Chancery: Tesla investors need only prove Musk had coercive influence ability in SolarCity deal

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 found that a trial is needed to decide whether, despite his minority share of Tesla Motors Inc., CEO Elon Musk could exert a controller’s “coercive influence” over the electric carmaker’s shareholders who approved the 2016 acquisition of Musk’s struggling SolarCity Corp. in the matter styled: In Re Tesla Motors, Inc. Stockholders Litigation, No. 12711-VCS  (Del. Ch., Feb. 4, 2020.)

The Court’s February 4 decision largely denied dueling summary judgment motions by plaintiff investors — who say they’ve proved Musk and the directors hid SolarCity’s virtual insolvency, and the defendants — who claim that without proof that Musk is a conflicted controller, the shareholders’ uncoerced approval vote cleanses the deal.

How did he allegedly do it?

The Court scheduled a trial for March that is expected to focus on whether Musk’s alleged dominance of Tesla was so pervasive that he could advance his self interest at the expense of the public investors, triggering a court review under the exacting requirements of the entire fairness standard.

If plaintiffs fail to demonstrate Musk’s control, the directors would be shielded by the deferential standard of the business judgment rule, which would give their actions the benefit of the doubt, and make it tough to prove breach of fiduciary duty and corporate waste charges.

Importantly, the vice chancellor rejected the defense argument that after his March 2018 decision allowed the suit to survive a motion to dismiss and move from the pleading phase to the proof stage, the plaintiffs were now obligated to show exactly how Musk used his alleged control to coerce the investors’ SolarCity deal approval. See In Re Tesla Motors, Inc. Stockholders Litigation, No. 12711-VCS  (Del. Ch., Mar. 28, 2018).

Only have to prove ability

Vice Chancellor Slights said a line of Delaware Supreme Court decisions beginning with Corwin v. KKR Financial Holdings, only requires plaintiffs to prove that an alleged controlling shareholder was so dominant that he had the ability to coerce shareholders to consent to a merger that benefited him at their expense. Corwin v. KKR Financial Holdings LLC, 125 A.3d 304 (Del. 2015)

But he found both parties’ summary judgment motions regarding stockholder ratification and director conflicts were not ripe because “it is desirable to inquire more thoroughly into the facts,” before deciding whether Musk possesses “inherently coercive influence over the other stockholders.”

He said, under Delaware law, a minority shareholder could be a controller if he was shown to possess “other factors” such as the “managerial supremacy” of a “hands-on” CEO and “inspirational force” whose loss would cause a “material adverse effect” on the company’s business operations. Musk is commonly referred to as the heart and soul of Tesla.

The assumption that such a conflicted controller “has strong incentives” to exert an “inherently coercive” effect on a transaction is “a finding of empirical fact rooted in the Supreme Court’s perception of how the world works,” Vice Chancellor Slights said, citing In re JCC Hldg. Co. Inc., 843 A.2d 713 n.25 (Del. Ch. 2003).

However, the vice chancellor noted that even if a trial demonstrates that Musk was Tesla’s controller at the time of the merger, defendants could still avoid liability if they could prove the deal was entirely fair to the shareholders.

Trial needed

The opinion also found summary judgment was not appropriate for either party regarding certain disclosure claims because there are genuine issues of material fact to be resolved at trial regarding whether the shareholder approval was fully informed as to:

  • SolarCity’s alleged near insolvency at the time of the merger
  • Tesla’s financial advisor’s purportedly omitted material information about the deal
  • Alleged misleading disclosures hiding Musk’s merger talks role despite his recusal
  • Whether Tesla misrepresented the status of SolarCity’s solar roof product.
  • Whether Tesla misrepresented the expected financial impact of the merger on Tesla
  • The independence of the Tesla board

“A failure adequately to disclose all material facts to voting shareholders will serve both as a bases for director liability and to preclude a stockholder vote from having a ratifying effect,” and the burden of demonstrating the vote was fully informed “falls squarely on the board,” Vice Chancellor Slights wrote.

He found that at trial, plaintiffs may prove at least four of the seven Tesla directors had divided loyalties because of their SolarCity stock holdings and/or dual positions at Musk companies and that there is a genuine material fact dispute as to whether the merger was a waste of assets.

Postscript

According to press reports, shortly after the February summary judgment opinion, the Tesla directors agreed to pay plaintiffs $60 million from the company’s insurance to settle their liability, leaving Musk the sole defendant in the scheduled 10-day March trial before Vice Chancellor Slights.

