Regular readers of these pages may recall multiple prior blog posts on both veil-piercing and reverse veil-piercing over the last 16 years. Serious students should review the book on the topic by the renowned corporate law scholar, and a friend of this blog, Professor Stephen Bainbridge. The Delaware Court of Chancery recently recognized reverse-veil-piercing in the matter styled: Manichaean Capital, LLC v. Exela Technologies, Inc., C.A. No. 2020-0601-JRS (Del. Ch. May 25, 2021).

Much commentary has already been published about the public policy and related implications of this decision. See, e.g., Professor Bainbridge’s emphasis that the opinion in this recent Chancery ruling only endorses “outside reverse veil piercing and not insider RVP.” See also Keith Paul Bishop’s commentary on the case.  See generally samples of Professor Bainbridge’s  multiple publications on the topic as referenced in many of this blog posts. I typically do not supplement existing extensive commentary on a decision that has already been the subject of many published insights, but because this is a topic of enduring importance, I want to call to the reader’s intention some of the existing commentary.

Of note, in connection with the facts of this case, is the long list of entities involved as parties, and the court’s observance that to disregard the legal entities, it was first required to engage in conventional corporate veil-piercing, as well as reverse corporate veil-piercing by traveling the following route: reaching upwards to the parent, and then downwards to reach wholly-owned subsidiaries. The court acknowledged that the legality of reverse veil-piercing appeared to be a matter of first impression in Delaware. The ruling was in the context of denying a motion to dismiss under Rule 12(b)(6), so we do not yet know the final outcome if the case goes to trial.

The court found that the pleadings sufficiently alleged fraud and injustice that might result, depending on the evidence presented at trial, from abusing the corporate form to avoid collection of a judgment.

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

The Delaware Court of Chancery recently ruled that SmileDirectClub Inc. investors did not have derivative standing to charge that their stock value was disloyally devalued by their directors’ excessively-priced insider transaction because it originated before the initial public offering in which plaintiffs became stockholders, in In Re SmileDirectClub Inc. Derivative Litigation, No. 2019-0940-MTZ, opinion issued (Del. Ch. May 28, 2021).

Vice Chancellor Morgan Zurn’s May 28 decision dismissing breach-of-duty charges interpreted a key Delaware Supreme Court opinion on the contemporaneous ownership requirement as saying the challenged insider stock sale must be dated when the SmileDirect board approved it—not when it took effect after the IPO.

The opinion should be a useful guide for determining derivative standing, particularly for thorny issues that often arise involving the timing of mergers and stock sales. It applies Section 327 of the Delaware General Corporation Law using the state supreme court’s ruling in 7547 Partners v. Beck, 682 A.2d 160 (Del. 1996), to determine when an alleged wrongful act occurred and the Chancery Court’s Leung v. Schuler, 2000 WL 264328 (Del. Ch. Feb. 29, 2000), ruling to decide whether a transaction qualifies as an exception to the Beck rule.

Using that guideline, Vice Chancellor Zurn found that the SmileDirect insider stock sale fit squarely into the Beck category and had little in common with the Leung exception.

Background
SDC, a pioneering direct-to-customer med-tech supplier of discounted orthodontic treatments founded in 2014, decided to reorganize its ownership structure as a Delaware-chartered company in 2019 and disclosed that it would use the proceeds of an IPO to repurchase the earlier investment of six insider directors and their entity allies.

The complaint filed by plaintiffs Kerry Harts and the Doris Shenwick Trust alleged that they were unaware when they bought stock in the SmileDirect’s 2019 IPO that it would be devalued by an insider stock sale that the board had agreed to earlier. The suit charged that the board breached its duty by agreeing to use most of the IPO’s proceeds to pay an “exorbitant price” to purchase the investments.

When the stock price cratered in the days after the IPO because of the prior purchase-price payout, new investors were cheated, plaintiffs said.

No stock, no standing, no suit
The defendants moved to dismiss, arguing that although the stock buy automatically went into effect at the time the IPO provided it with funds, the agreement was inked earlier, when plaintiffs had no stock. The Vice Chancellor agreed, noting that the IPO prospectus clearly disclosed the board’s intention to use up to $808 million of the proceeds to pay for the old SmileDirect stock.

“In Beck, the Delaware Supreme Court held “the timing of the allegedly wrongful transaction must be determined by identifying the wrongful acts which [the plaintiffs] want remedied and which are susceptible of being remedied in a legal tribunal,” the Vice Chancellor said.

But she noted that, “When the plaintiff challenges “the technicality of [a transaction’s] consummation,” rather than the terms of the transaction itself, the Court will measure standing from the time the transaction was completed.”

Nothing like Leung
Plaintiffs argued that, as in Leung, “the wrongful act forming the basis of the derivative claim took place when the [Insider Transactions] w[ere] completed, after Plaintiffs became stockholders,” as “no claim could have arisen until the Company’s intent was manifested despite changed circumstances,” namely the continuously declining stock price and the allegedly undisclosed regulatory challenges that were publicly aired only after the IPO closed”

But the Vice Chancellor ruled that this case bears no resemblance to Leung or any other opinion on Beck exceptions. She said plaintiffs’ primary issue is that the Board:
(1) fixed the Insider Transactions’ price together with the IPO, knowing both prices were inflated; and (2) consummated the Insider Transactions at those prices, even as the market.

