reaction might be: what more can be said about the relatively simple right of stockholders to demand corporate records, in some circumstances, pursuant to DGCL Section 220–that hasn’t already been covered by the hundred or more Section 220 cases highlighted on these pages over the last 17 years, as well as the thousands of court decisions on the topic over the many decades preceding this publication? In short, when the Delaware Supreme Court speaks, those who labor in its vineyard need to listen. And one indication that this topic is not as simple as the statute might suggest, is that those with the final word on Delaware corporate law–the members of the Delaware Supreme Court–were not in complete unanimity in their decision in this case. A concurrence was not in 100% agreement with the majority opinion.

Key Takeaway

Prior to this decision, it was not well-settled whether a stockholder could satisfy the “proper purpose” requirement under DGCL Section 220 with hearsay–instead of live testimony, for example. The Delaware Supreme Court ruled that: “The Court of Chancery did not err in holding that sufficiently reliably hearsay may be used to show proper purpose in a Section 220 litigation, but did err in allowing the stockholders in this case to rely on hearsay evidence because the stockholders’ actions deprived NVIDIA of the opportunity to test the stockholders’ stated purpose.” Slip op. at 4. (emphasis added).

Overview of Background

After finding post-trial both a proper purpose and a credible basis for the requests, the trial court ordered the production of documents to investigate: possible wrongdoing and mismanagement; the ability of the board to consider a pre-suit demand; and to determine if the board members were fit to serve on the board. The trial court rejected the defenses that: the requests were overbroad and not tailored with rifled precision to what is necessary and essential for the stated purpose; no proper purpose was shown; no credible basis was demonstrated to infer wrongdoing; and the stockholder failed to follow the “form and manner” requirements–in part by changing the list of requested documents during the litigation.

Several stockholders consolidated their demands prior to suit, and 530,000 pages were produced prior to the litigation. Suit was filed in February 2020 based in part on public statements made during an earnings call. Prior to trial, the stockholders were less than forthcoming about whether they would call any witnesses, or which witnesses they would call at trial to establish their proper purpose. The Supreme Court held that the lack of pre-trial transparency by the stockholders deprived the company of the option to depose witnesses to explore the proper purpose issue prior to trial.

The Basics

Most readers are familiar with the basic Section 220 requirements, but the Court’s review provides a helpful reminder. Some of the prerequisites include:

  • Stockholders must demonstrate by a preponderance of the evidence a credible basis from which the court may “infer possible mismanagement that would warrant further investigation.” Slip op. at 18
  • The requested documents must be “essential to the accomplishment of the stockholder’s articulated purpose of inspection.” Id.

Key Highlights and Takeaways

  • The Court of Chancery has discretion to trim overly broad requests to craft a production order circumscribed with rifled precision.
  • Although a stockholder may not broaden the scope of their requests throughout the litigation, a Section 220 plaintiff may narrow their requests if they do so in good faith and such narrowing does not prejudice the company.
  • The Court observed that Section 220 cases are “summary proceedings” and such trials do not always include live testimony. Thus, the court reasoned that: “hearsay is admissible in a Section 220 proceeding when the hearsay is sufficiently reliable.” Slip op. at 38.
  • The Court cautioned that Section 220 plaintiffs should not abuse the hearsay exception, and “must be up front about their plans regarding witnesses” in the pre-trial phase of a case. Slip op. at 41. In this case the Court held that the company was deprived of the “ability to test the stockholders’ purpose”, such as through a deposition or otherwise, because the stockholders did not give the company sufficient notice about what they would rely on at trial to establish a proper purpose. Slip op. at 42-43.
  • In dicta, the Court upheld the trial court’s inference made by “connecting the dots” that the credible basis requirement was satisfied based on a combination of: insider stock sales, public statements that may have been false, and concurrent securities litigation supported by ample research. Slip op. at 45.
  • The Court restated the law that the “credible basis threshold may be satisfied by a credible showing, through documents, logic, testimony, or otherwise, that there are legitimate issues of wrongdoing.” Slip op. at 46.

The concurring opinion of one member of the High Court observed that Section 220 cases often involve the issue of whether the “stated purpose” is the “actual purpose”, which makes the truth of the stockholder’s statements on that point a key issue.  The concurrence also emphasized the importance of the distinction between a proper purpose and the threshold requirement of credible basis–and that a stockholder who is neither an employee nor an officer of a company will rarely have first-had knowledge of wrongdoing, but a typical stockholder “will always have knowledge of her purpose because it is, after all, her purpose.” Slip op. at 54. (emphasis in original).