Chancery Denies Attorneys’ Fees for Successful Suit to Compel Annual Meeting

The Court of Chancery recently denied a request for attorneys’ fees that were sought pursuant to the corporate benefit doctrine despite a successful suit under Section 211 of the Delaware General Corporation Law (DGCL) to compel a company to hold an annual meeting. In Martin v. Harbor Diversified, Inc., C.A. No. 2018-0762-SG (Del. Ch. Feb. 5, 2010), the court also rejected the request for fees based on allegedly bad faith litigation tactics. A third basis for requesting fees, that the court also found unpersuasive, was the argument that the plaintiff prevailed in its demand for documents under DGCL Section 220. (As an aside, fee shifting is rarely granted in Section 220 cases, as indicated in the multitude of Section 220 decisions highlighted on these pages over the last 15 years.)

In sum, the court explained that the predominant benefit, and primary motivating factor in this case, was personal to the stockholder pursuing the claims. By comparison, when fees are granted based on the corporate benefit doctrine, which is a sub-species of the common benefit doctrine, which allows (but does not require) a court to grant attorneys’ fees based on various equitable criteria, the theory is designed to avoid the “free rider” inequity when all stockholders–and a corporation generally–benefit from the litigation efforts of one stockholder.

One example of an application of the common benefit doctrine applied to allow a attorneys’ fee request is often seen in derivative litigation when the corporation receives a lump sum payment as a result of the litigation efforts of a derivative plaintiff. By contrast, the corporate benefit doctrine applies when the corporation receives, for example, a therapeutic benefit from the litigation even if no “common fund” is created.

Delaware Supreme Court’s forum selection ruling reversal cancels stock dispute’s trip to Austria

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 Supreme Court recently ruled that the Court of Chancery wrongly decided to move a Swiss holding company’s dispute over Allomet Corp.’s stock from Delaware to Austria, even though the struggling metal powder coating company did not carry its burden of proof under a financing pact’s forum selection clause, in Germaninvestments AG, et al. v. Allomet Corp., et al., Del. Supr., No. 2019 (Jan. 27, 2020).

Justice Karen L. Valihura’s Jan. 27 opinion on behalf of a three-justice panel reversed Chancery’s Rule 12(b)(3) dismissal of Germaninvestments AG’s suit to force Allomet to transfer stock, intellectual property and land in return for loans and investments that kept it afloat.

The Vice Chancellor held that under European Union regulations, companies in member nations like Austria can use a mandatory forum selection clause to designate a single jurisdiction to resolve their disputes and that’s what the 2017 Allomet Restructuring and Loan Agreement did. See Germaninvestments AG, et al. v. Allomet Corp., et al., No. 2018-0666-JRS, 2019 WL 2236844 (Del. Ch. May 23, 2019).

But in its partial reversal, the high court found that the vice chancellor wrongly put the forum burden of proof on Germaninvestments AG and should have required expert testimony throughout the briefing on the complex and novel question of the application of foreign law.

Who’s burden of proof?

The appellate panel said Allomet had the burden of proof in establishing foreign law but failed to carry it, so Delaware law should be applied to the forum selection issue, and the result is that the loan agreement’s forum clause is permissive, enabling the Chancery Court case to continue.

Recognizing that there are “very few decisions from this Court that can serve as a reference  in this area,”  it said, “we hold that the party seeking application of foreign law has the burden not only of raising the issue of the application of foreign law, but also, of establishing the substance of the foreign law to be applied.”

The dispute arose over loans and investments that Germaninvestments AG — a Swiss holding company formed to manage the Herrling family’s assets — made in Allomet and the tentative joint venture that the investors and Allomet’s owners formed in 2017 to raise capital.

In May of that year, the parties drafted a Restructuring and Loan agreement to pave the way for the July 3 formation of AHMR GmbH, an Austrian holding company in which the Herrlings and Allomet pioneer Dr. Hannjorg Hereth would eventually hold all of Allomet’s stock.

No final draft

An immediate transfusion of capital in the form of a series of loans totaling $850,000 began and the temporary pact was extended; however, according to the court record, trouble began over how the loans would translate into equity for the investors and negotiations for a permanent agreement that would address that issue broke down in May 2018.

The Hereth faction took the position that the Herrlings could not claim any stock in Allomet and deserved the return of only “a fraction” of their loans and investments, sparking the Chancery Court complaint asking for a “reissue” of stock owed to them.