Baked-in price
Regarding the alleged board agreement to an overpriced insider sale, she said the board, “must have approved or acquiesced in the pricing” before Plaintiffs purchased stock in the IPO because that price “was baked into the IPO, and Plaintiffs were aware of it.”

In granting the motion to dismiss, Vice Chancellor Zurn noted that “this does not mean Plaintiffs are without recourse; it simply means that Plaintiffs do not have the authority to pursue these derivative claims on SDC’s behalf.”

For the most recent iteration of Delaware law on the topic of forum non conveniens, as it has evolved over the last few years, careful readers should be aware of the recent Chancery decision in Sweeny v. RPD Holdings Group, LLC, C.A. No. 2020-0813-SG (Del. Ch. May 27, 2021). This decision is consistent with the latest developments in Delaware law regarding forum non conveniens, to the extent that “overwhelming hardship” need not be established by the defendant where, as in this matter, the plaintiff did not file suit first, and the cases in competing states are deemed to have been simultaneously filed. The shift towards a reduced importance of that “hardship criteria” developed after the Delaware Supreme Court’s 2014 opinion in the Martinez case, which was highlighted on these pages.

The opinion also features a reference to an unusual form of financing not essential to its conclusion, called the tontine, named after a 15th century Italian financier Lorenzo de Tonti.

One of the more quotable parts of this decision is that the court decided that it should not retain jurisdiction to apply New Jersey law because that would be “lane-hogging”, and that the court wanted to “stay in [its] lane.”

The Delaware Court of Chancery recently provided a nearly book-length tutorial on the law of statutory appraisal in Delaware in a 132-page post-trial decision styled In re Appraisal of Regal Entertainment Group, Cons. C.A. No. 2018-0266-JTL (Del. Ch. May 13, 2021). The court held that the proper price was the deal price, adjusted to eliminate the value arising from the accomplishment or expectation of a merger. An adjustment also had to be made because of the increase in the value after signing, but before closing. The court reviewed the various valuation methods used by the parties’ experts and explained why one deserved the most weight in this case.

In the case of Snow Phipps Group LLC v. KCAKE Acquisition, Inc., C.A. No. 2020-0282-KSJM (Del. Ch. April 30, 2021, modified  June  2021), the court reviewed a topic of importance in deal litigation and one that has been the subject of many blog posts on these pages: an analysis of when reasonable best efforts or commercially reasonable efforts, which are deemed equivalent standards, have been satisfied.  This decision found that reasonable best efforts were satisfied in the context of obtaining financing–and found no MAE in the context of the pandemic. Also notable in this decision is the discussion of the “prevention doctrine.”

This 125-page decision, authored by newly-appointed Chancellor Kathaleen St. J. McCormick while she was still a Vice Chancellor, has already been the subject of much commentary by practitioners and others. See, e.g., the overview that appeared on Harvard Law School’s Corporate Governance Blog (on which yours truly has published multiple articles in the past.)  In part because I prefer not to duplicate extensive existing commentary, I simply want to highlight a few key issues addressed in the opinion that have widespread applicability to corporate and commercial litigators.

A prior Chancery decision in AB Stable VIII LLC v. Maps Hotels and Resorts One LLC (Del. Ch. Nov. 30, 2020), was another magnum opus of epic length that addressed similar issues, such as reasonable best efforts, and similarly did not find an MAE in the context of the pandemic.

A common type of business litigation case in Delaware involves post-closing purchase price adjustments, a variation of often-litigated earn-out disputes. Many agreements for the sale of a business include a provision that appoints an independent accounting firm to resolve disputes regarding a determination post-closing of working capital as of the closing date, for example, which impacts the final purchase price. A well-reasoned and pithy analysis of this type of issue was featured in a recent decision by the Complex Commercial Litigation Division of the Delaware Superior Court in the matter styled LDC Parent, LLC v. Essential Utilities, Inc., C.A. No. N20C-08-127-MMJ-CCLD (Del. Super. Apr. 28, 2021).

This decision determined that the particular post-closing dispute involved was subject to the binding decision of an independent accountant. More specifically, the parties disagreed about whether a Capital Expenditure, defined in the agreement as actually paid or payable, was properly capitalized according to U.S. GAAP. The Court rejected the argument that the issue was one of contract interpretation that should be subject to judicial review–and agreed with the argument that the dispute was covered by a clause that made it fall within the scope of the independent accountant’s decision-making authority.

The Court also held that it was not necessary to decide at this point whether the accounting issue involved would result in the independent accountant serving as an expert or an arbitrator–though the opinion features many citations to Delaware opinions that have addressed that specific issue in the context of similar post-closing dispute clauses that provide for certain post-closing issues to be decided by an independent accountant.

This opinion should be kept handy in the toolbox of those who litigate post-closing price adjustment cases as well as those who draft such agreements.