In Sum

Although this decision may make it easier in some ways for a stockholder to prove its case in a Section 220 lawsuit, companies still have several tools at their disposal to test the basis for a stockholder’s assertion of a proper purpose and other statutory and court-made prerequisites for a Section 220 demand.

A recent Court of Chancery decision provides a few basic but important statements of Delaware law that are useful for the toolbox of corporate and commercial litigators. In Klein v. ECG Topco Holding, LLC, C.A. No. 2021-0701-LWW (Del. Ch. July 8, 2022), the Court pithily decides issues that arose in the context of the disputed buyout of a member of an LLC. Specifically, the issues included (i) whether the lack of ripeness of the disputed payment for the member’s LLC interest deprived the court of subject matter jurisdiction; (ii) whether the failure to allege any harm from the application of the restrictive covenant warranted dismissal under Rule 12(b)(6); and (iii) if an alleged breach excused performance.

Essential Background Facts

For this very short blog post, the salient facts involve a member of an LLC whose divorce led to his ex-wife acquiring most of his interest in the LLC. That event triggered a buyback provision in the LLC agreement which described how the shares were to be bought back, and at what price and when payments were to be made. The event also triggered a restrictive covenant.

Key Takeaways

The complaint appeared to ask for a declaratory judgment regarding the exact price that was due for the purchase of the LLC interests. But the court read the LLC agreement as not requiring payments, at the earliest, for several more months–which rendered that issue not yet ripe for the court to decide it. Thus, under Rule 12 (b)(1), the court did not have subject matter jurisdiction to decide an issue that was not ripe.

The next two issues involved a restrictive covenant. The court reasoned that there were no allegations that the restrictive covenant was harming the plaintiff. To the contrary, the court took judicial notice of a press release indicating that the plaintiff was already gainfully employed. Moreover, there was an argument that the company did not comply with a notice provision. The court was not persuaded that the notice provision applied, but even it did apply, and if the notice were not sent, the court restated basic principles applicable to restrictive covenants: “Delaware courts excuse performance on non-compete obligations following a material breach” that “goes to the essence” of the agreement. Slip op. at 16 (citation omitted). Even if the notice provision at issue applied, the plaintiff did not allege harm from the lack of notice–or that the alleged breach was material.

The Delaware Court of Chancery recently denied a frivolous pro se motion to recuse, and the introduction to the reasons why the motion was denied might be used as an eloquent preface for a rebuttal to almost any frivolous accusation that a recipient may be reluctant to dignify with a response.

In Wollner v. PearPop Inc., C.A. No. 2021-0157-KSJM (Del. Ch. July 9, 2022), the Court began its analysis with the following “money quote”:

In a world of misinformation, disinformation, and mal-information, [the pro se movant]’s theory falls in one of the first two categories because it is based on totally false premises. At the risk of seeming to credit by response a theory too divorced from reality to warrant one, I can easily dispel it….”

Slip op. at 3.

This post was prepared by Frank Reynolds, who has been following Delaware law and writing about it in various publications for over 30 years.

The Chancery Court recently ruled Carvana Company’s controlling family must prove their  stock deal was entirely fair to the on-line used car dealer’s investors after finding the long, dependent business relationships two directors had with the CEO excused the plaintiffs’ pre-suit demand on the board in  In Re Carvana Co. Stockholders Litigation, C.A. No. 2020-0415-KSJM (Del. Ch. June 30, 2022).

In her June 30 opinion, Chancellor Kathaleen McCormick declined to dismiss breach of duty charges against Carvana CEO, President and Chairman of the Board Ernest Garcia III for allegedly profiting by orchestrating an allegedly unfairly-priced $600 million stock offering while Carvana’s share price was depressed by the pandemic.  She found that even under the new universal pre-suit demand standards affirmed by the Delaware Supreme Court in a failed challenge to Mark Zuckerberg’s Facebook stock dealings, the pension fund plaintiffs showed that two Carvana directors owed their careers, fortunes and livelihoods to Ernest Garcia III and his father, Ernest Garcia II.

Her decision — that those two directors could not make an objective decision as to whether the company should press charges against the Garcias over the stock deal – meant that counting Garcia III, half of the six-member board was compromised; therefore, pre-suit demand was excused and the derivative suit could go forward.