The Herrlings’ suit also claimed breach of the agreements and unjust enrichment as a result of the alleged failure to transfer all of Allomet’s outstanding stock, property and intellectual property to them.

The defendants won the motion to dismiss in favor of the Vienna court even though they “provided scant information to the Court of Chancery on Austrian law, citing to Article 25 of the Brussels Regulation …but no cases in support of their Rule 12(b)(3) motion on the substance of Austrian law” Justice Valihura wrote.

The plaintiffs argued that:

·     The forum clause is neither mandatory nor enforceable with respect to their stock replacement claim under Section 168 of the Delaware General Corporation Law.

·     The defendants failed to carry their burden of proof because they made only conclusory statements on Austrian law, so the forum clause is permissive under either Delaware or Austrian law.

·     Even an Austrian court would not find that the forum clause would confer mandatory jurisdiction on Vienna courts because it should be interpreted in accordance with Delaware law.

·     Article 8 of the Brussels Regulation provides that the defendants can be sued where their corporation is domiciled — in Delaware.

The high court found that the plaintiffs had supported their arguments with citations to translated Austrian cases and that in a reply in support of their motion for re-argument on the Chancery Court decision, they had provided a law school professor’s expert opinion on Austrian law.

Justice Valihura noted the Vice Chancellor’s frustration with the sparse, eleventh-hour amount of citation and expert opinion on novel foreign law issues, but said without soliciting further information from the parties, he dismissed the complaint.

“The failure to identify, early on and properly join the issues, coupled with the lack of any expert input on the numerous nuances of Austrian and European law that were ultimately raised, lead us to conclude that the Court of Chancery erred in determining that appellees had satisfied their burden of proof,” the Justice said.

However, she affirmed the vice chancellor’s finding that Section 168 — which deals with lost, stolen or destroyed stock certificates — “does not fit” for competing stock ownership claims where the certificates are “in a vault in Austria” pending resolution of this suit.

Court of Chancery Denies Motion to Dismiss Implied Covenant of Good Faith and Fair Dealing Claim

This post was authored by R. Montgomery (“Monty”) Donaldson, a Delaware business and commercial litigator for many years, a friend and colleague of Francis Pileggi, and a follower of this blog.

The implied covenant of good faith and fair dealing has received considerable play in Delaware in recent years. In fact, over the last half-decade, the Delaware Supreme Court has weighed in on the issue in at least three noteworthy decisions, reported previously on this blog here, here, and here. As the matrix of Delaware decisional law has evolved, at least some academicians  have questioned whether it offers a uniformly reliable predictive tool in terms of how the covenant may be applied under a given set of circumstances.

Against this backdrop, a recent Delaware Court of Chancery opinion evaluating an implied covenant claim (and other contract-based claims) through the forgiving lens of a Rule 12(b)(6) challenge, In re CVR Refining, LP Unitholder Litigation, C.A. No. 2019-0062-KSJM (Del. Ch. Jan. 31, 2020), provides another useful illustration of where the implied covenant of good faith and fair dealing likely will be found to have traction, at least at the pleading stage.

Broad Contours of the Implied Covenant.

In Oxbow Carbon & Minerals Holdings, Inc. v. Crestview-Oxbow Acquisition, LLC, Del. Supr. No. 536, 2018 (Jan. 17, 2019), the Delaware Supreme Court described essentially two scenarios in which the implied covenant may come to bear. The first, broadly speaking, is where a contingency arises that was not anticipated by the parties, and therefore was not addressed in the explicit terms of the underlying contract. Here, the implied covenant may serve as a gap-filler. The second scenario, again broadly speaking, is where a party to the contract is given discretion to act with respect to a certain subject matter, but exercises that discretion in a manner that frustrates the purpose of the contract – that is, in a manner implicitly proscribed by the contract’s express terms.

The cases likewise delineate what cannot be accomplished by way of the implied covenant, and the list of prohibited applications is lengthy. Among them, the covenant cannot be used to:

  • rebalance economic interests after events that could have been anticipated but were not cause harm to one of the parties (see, e.g., Bandera Master Fund LP v. Boardwalk Pipeline Partners, LP, 2019 WL 4927053, *22 (Del. Ch. Oct. 7, 2019));
  • “fill a gap” where the contract in fact addresses the conduct at issue (see, e.g., Oxbow Carbon & Minerals Hldgs. V. Crestview-Oxbow Acq., LLC, 202 A.3d 482, 507 (Del. 2010)); or
  • effectively re-write the parties’ agreement (or, as famously written by former Chancellor Strine, “[t]he implied covenant of good faith and fair dealing is not a license for a court to make stuff up . . .” Winshall v. Viacom Int’l, Inc., 55 A.2d 629, 631 (Del. Ch. 2011), aff’d, 76 A.3d 808 (Del. 2013)).

