Delaware A.G. Obtains Cancellation of LLC Certificate of Formation

The Delaware Attorney General announced today that she obtained a Consent Judgment to secure the cancellation of  the Certificates of Formation for several LLCs allegedly involved in criminal activities or otherwise “abusing its LLC powers and privileges” in connection with the website Backpage.com. The Consent Decree signed by the Court of Chancery was dated June 11, 2019.

Chancery Orders Mandatory Indemnification per DGCL Section 145(c)

A recent Delaware Court of Chancery decision ordered mandatory indemnification based on success in underlying litigation pursuant to DGCL § 145(c), in the matter styled:  Brown v. Rite Aid Corporation, C.A. No. 2017-0480-MTZ (Del. Ch. May 24, 2019).

Issue Addressed Whether dismissal of the underlying litigation based on a technical argument was “success” for purposes of mandatory indemnification under DGCL Section 145(c)–even if all of the arguments in the underlying litigation were not successful?

Answer:  Yes.

Procedural Background:

The procedural history of this litigation involves multiple court decisions in several jurisdictions over the span of a decade.  See, e.g., cases cited at footnotes 4, and 13 through 17.

Even though Brown was convicted and sentenced for certain financial crimes in connection with his role as an officer and a director of Rite Aid, in separate civil litigation pursued against him by Rite Aid, Brown was successful in having that litigation dismissed based on technical procedural arguments.  See footnotes 18 through 20 and accompanying text.

Key Aspects of Court’s Legal Analysis:

The court began its analysis by explaining that indemnification sought in this matter was based on three separate sources.

First, Brown relied on DGCL Section 145(c) which requires indemnification when a present or former director or officer has been “successful on the merits or otherwise” . . ..  The court noted that Section 145(c) is independent and non-exclusive of any right based in the charter, which in turn is independent and non-exclusive of any bylaw right, which in turn is independent and non-exclusive of any contract right, absent specific agreement to the contrary.  See Section 145(f), which makes this clear in both the indemnification and the advancement context.

The second basis for indemnification in this case was a provision in the corporate bylaws.

The third basis for indemnification sought in this matter was a provision in the corporate charter.

Notably, the court observed that even though Section 145(c), in the current version of the statute, covers officers and directors, the court added : 

“But when a corporation has provided other authorized individuals with mandatory indemnification to the fullest extent of the law, then that right extends the mandatory indemnification contemplated by Section 145(c) to those individuals”  (citing Dore v. Sweports, Ltd., 2017 WL 415469, at * 18 (Del. Ch. Jan. 31, 2017)).

The foregoing extension of the mandatory indemnification of Section 145(c), which in its current form only benefits directors and officers–to employees, agents and others that are expressly granted indemnification in the bylaws “to the fullest extent allowed by law”–is not well-known even by those familiar generally with the nuances of advancement law in Delaware.

The court explained that Section 145(c) provides for mandatory indemnification for an officer and a director who meets the requirements of the statutory provision, which is when: “a covered person defending himself in a covered proceeding . . . succeeds on the merits or otherwise . . ..”  See Slip op. at 10.  See also footnotes 39-41.

Other Notable Bullet Points:

·     The court recited the public policy rationale behind mandatory indemnification as including the need to encourage capable individuals to serve as corporate directors, which is viewed less as an individual benefit and more as a desirable mechanism in return for greater corporate benefits.

·     A key point and an essential aspect of the court’s reasoning is its reliance on an abundance of case law that interprets the “success” requirement in Section 145(c) very broadly.  That is, in order to satisfy the requirement of success “on the merits or otherwise” under Section 145(c), one must merely obtain any result in a lawsuit “other than conviction,” which does not equate with moral exoneration, but rather can be satisfied merely from:  “escape from an adverse judgment or other detriment, for whatever reason . . ..”  See footnotes 54 to 55 and accompanying text.

·     Moreover, if such a broad definition of success is achieved, it is not relevant, and the court will not inquire into, whether all arguments were won, or if preliminary motions or other efforts in the underlying litigation failed before the final successful result was reached.  See footnote 56 and accompanying text.  See also footnotes 72 to 80 and accompanying text.