The Chancellor’s June ruling sets out a clear though demanding heavily fact-supported standard to satisfy what has been dubbed the third of three prongs of the Zuckerberg opinion, which was initially penned by Vice Chancellor J. Travis Laster and endorsed by the Supreme Court.  United Food & Com. Workers Union & Participating Food Indus. Empls. Tri-State Pension Fund v. Zuckerberg, 250 A.3d 862, 876 (Del. Ch. 2020), aff’d, 262 A.3d 1034 (Del. 2021).

It sets out a new universal three-part, director-by-director test for a plaintiff bringing suit on behalf of all shareholders to avoid letting the board decide whether the company should take up the action:

  • whether the director received a material personal benefit from the alleged misconduct that is the subject of the litigation demand;
  • whether the director faces a substantial likelihood of liability on any of the claims that would be the subject of the litigation demand; and
  • whether the director lacks independence from someone who received a material personal benefit from the alleged misconduct that would be the subject of the litigation demand or who would face a substantial likelihood of liability on any of the claims that are the subject of the litigation demand.

Background

The Garcias founded several companies that bought and sold or rented cars, including Carvana in 2012.  Carvana had a unique dual class stock structure with a common stock carrying one vote per share and a Class B which had 10 votes per share—but only when owned by the Garcias, who controlled 88 million shares of the company.

Following the pandemic in 2020, the stock price dropped dramatically but as an e-commerce company it was uniquely situated to weather the economic storm.  Nevertheless, even though Carvana did not need the funds to operate, Garcia III orchestrated a $600 million stock sale while the stock price was depressed.  It was available only to hand-picked investors, the court said.

Three pension funds filed breach of duty allegations that were consolidated in January 2021.  Carvana and Garcia moved to dismiss for lack of pre-suit demand and failure to state a complaint.  Garcia Senior moved to dismiss for lack of personal jurisdiction, but the Court said it would rule on that later.

Garcia Junior’s motion to dismiss focused on whether two of the six Carvana directors — Gregory Sullivan and Ira Platt — both of whom allegedly had a long and tangled relationship with the Garcias — could render an objective opinion on the charges against the Garcias.

Sullivan — Thick-as-thieves?

Sullivan’s business relationship allegedly dates back to Garcia Senior’s founding of his used-car empire after pleading guilty in 1990, to a felony bank fraud related to Charles Keating’s Lincoln Savings & Loan scandal. In 1992, Senior consented to a censure and permanent bar from “membership or employment or association with any New York Stock Exchange member or member organization.”

Sullivan was censured by the government for his role in the Garcias’ companies in connection with the Garcias wrongdoing, but they provided him with positions that supplied him with a career, a livelihood and a fortune during that time, the Chancellor said.

“Put succinctly, it is reasonably conceivable that Sullivan might be incapable of impartially considering a demand to sue the man who allegedly saved his career, helped generate his personal wealth, and financially shores his current livelihood,” he said.

This closeness creates a reasonable doubt about Sullivan’s ability to objectively consider a demand to pursue litigation against Garcia Senior’s son, particularly litigation for the same wrongdoing alleged against Garcia Senior, the court said.

“Mere allegations of payment of director fees are insufficient to create a reasonable doubt as to the director’s independence,” the Chancellor said, but she added that, “Indeed, the fee allegations are eclipsed entirely by Plaintiffs’ unusual thick-as-thieves narrative concerning Sullivan and Garcia Senior.”

Platt — Reasonable doubt?

“Although the allegations regarding the large stock gift and exclusive investment opportunities shine brightest in Platt’s constellation of facts raising a reasonable doubt as to his independence from the Garcias, there are other stars as well,” the court said.   These include:

  • Platt securing a position for Garcia Junior and Garcia Junior securing a position for Platt’s son;
  • Platt’s appointment to the boards of numerous Garcia-controlled entities and accompanying director compensation; and
  • the historical relationship between Platt and Garcia Senior while Platt was DriveTime’s primary relationship banker at Greenwich Capital.

States a claim
The Chancellor also declined to dismiss for failure to state a claim because although Garcia Junior abstained from the vote on the stock deal, plaintiffs allege that Garcia Junior “shepherded the [Direct] Offering” from “conception to its execution over the course of a few hurried days.”

Delaware’s favorite corporate law scholar, the prolific and widely-quoted Professor Stephen Bainbridge, writes that the effort afoot to promulgate a Restatement of the Law of Corporate Governance is unnecessary at best, citing to extensive scholarship–including his own–as well as extensive case law to support his position opposing the titular topic.

The good professor makes his case in a persuasive manner on his eponymous blog.

This post was prepared by Frank Reynolds, who has been following Delaware law and writing about it in various publications for over 30 years.