Of course, these and other proscribed applications have been analyzed in detail far beyond the general scope of this post

The CVR Refining Decision

The claims in CVR Refining alleged that entities controlled by Carl Icahn engaged in a multi-step scheme (patterned after the one challenged in the Boardwalk Pipeline decision cited above) culminating in the exercise of a call right to buy out the minority unitholders of CVR Refining, L.P. at an unfair price. In particular, the minority unitholders alleged that CVR Energy (the indirect owner of CVR Refining’s general partner) launched a partial exchange offer to achieve the contractually-designated ownership threshold for exercising the call right. The general partner’s board, besprinkled with individuals closely affiliated with Icahn, did not make a recommendation concerning the exchange offer, and publicly disclosed its non-recommendation (this, in the face of a reasonably conceivable possibility that the exchange offer would trigger speculation in the market about the call right, thereby depressing the unit price). In filings made contemporaneously with the launch of the exchange offer, Icahn entities disclaimed any intention to exercise the call right after consummating the exchange offer – the predictable consequence of which (along with the exchange offer itself) was to cause analysts to speculate that the opposite was true, thereby driving down the price of CVR Refining.

As predicted, CVR later announced publicly that it was contemplating exercising its call right, causing the trading price to drop precipitously. When the call right was exercised, CVR Energy paid $393 million less than it would have had the unit price remained unaffected. Aside from breaches of the express terms of the partnership agreement, the minority unitholders alleged that the implied covenant of good faith and fair dealing prohibited the defendants from taking actions to depress the trading price of the units and undermine the price-setting mechanisms contained in the call right.

In denying the defendants’ motion to dismiss the implied covenant claim, the Court of Chancery observed:

  • that the claim implicated two partnership agreement provisions designed to protect minority shareholders – a 90-day provision and a 20-day formula. The former was designed to prevent minority unitholders from having their units called at a price below what the General Partner of its affiliates paid to purchase units in the 90 days preceding the exercise date. The latter was designed to ensure that the exercise price was unaffected by any announcement of the exercise by requiring that the price be determined with reference to the average of the daily closing prices for the 20 days immediately prior;
  • that it was reasonably conceivable that implicit in the language of the call right provision is a requirement that the defendants not act to undermine the protections afforded to unitholders by the price-protection mechanisms; and
  • that it would be “obvious” and “provocative” to demand the inclusion of an express condition that a general partner and its affiliates not subvert price-protection mechanisms through a multi-step scheme designed to manipulate the unit price (see Diekman v. Regency GP LP, 155 A.3d 358, 368 (Del. 2017) (“Partnership agreement drafters, whether drafting on their own, or sitting across the table in a competitive begotiation, do not include obvious and provocative conditions in an agreement . . .”).

Postscript

  • While narrowly construed and cautiously applied, the implied covenant of good faith and fair dealing, where properly invoked, has teeth. CVR Refining drives home the point (once again) that claims predicated on the implied covenant may survive dismissal where well-pled factual allegations support a reasonable inference that a contracting party has, in exercising otherwise-legitimate contractual rights, taken actions to undermine express contractual rights of the other party. This is especially so where the offending actions were such that explicitly proscribing them in the contract would have been too obvious or provocative. And so, the implied covenant marches on.

 

Chancery Grants Defamation Damages

A recent Delaware decision is notable for two reasons. First, it provides an example of a relatively rare defamation finding in a decision by the Delaware Court of Chancery. In Laser Tone Business Systems, LLC v. Delaware Micro-Computer LLC, C.A. No. 2017-0439-TMR (Del. Ch. Jan. 17, 2020), the court granted damages in the amount of $100,000 for slander and libel per se. The defamation claim arose in the context of a counterclaim by an ex-employee who was sued by his former employer. The court described the award, that it determined in its discretion to be an appropriate amount, as compensating for injury resulting from the defamatory statements that included lost jobs, customers and friends.

Secondly, this ruling is notable as a reminder that motions for reargument are rarely successful, and this motion under Rule 59(f) is no exception.