·     The court also granted fees on fees and required Brown to file an affidavit under Rule 88, itemizing the fees for which he seeks indemnification, along with a motion seeking an entry of an order requiring the corporation to indemnify him in the amount specified in the damages motion.

Forum Selection Clause Interpreted Based on Austrian Law

A forum selection clause, controlled by Austrian law, was recently interpreted by the Delaware Court of Chancery as a mandatory forum selection clause requiring the dispute to be litigated in Vienna.  In Germaninvestments A.G. v. Allomet Corporation, C.A. No. 2018-0666-JRS (Del. Ch. May 23, 2019), the court also determined that the choice of law provision designating Austrian law and the forum selection clause requiring litigation in Vienna were both enforceable.

Procedural Background:

The court observed that Rule 12(b)(3), which addresses improper venue, was “the proper procedural rubric” for addressing a motion to dismiss based on a forum selection clause.  The court also explained that a motion under Rule 12(b)(3) does not “shackle” the court to the plaintiff’s complaint, but rather the court is permitted to consider extrinsic evidence from the outset.  See footnote 63. 

The court also noted that Chancery Rule 44.1 provides the procedure for presenting foreign law to the court to allow the court to interpret a document governed by foreign law.  The rule provides that a party is required to give notice in the pleadings or other reasonable written notice that the law of a foreign country will control.  Prior decisions have recognized that expert affidavits may be considered along with expert testimony.

Key Statements of Law:

·     The court explained the well-settled rule that Delaware courts will give effect to the terms of private agreements providing for forum selection clauses.  See footnote 64 and accompanying text.

·     In order for a forum selection clause to be considered exclusive under Delaware law, the “contractual language must be crystalline in stating the parties’ intent to litigate only in the designated forum.”  See footnote 66.

·     The Delaware courts also generally honor contractually-designated choice of law provisions as long as the jurisdiction selected “bears some material relationship to the transaction.”  See footnote 70.

·     A key issue is whether the forum selection clause states that it is exclusive, or whether the language will be construed as merely permissive. See footnote 80 (citing Delaware cases holding that a mandatory forum selection clause must make clear that the litigation is required to proceed in the designated forum).

·     In this instance, the applicable Austrian law applied to require litigation only in Vienna.

·     The court also rejected the argument that DGCL Section 168 applied because the statute relates to replacements for lost stock certificates, and in this instance the issue was whether the original stock certificate should have been issued.

Chancery Grants Advancement on Counterclaims

A recent Delaware Court of Chancery bench ruling granted advancement in connection with defensive counterclaims against a former officer and director.  In Dodelson v. AC Hold Co., Inc., C.A. No. 2019-0029-SG (transcript) (Del. Ch. May 21, 2019), the court interpreted the provisions of a charter with advancement provisions, and reasoned that advancement was warranted.

An issue arose about whether or not the advancement provision in the charter expressly covered former officers and directors.

The court reasoned that the advancement provision referred to coverage for “indemnified parties”, and the definition of “indemnified parties” was incorporated by reference in the court’s interpretation. The court reasoned that the definition applied to former officers and directors as well.  The court also distinguished the Chancery decision in Charney v. American Apparel, Inc., which was highlighted on these pages, and which the court found was based on language different from that present in this matter.

Brief Commentary: 

Many advancement decisions have been highlighted on these pages over the last 14 years, and this 13-page transcript ruling can be generally categorized as representing the overwhelming body of case law that grants advancement when it’s a “close call.” See, e.g., recent advancement decision highlighted.

 The court reasoned that at best for the corporation, the provision was ambiguous–and ambiguous provisions are construed against the drafter, which in this case is the corporation. That was a second reason to grant advancement in addition to the court’s interpretation of the applicable language.

Postscript Thanks to Kurt Heyman of Heyman Enerio Gattuso Hirzel LLP, the winning attorney in this case, for forwarding the transcript ruling.