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

Delaware’s Court of Chancery recently threw out an attempt to undermine activist investor Carl Icahn’s claim of business judgment protection under the seminal MFW ruling for his buyout of Voltari Corp.’s minority, finding plaintiffs failed to prove a special director committee lacked independence or that a shareholder vote was uninformed or coerced in Franchi, et al. v. Firestone, et al., No. 2020-0503 KSJM, order issued (Del. Ch. May 10, 2021). 

Newly-appointed Chancellor Kathaleen St. J. McCormick’s May 10 order dismissing a combined shareholders’ breach-of-duty lawsuit provides an updated application of a key Delaware Supreme Court opinion on the requirements shareholder plaintiffs must meet to force an interested majority shareholder like Icahn to show that a deal’s price and negotiation were entirely fair to investors.   Kahn v. M & F Worldwide Corp. 88 A.3d 635 (Del. 2014)(“MFW“), overruled on other grounds by Flood v. Synutra Int’l, Inc., 195 A.3d 754 (Del. 2018).

The crux of that touchstone high court ruling was that in a challenged controller-backed deal the defendants could get benefit-of-the doubt deference – and a much-improved chance of winning — only if the controller insured that the minority’s interests were protected by:

(i) conditioning the transaction on the approval of both a special committee and a majority of the minority stockholders; 

(ii) making the special committee independent; 

(iii) empowering the special committee to freely select its own advisors and to say no definitively; 

(iv) allowing the special committee to meet its duty of care in negotiating a fair price; 

(v) ensuring that the vote of the minority is informed; and

(vi) barring any coercion of the minority vote.

Background

Plaintiffs’ suit claimed the $7.7 million Icahn and his allies paid in 2019 for the 48 percent of Voltari they did not yet own undervalued the commercial real estate investment company and resulted in a “windfall” to Icahn in the form of $78.7 million in tax savings from Voltari’s past losses called “net operating loss carryforwards”

The combined complaints of former shareholders Adam Franchi and David Pill charged that: Icahn was unjustly enriched by coercing a deep discount price for the NOL’s, the Voltari directors breached their duties by wrongly approving the merger and that along with Icahn and his companies, they comprised an improper control group.

They claimed that:

(i) the Special Committee lacked independence;

(ii) the Special Committee failed to exercise its duty of care; and

(iii) the vote of the minority was not informed

No unreasonable, reckless actions

The Chancellor ruled in favor of dismissal of the challenge to the special committee’s independence because, “To plead that a director is not independent “in a manner sufficient to challenge the MFW framework, a plaintiff must allege facts supporting a reasonable inference that a director is sufficiently loyal to, beholden to, or otherwise influenced by an interested party so as to undermine the director’s ability to judge the matter on its merits.”

She said, “If the complaint supports a reasonable inference that [any] member [of the special committee] was not disinterested and independent, then the plaintiffs have called into question this aspect of the MFW requirements.” 

But the complaint here fails to show “conduct that constitutes reckless indifference or actions that are without the bounds of reason.”  Disagreeing with a special committee’s strategy is not a duty of care violation, nor is a “windfall“ allegation that amounts to “questioning the sufficiency of the price,” the Chancellor noted.

No controlled mindset

The fact that the special committee “met seven times, engaged and consulted with independent advisors, came to a reasoned decision to negotiate a transaction with Icahn, and successfully bid the deal price up by 48% percent” does not support the allegation that it fell under a “controlled mindset,” the court held.

No material disclosure left behind

Under MFW, the board’s consideration and rejection of a special committee candidate who had been an employee of an Icahn company did not need to be disclosed in the buyout proxy because it would not have been material to the average investor, the Chancellor ruled, finding that, “This alleged omission does not render the vote of the minority stockholders uninformed.”

Only gross negligence claims survive

Finally, the chancellor dismissed the unjust enrichment charge because it only involves ordinary negligence and since it has been determined that the business judgment standard applies, under MFW, only claims of gross negligence could survive the motion to dismiss.

                                                                                                                                                 

In the matter of Patel v. Duncan, C.A. No. 2020-0418-MTZ (Del. Ch. May 17, 2020), the Court of Chancery addressed whether a party was indispensable for purposes of Court of Chancery Rule 19(a), and held that the case would not proceed until those parties were added. Anyone needing to know the latest iteration of Delaware law on Rule 19 should be familiar with this decision.

 

One of the country’s foremost corporate law scholars, Prof. Stephen Bainbridge, who readers of Delaware corporate law decisions and readers of these pages will recognize as having earned a place in the pantheon of corporate law luminaries, has commented on the titular topic, based on a recent Wall Street Journal article that discusses a backlash by conservatives against CEOs who also have a “side hustle” as “social justice warriors”. The good professor cites to a related law review article he wrote (among the voluminous scholarship he has published), and also muses about:

… why so few conservative activists have seized upon the SEC shareholder proposal rule (Rule 14a-8) to put proposals on company proxy statements supporting conservative causes or opposing woke policies by corporations. Especially when there’s a slightly bored corporate law professor just waiting to advise them.