The Chancery Court recently required Authentix Holdings L.P. directors who were also employees of the brand protection services company’s controlling stockholder, private equity giant The Carlyle Group, to show that Authentix’s sale to Carlyle-connected Blue Water Energy met Delaware’s exacting entire fairness standard, in Manti Holdings LLC et al. v. The Carlyle Group Inc., et. al., No. 2020-0657-SG, opinion issued (June 3, 2022).

In a June 3 opinion, Vice Chancellor Sam Glasscock declined to dismiss investor charges that three Authentix directors and controller Carlyle disloyally shortchanged Authentix’s common shareholders by ramming through an inadequately priced deal and falsely claiming a “drag-along” provision in the company charter barred them from challenging it.  The decision allows the plaintiff investors to proceed with most of their breach of duty and unjust enrichment charges, but dismisses some aiding and abetting charges against the same defendants as duplicative.

The ruling is noteworthy for corporate transaction specialists because it found that even though Carlyle got no more than other preferred shareholders, the defendants were not shielded by Delaware law’s deferential business judgment rule or an exculpatory clause in the by-laws that exempts directors from monetary liability for breaches of fiduciary duty-of-care under 8 Del. C. § 102(b)(7).

Importantly, the vice chancellor said there are two reasons a deal can be tainted by a conflicted controller:

(a) where the controller stands on both sides; or

(b) where the controller competes with the common stockholders for consideration.

And a controller violates that second category where it:

  • “receives greater monetary consideration for its shares than the minority”
  • “takes a different form of consideration than the minority stockholders”, or
  • extracts “‘something uniquely valuable to the controller, even if the controller nominally receives the same consideration as all other stockholders.’”

“I find it reasonably conceivable that Carlyle received a unique benefit from closing the sale by September 2017 that rendered it conflicted,” the Vice Chancellor explained, noting allegations that  a majority of Carlyle-affiliated directors misused their control to force an early sale to their preferred buyer and to “monetize and close that fund so the money could be returned to investors.”  He said that disloyalty charge, if proven would not be exempted under 8 Del. C. § 102(b)(7).

Background

Authentix agreed to try to attract big capital investments by adopting a so-called “drag-along” clause that barred shareholder challenges to any deal approved by a majority of the Authentix stock.  That persuaded  Carlyle to buy a majority of Authentix stock – which in turn enabled Carlyle to place three directors on the five-member board.

But according to the complaint the Carlyle-affiliated directors were directed to sell Authentix as soon as possible in order to pay off the Carlyle investors who had funded the acquisition of a controlling interest in Authentix. In addition, a stockholder agreement allowed the preferred shareholder to take the first $70 million from any sale of the company with the common shareholders getting most of what was left.

And the Sept. 13, 2017 sale price that the Carlyle-majority of directors negotiated with Blue Energy was $77.5 million, with a possibility of additional funds if certain conditions were met later, according to the complaint filed by lead plaintiff Manti Holdings on behalf of other Authentix common shareholders.  There was no independent review or shareholder vote on the deal because none was called for under the consent agreement.

Must take entire fairness test

In his June opinion, Vice Chancellor Glasscock found the deal must be reviewed under the entire fairness standard because it was “reasonably conceivable” that:

(i) The Sale was an alleged conflicted controller transaction and

(ii) The Sale was not approved by an independent and disinterested Board.

He found that even though Carlyle did not stand of both sides of the transaction it was nevertheless conflicted because this was a deal “where the controller competes with the common stockholders for consideration.”  And although there was no extra money, the benefit Carlyle received was “something uniquely valuable” from the Sale because it had a unique desire to close its investment in Authentix by September 2017.”

He noted that “the Director Defendants’ decision to cut the lone dissenting stockholder, Barberito, out of the deliberations gives rise to a reasonable inference that Carlyle derived a unique benefit from the timing of the Sale.”

No exculpatory shield

The two Carlyle-affiliated director defendants here are protected by an exculpatory charter provision pursuant to 8 Del. C. § 102(b)(7), which normally insulates them from liability for duty of care claims, but here there are allegations that their loyalty was conflicted by their roles as officers of various Carlyle entities. The court said.  “If the interests of the beneficiaries to whom the dual fiduciary owes duties are aligned, then there is no conflict. But if the interests of the beneficiaries diverge, the fiduciary faces an inherent conflict of interest,” the vice chancellor explained.

However, he had already found that Carlyle’s interests diverged from the common stockholders with respect to the Sale and “There is no ‘safe harbor’ for such divided loyalties in Delaware.”