Chancery Denies Motion to Disqualify Firm

A recent Order by the Delaware Court of Chancery restated the well-established case law that a motion to disqualify counsel that is based an alleged violation of the Delaware Lawyers’ Rules of Professional Conduct will not be granted unless it is shown by clear and convincing evidence that there is not only a violation of the DLRPC, but also the breach must be “so extreme that it calls into question the fairness or the efficiency of the administration of justice.”  Indemnity Insurance Corporation, RRG, v. Cohen, C.A. No. 8985-VCZ (Del. Ch. Apr. 22, 2019) (Order)(citing Dunlap v. State Farm Fire & Cas. Co., 2008 WL 2415043, at * 1 (Table) (Del. May 6, 2018)).  The Order added that trial courts do not have jurisdiction in Delaware to consider applications for breach of the DLRPC unless the challenged conduct prejudices the fairness of the proceedings. (citing In re Infotechnology, Inc., 582 A.2d 215, 221 (Del. 1990)).

Court’s Rationale & Key Rules Cited:

An eminently quotable passage from the Order in this case deserves to be highlighted:

“A corporation being a purely metaphysical creature, having no mind with which to think, no will with which to determine and no voice with which to speak, must depend upon the faculties of natural persons to determine for it its policies and direct the agencies through which they are to be effectuated.” 

(citing N. Assur. Co. v. Rachlin Clothes Shop, 125 A.184, 188 (Del. 1924)); see 8 Del. C. § 141(a); 18 Del. C. § 5911.  See also, DLRPC 1.13 which recognizes that an organizational entity cannot act except through its officers, directors, employees, shareholders or other constituents and that a lawyer representing an organization represents it through its duly authorized constituents. 

The court also discussed DLRPC 1.7 which provides, with exceptions not relevant here, that a lawyer shall not represent a client if the representation involves a concurrent conflict of interest, which exists if: “(1) the representation of one or more clients will be directly adverse to another client; or (2) if there is a significant risk that the representation of one or more clients will be materially limited by the lawyers’ responsibilities to another client, a former client or a third person or by personal interest of the lawyer.”

The court’s reasoning is included in the following conclusion: simply because the firm [that was the subject of the motion to disqualify] was hired by the board to represent the corporation initially, does not disqualify it from representing the corporation on behalf of a receiver appointed by the insurance commissioner.

Concluding Note:

This case involves a lengthy procedural history of prolonged litigation by the Delaware insurance commissioner due to financial improprieties by the controlling stockholder of the insurance company that was forced into a receivership by the insurance commissioner. 

Court Orders Waiver of Privilege Due to Deficient Privilege Log

A recent bench ruling from the Court of Chancery granted a motion to compel production of documents improperly withheld as privileged–and in the process ordered that privilege was waived due to the deficient preparation of the privilege log.  See Mountain West Series of Lockton Companies, LLC v. Alliant Insurance Services, Inc., C.A. No. 2019-0226-JTL (transcript) (Del. Ch. May 17, 2019).

A number of prior Chancery decisions highlighted on these pages have held that asserted privileges have been waived due to the deficient nature of the privilege log prepared.  In this case, the court adopted the arguments in the 14-page motion to compel which is provided at this hyperlink, made available in The Chancery Daily edition of Friday, May 24, 2019. Also note the reply at this hyperlink, filed after the response to the motion, made available by The Chancery Daily in its edition of May 24, 2019.

The motion also featured the vexing and unfavored practice of “dribbling” production of documents–after the deadline  for production, and with no clarification about when the final production will be complete–without asking for an extension. See footnote 6 in Motion to Compel linked above.

Miscellaneous Delaware Corporate and Commercial Practice Updates

This post is an aggregation of miscellaneous worthwhile Delaware corporate litigation developments that was easier to present as one post instead of multiple smaller posts:

1.     Case Law Regarding Importance of Formalities to Modify Pretrial Scheduling Orders:

A Delaware Supreme Court opinion of several years ago, highlighted on these pages, emphasized that informal extensions of a scheduling order, without court approval, might not be recognized by the court if the unapproved new deadlines are not met.  See Christian v. Counseling Resources Associates.  A recent Chancery transcript ruling indicates that there may not be uniform application of that Supreme Court decision in the trial courts.  See Greenstar IH Rep, LLC v. Tutor Perini Corp., C.A. No. 12885-VCS, transcript (Del. Ch. Mar. 11, 2019; filed Mar. 27, 2019); see also Vanilla Corp. v. VelQuest Inc., C.A. No. 7459-VCL, transcript (Del. Ch. Jan. 15, 2013). But see and compare: a relatively recent Chancery decision that went to great lengths to emphasize the importance of adhering to scheduling orders and court-imposed deadlines, which was highlighted on these pages.