Lastly, as an aside on a procedural note, the decision on which reargument was sought, styled Laser Tone Business Systems, LLC v. Delaware Micro-Computer LLC, 2019 WL 6726305 (Del. Ch. Nov. 27, 2019), was written by Justice Montgomery-Reeves when she was a Vice Chancellor, but Her Honor wrote this decision on the motion for reargument after she recently became a Justice of the Delaware Supreme Court (but the case is still referenced as a Chancery case).

 

Delaware Supreme Court revives suit over telecom sale payment, clarifies Utah fraud definition

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 high court has reversed the dismissal of charges that Jive Communications Inc. fraudulently duped KnighTek LLC’s owner into accepting a million-dollar discount in its payment for his telecom business by falsely claiming Jive was short of cash and concealing its imminent acquisition by LogMeIn in KnighTek, LLC. v. Jive Communications Inc., No. 570-2018, (Del. Jan. 27, 2020).

The high court’s Jan. 27 ruling found that Erik Knight’s Superior Court complaint sufficiently alleged fraud and stated a fraudulent misrepresentation claim under Utah law by charging Jive Vice President Samuel Simmons and other company representatives falsely told Knight he would have to wait five years for full payment if he didn’t immediately accept a heavily discounted cash-out.

Writing for the court en banc, Chief Justice Collins J. Seitz Jr. said Jive’s representatives intentionally concealed their $342 million sale to cloud-based connectivity company LogMeIn because that would entail a change-of-control at Jive that would entitle Knight to an immediate $2.7 million payout under his sale agreement.

Knight’s complaint charged that years after Jive bought his telecom equipment and services business for $100,000 upfront and a revenue-based payment stream capped at $4.6 million, Jive offered to cash him out for $1.75 million — a substantial discount from the remaining cap amount.

An unpleasant surprise

Knight said he took the Jan. 18, 2018 offer only because Jive vowed that if he did not accept by the end of the month, it would use its limited funds elsewhere and he would have to wait five years for his buy-out; but two days after he accepted, Jive announced the LogMeIn merger and he filed suit.

The Superior Court granted Jive’s motion to dismiss for failing to allege fraud and misrepresentation with particularity under Utah law—which governed the KnighTek sale agreement — and Knight appealed. KnighTek, LLC. v. Jive Communications Inc., No. N18C-04-260-JRJ opinion(Del. Super. Oct. 23, 2018).

The Superior Court held that Simmons’ statements were only “forward-looking predictions, opinion statements or subjective opinions” rather than presently existing material fact and that the complaint did not allege his statements were knowingly or recklessly false.

Justices disagree

The high court disagreed, finding that under Superior Court Civil Rule 9(b), Knight sufficiently alleged that Simmons falsely told him Jive had limited buyout funds and would use them on a first-come, first served basis.

The justices said it was sufficient for Knight to attribute to “Jive” — rather than a specific individual — the statement that he would have a five-year wait for final payment if he passed up the discounted cash-out, because it was one of the misrepresentations Simmons allegedly made on behalf of the defendant company.

The high court said the complaint satisfies Rule 9(b)’s requirement because it adequately specifies the speaker, time and place of the alleged misrepresentations — which Knight claims happened during a two-week negotiation period with Simmons and Jive’s General Counsel.

The justices said they reversed and remanded because:

  • Alleging that Jive “misrepresented” facts is the same as making the required claim that “this representation was false” and “to hold otherwise would be to elevate form over substance.”
  • The complaint reasonably infers that Jive was not short of cash and made misrepresentations “to dupe KnighTek into a discounted payment” when it knew KnighTek would soon be entitled to $1 million more because of the LogMeIn merger.
  • Utah and most other jurisdictions normally expect that a party engaged in arms-length negotiations will make reasonable inquiries of its counter-party, but the high court said “a party need not make inquiry when the counter-party knows [certain facts] to be necessary to prevent” a statement from being misleading, citing a Utah Supreme Court ruling in First Sec. Bank N.A. v. Banberry Dev. Corp.,786 P.2d 1326, 1330-31 (Utah 1990).
  • If the plaintiff can prove its allegations, it would have been justified in relying on Jive’s statements as inferring that no change-of-control was imminent — “especially under Jive’s manufactured deadline.”
  • KnighTek’s acceptance of the cash-out did not waive its right to sue because under Utah law “a release will be voidable if it was an integral part of a scheme to defraud” and Jive knew the release was necessary to benefit from the merger, the high court said, citing Ong Intern. (U.S.A.) Inc. v. 11thAve Corp., 850P.2d 447, 453 (Utah 1993).