The Authentix CEO – who was also a member of the board is also conflicted for purposes of this motion because he “allegedly stated during Sale negotiations that he “worked for Carlyle” and “had been told to sell the company,” the court said.

The court dismissed alternate aiding and abetting claims against all defendants since they already face similar claims based on their fiduciary duty.

My latest ethics column for the publication of the American Inns of Court, The Bencher, appears in the current edition regarding the titular topic, and is reprinted on these pages with the courtesy of the publisher. (I have been writing the ethics column for more than 20 years for The Bencher.)

Delaware Supreme Court Clarifies Pro Hac Vice Standards

By Francis G.X. Pileggi, Esquire

A recent ruling from the Delaware Supreme Court reversed a trial court’s revocation of a non-Delaware attorney’s admission pro hac vice. In the process, Delaware’s high court clarified for Delaware trial courts and lawyers the appropriate standard for pro hac vice admissions and revocations.

Overview of Decision

In July 2020, a defamation action was filed in Delaware Superior Court alleging that published articles falsely accused the plaintiff of “colluding with Russian agents to interfere with the 2016 presidential election.” Page v. Oath Inc., Del. Supr., No. 69, 2021, Order at 1 (Jan. 19, 2022). The same day as the ruling on the pro hac vice issue, the Supreme Court issued a decision on the substantive appeal in the defamation action.

The Superior Court sua sponte issued a rule to show cause why the admission pro hac vice of the non-Delaware lawyer should not be revoked—based on conduct that the trial court on its own observed as having taken place in other jurisdictions. The non-Delaware lawyer responded by explaining that there was no finding by any court in any other state of either litigation misconduct or other wrongdoing in the matters the trial court referred to in its rule to show cause.

Notwithstanding his rejection of any basis for the court to revoke his pro hac vice admission, the non-Delaware attorney voluntarily withdrew his application for pro hac vice admission and his appearance in the case. Nonetheless, without a hearing, the trial court revoked his pro hac vice admission.

Delaware’s high court was troubled by the trial court’s description of the non-Delaware lawyer’s actions in other states as wrongful, even though the courts in those states did not make any such findings. The trial court also cast aspersions on the non-Delaware attorney’s character with vituperative allegations and reference to what the trial court thought was the non-Delaware lawyer’s role in national political events—an issue not included in the rule to show cause.

Highlights of the Supreme Court’s Decision

The appellate review standard for the revocation of a pro hac vice admission under Superior Court Rule 90.1(e) is abuse of discretion. Because the revocation ruling by the trial court was “based on factual findings for which there was no support in the record,” the Supreme Court determined that the trial court’s decision was an abuse of discretion.

The high court reasoned that even though a trial court is not powerless to act when a lawyer admitted pro hac vice is accused of serious misconduct in another state:

“…when, as here, the allegations of misconduct in another state have not yet been adjudicated, there is no assertion that the alleged misconduct has disrupted or adversely affected the proceedings in this State, and the lawyer agrees to withdraw his appearance and pro hac vice admission, it is an abuse of discretion to preclude the lawyer’s motion to withdraw in favor of an involuntary revocation of the lawyer’s admission.”

The Supreme Court’s reasoning was also buttressed by its finding that despite the trial court’s statement that the trial court’s decision was not impacted by its “conjecture” that the non-Delaware lawyer’s conduct had “precipitated the traumatic events” that occurred in Washington, DC, in January 2020: The trial court’s “willingness to pin that on [the non-Delaware lawyer] without any evidence or giving [the non-Delaware lawyer] an opportunity to respond is indicative of an unfair process.”

The trial court also held that the denial of a request for injunctive relief in a Georgia case the non-Delaware lawyer was involved in was, in the trial court’s estimation, “textbook frivolous litigation.” To the contrary, the Supreme Court explained that a determination of the absence of factual or legal support for injunctive relief is not the equivalent of a finding that a complaint is frivolous. Rather, the Supreme Court instructed that “our own ethical rules, by prohibiting a lawyer from asserting claims ‘unless there is a basis in law for doing so that is not frivolous,’ implicitly recognize that a claim ultimately found to lack a basis in law and fact can nonetheless be non-frivolous.”

Although it was not stated in the ruling, this author’s insight suggests that additional support for the Supreme Court’s decision might also be found in a recent opinion of Delaware’s high court that underscored the general rule that only the Delaware Supreme Court has authority to regulate the professional conduct of Delaware attorneys and to enforce the Delaware rules of legal ethics.