2.     Rule 54 Interpretation:

Court of Chancery Rule 54 allows “costs” to be awarded to the “prevailing party,” but disputes about: (i) who is the prevailing party; and (ii) which exact costs are covered by the rule, are not well developed nuances explained by many reported Delaware court opinions. Not to worry: a recent Chancery transcript ruling added to the paucity of court decisions on this important, esoteric topic by finding that the costs of a supersedeas appeal bond were included as Rule 54 costs when, after a Supreme Court remand, the party who lost in the trial court and posted a bond pending appeal–and became the prevailing party on remand–was entitled to the costs of the supersedeas bond.  The court distinguished a prior case where a compromise by the parties on a substitute for a bond did not make it a “necessary expense” in that matter.  See In re Oxbow Carbon, LLC Unitholder Litigation, C.A. No. 12447-VCL consol. (Order )(Del. Ch. May 10, 2019).  One of the many prior Chancery decisions in this matter was highlighted on these pages–a lengthy post-trial Chancery opinion which was reversed in part on appeal and remanded.

3.     Amendments to Court of Chancery Rules of Procedure:

The Court of Chancery Rules are modeled after the Federal Rules of Civil Procedure which were recently amended.  Consistent with the recent amendments to the FRCP, the Court of Chancery recently amended Rules 1, 26, 34 and 37–effective on July 1.  The press release from the court is at the following link.   The order changing the rules is available at this link, and a redlined version of the new rules is available at this link

In short, highlights of the amendments include the following:

(i)  the proportionality standard is imposed, based on the type of the case, as an explicit parameter for the scope of discovery instead of the former “unduly burdensome” standard;

(ii)  specific references added to “ESI” for electronically stored information;

(iii)  the new rules follow the federal amendments and omit the well-worn standard of “reasonably calculated to lead to the discovery of admissible evidence,” and replace it, in the comment section only, with: “any possibility that the discovery will lead to relevant evidence.”

4.     Useful Commentary on “Non-Financial” Caremark Claims:

The Harvard Corporate Governance Blog has a useful blog post about Caremark claims for non-financial matters such as: condoning a culture of harassment, e.g., the Harvey Weinstein matter.  It’s a 2018 post, but still relevant today.

Chancery Denies Indemnification Claim Seeking Recoupment of Advancement

A recent Court of Chancery decision rejected an attempt to recoup advancement based on the terms of an indemnification clause. See Computer Sciences Corporation v. Pulier, C.A. No. 11011-CB (Del. Ch. May 21, 2019), for this recurring issue in Delaware corporate and commercial litigation.

Issue Addressed:  May a company recoup, via an indemnification claim, the amounts it previously was required to pay via an advancement ruling, based on the applicable contractual indemnification provisions.

Prior Procedural History:

·     Prior rulings in this matter were highlighted in prior blog posts on these pages–including rulings granting advancement.  See also transcript ruling in this matter cited at footnotes 12 and 13, that granted advancement based on the prior holding that: “conduct as an officer . . . was squarely at issue.”  Slip op. at 4 (citing footnotes 12 and 13).

Court’s Holding:

·     Based on the applicable terms of the indemnification provision in the agreement of sale, the court determined that the indemnification provisions only covered post-closing losses for “board-approved” liabilities related to the sale, which was not the basis for the prior advancement granted in this case.

Chancery Instructs on DGCL Merger Requirements

A recent Delaware Court of Chancery opinion began by describing the complaint as reading like a law school exam designed to test the knowledge of a student regarding the requirements in the DGCL that must be satisfied in connection with a merger, and the court commented that the company would not have done well on the exam. 

In Mehta v. Mobile Posse, Inc., C.A. No. 2018-0355-KSJM (Del. Ch. May 8, 2019), the court identified the six primary issues in this case as follows: 

(1) Whether DGCL Section 262 was not complied with in connection with the failure to notify stockholders of their appraisal rights within the required timeframe;

(2) Whether DGCL Section 228 was not complied with due to the failure to send prompt notice of the written stockholder consents;

(3) Whether the merger agreement, or documents it incorporates, failed to comply with DGCL Section 251 by not including the amount of cash the preferred stockholders would receive for their shares;

(4) Whether the stockholder consents did not enjoy the ratifying effect under DGCL Section 144;

(5)  Whether the director defendants breached their fiduciary duty of disclosure; and

(6) Whether the director defendants breached the fiduciary duty of loyalty because the merger was a self-dealing transaction and not entirely fair.  With one small exception, the court found that the statutory violations were sufficiently established at the early procedural stage of a motion for judgment on the pleadings.

Key Highlights of Decision:

·     As an initial procedural matter, in connection with this motion for judgment on the pleadings, the court observed that it was not well-established in Delaware case law or Rules of Civil Procedure whether a “supplemental notice” attached to a motion for judgment on the pleadings could be considered “part of the record or pleadings.”  Based on this opinion, however, it is established that under Delaware law, under some circumstances, it is now possible for such a supplemental notice to be included as part of the pleadings in such a procedural posture.  See, e.g., footnotes 1 through 6 and accompanying text.

DGCL Section 262:

·     The company sought a “do-over” or a mulligan for its statutory errors, because it purported to send proper notices required by DGCL Section 262–only after suit was filed.  Three problems with that approach are that: (i) Such a “replicated remedy proposal” had never before been blessed by a Delaware court; (ii) Even the supplemental notice proposed was itself wrong (in part because it quoted the statute of another statute); and (iii) trying to make a “supplemental notice” sent after the lawsuit was filed does not always make it part of the pleadings, although as noted above–in some circumstances–based on the opinion in this case, it is now possible to do so.  See Slip op. at 13.

DGCL Section 228:

·     Based on an amendment to the statute passed in 2017, Section 228 no longer requires that the written consent of stockholders be dated next to each signature.  See Slip op. at 19. 

·     The court addressed the “less than bright-line rule” about whether or to what extent disclosures are required in connection with written consents of stockholders pursuant to Section 228, but cases cited by the court in this opinion support the view that in this case the company is not entitled to judgment on the pleadings on this issue in light of the lack of material data, or their supplying of incorrect data, with the solicitations for consents that were sent to the minority stockholders in this case.

DGCL Section 228(e)–Prompt Notice Requirement:

·     The prompt notice requirement under Section 228(e) requires that notice of action by written consent of stockholders to those who did not consent must be prompt.  Nonetheless, the exact timetable for such “prompt notice” is not defined in the statute.  One case found that five months was not prompt.  In this matter, notice was given after the Section 262 appraisal deadline, which the court found as a sufficient basis to deny the motion for judgment on the pleadings filed by the company (rather audaciously) in this case.

DGCL Section 251(b):

·     This section of the DGCL requires that a merger agreement include specified details about the deal terms, including compensation to stockholders, but the company failed to comply with this requirement.

DGCL Section 144:

·     The court held that the safe harbor under Section 144(a)(2) was not satisfied in this matter because the stockholders were not given material facts about the interests of the directors in the merger.

The court also denied the company’s motion for judgment on the pleadings regarding claims for breach of fiduciary duty.

Delaware Supreme Court Addresses Damages for Breach of Consent-Rights, and Efficient Breach Theory

A recent Delaware Supreme Court decision is noteworthy for: (1) addressing damages for breach of consent-rights, as well as (2) discussing the concept of efficient breach.  In Leaf Invenergy Company v. Invenergy Renewals LLC, No. 308, 2018 (Del. Supr., May 2, 2019), the en banc court also engaged in a rare reversal of a Court of Chancery decision.

Brief Background:

The LLC Agreement included a provision which prohibited a company called Invenergy from conducting a “material partial sale” without the consent of the plaintiff, unless Invenergy paid plaintiff a premium called a “target multiple.”  The Court of Chancery determined that although Invenergy had breached the material-partial-sale consent provisions, the plaintiff was not entitled to the target multiple.  The court awarded nominal damages, because the Court of Chancery found that Invenergy engaged in an “efficient breach.”

Highlights of the Supreme Court Decision:

·     A helpful reminder of basic contract interpretation principles, including the objective theory of contracts followed by Delaware, is found at pages 16 and 17.

·     Delaware’s High Court discusses the concept of consent rights, and refers to Delaware case law on the topic at page 21.  The court rejected the reasoning of a 2017 Court of Chancery decision that ruled on consent rights. See In re Appraisal of GoodCents Holdings, Inc., 2017 WL 2463665 (Del. Ch. June 7, 2017).  Specifically, the Supreme Court ruled as follows:  “to the extent that GoodCents turns on an interpretation that the above-quoted provision [regarding consent rights quoted at page 23 of the Slip Opinion], cannot yield damages in the amount of the liquidation preference even in the absence of consent, we reject it.”  Slip op, at 24.

Breach of Consent-Right Damages:

·     The Supreme Court explained that the proper measure of damages for breach of the consent right in this case should give Leaf the benefit of the bargain it struck with Invenergy, and should be based on Leaf’s expected position–but for Invenergy’s breach.  Slip op. at 26.

·     The court further reasoned that the correct:

“but-for-the-breach” frame of reference is not what might had happened had Invenergy asked Leaf for its consent, because Invenergy’s contractual obligations and the means of performing them were not so narrowly drawn.  Invenergy’s “breach was only complete when it failed to obtain Leaf’s consent and when it failed to pay the target multiple at closing.”

·     The court further explained that:

“. . . when considering the breach as a whole, what would most aptly repair that breach is Invenergy’s payment–now in satisfaction of a damages award–of the amount it agreed it would pay for the right to engage in a material partial sale without Leaf’s consent.”

·     Delaware’s High Court also explained that remedial provisions and liquidated damage clauses are not the only way for a contract to specify the damages flowing from the breach.  For example, in a sales contract in which the seller fully performs and the buyer does not pay at all, the seller is entitled to the sales price specified in the contract.

Efficient Breach:

·     The court thoroughly addressed the concept of efficient breach.  See Slip op. at pages 29 The court’s reasoning is at pages 29-30.

·     The court explained efficient breach as a “concept that recognizes that ‘properly calculated expectation damages increase economic efficiency by giving the other party an incentive to breach the contract if, but only if, he gains enough from the breach that he can compensate the injured party for his losses and still retain some of the benefits from the breach.’”  See footnote 49.

·     The court further explained efficient breach as being “based on the idea that a party might find it economically worthwhile to breach a contract because that breach yields economic benefits that exceed the value of the damages it must pay to the non-breaching party.”

·     The court further instructed that: efficient breach does not bar recovery or modify damages calculations.  Rather the efficient-breach theory recognizes that “a party may find it advantageous to refuse to perform a contract if he will still have a net gain after he has fully compensated the injured party for the resulting loss.”  See footnote 52 (emphasis omitted).

·     The Supreme Court in this opinion rejected or distinguished at least one aspect of another Court of Chancery opinion–from 2013.  The court observed that Fletcher International, Ltd v. ION Geophysical Corp., 2013 WL 6327997 (Del. Ch. Dec. 4, 2013), involved a hypothetical negotiation as a method of calculating damages, but the court found that to be inapposite in this matter.  In Fletcher, there was no practical, contractually specified way for the breaching party to cure its breach.  Unlike in the instant matter, in Fletcher, the only way the breaching party could close the transaction in substantial conformity with the contract was by obtaining the injured party’s consent, which was impractical given the status of the litigation.  By contrast, in the instant matter, the agreement did specify how Invenergy could avoid obtaining Leaf’s consent and still perform the contract.

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