Chancery Enforces Post-Mediation Term Sheet

A recent decision of the Delaware Court of Chancery provides a useful example of why the terms of a successful mediation need to be sufficiently memorialized in writing, immediately, so that the settlement can be enforced in the event that a formal and comprehensive settlement agreement is not completed later. In Starkman v. O’Rourke, No. 2018-0901-KSJM, Order (Del. Ch. Jan. 14, 2019), the court ordered the enforcement of the term sheet that was signed by the parties after a mediation, even though the parties could not complete a more formal agreement.

Why this Case is Noteworthy:

  • This decision explains why the term sheet signed after a successful mediation must include all the essential terms. This is so, because if it is not included in the term sheet, and as sometimes happens, a formal agreement cannot be agreed upon later, the term sheet signed after the mediation will be the only document that the parties will have to rely on.

The Moral of this Story:

  • If a settlement is reached after mediation, do not let anyone who is a decision-maker leave the room unless all the material terms that are important to the parties are included in a signed document, however informal, that expressly provides that it is a binding agreement. Do not wait for a more formal and comprehensive agreement–which may never come.

Key Takeaways from this Ruling:

  • A term sheet that explicitly provides that it is binding, however informal it may be, signed by all parties, with authority, after a successful mediation will be enforced even if the parties cannot later agree on a more formal and comprehensive agreement.
  • If a term or condition is important, it needs to be in the signed term sheet, or otherwise don’t expect the Court to enforce it.
  • This decision comes in the form of an Order, but Orders can be cited as authority in submissions to Delaware Courts.
  • The ruling refers to Court of Chancery Rule 174, which provides clarity about the parameters of mediation, such as confidentiality when a member of the Court conducts the mediation.
  • This Order distinguishes a prior Chancery ruling involving an “oral agreement” reached after mediation, that was not reduced to writing, and that was not enforced due to certain ambiguities and lack of proof about what was a part of the so-called oral agreement.
  • The Court also distinguished other Chancery decisions where a post-mediation agreement was not sufficiently documented.

Vice Chancellor Does Not Follow Prior Section 220 Decisions

A recently published Delaware Court of Chancery decision must be read by anyone who seeks to understand the latest iteration of Delaware law involving Section 220 of the Delaware General Corporation Law in connection with demands by stockholders for corporate books and records. Lebanon County Employees’ Retirement Fund v. AmerisourceBergen Corporation, No. 2019-0527-JTL (Del. Ch. Jan. 13, 2020), is the name of this seminal opinion that will be often-cited as one of the more consequential cases interpreting DGCL Section 220, in part due to the manner in which it performs a deep analysis of the fundamental principles that animate Section 220, as well as how it illuminates the prerequisites that must be satisfied–beyond what the statute explicitly states–in order for one to make a successful claim. It also serves as a reminder that 220 cases are not simple.

Key Takeaways from this 63-Page Opinion:

Although this decision deserves a careful reading in its entirety, and warrants a lengthy analysis, I will merely provide in this short blog post selected bullet points highlighting what this writer views as the most noteworthy aspects that make this decision must-reading for those interested in the latest developments in this area of corporate litigation:

       Proper Purpose Requirement:

  • After providing a justification for why enumerated prior Chancery decisions would not be followed to the extent they added prerequisites to Section 220 that have not been recognized by the Delaware Supreme Court, the Vice Chancellor refused to superimpose on the statute as part of the “proper purpose” requirement, an explanation for what will be done with the documents that are received.
  • That is, this Chancery decision confirmed that in order to satisfy the proper purpose requirement under Section 220, it is not necessary to explain what a stockholder will do once he receives the documents after a Section 220 demand. See Slip op. at 25-29. See also footnote 13.
  • The Court recited the doctrinal underpinnings that animate Section 220, as well as the competing interests between the corporation and the stockholder.
  • This opinion provides an eminently quotable list of the many previously recognized “proper purposes” that satisfy the requirements of Section 220. See page 14. (This alone is a reason that this ruling should have a prominent place in the toolbox of every corporate litigation practitioner.)

       Credible Basis Requirement:

  • This decision also illuminates the meaning of the “credible basis” requirement, which allows the court to infer a sufficient reason for a stockholder to seek records in order to pursue an investigation for certain potential claims. See page 16. See also pages 30-40 (explaining the credible basis standard in the context of an investigation into types of wrongdoing).
  • The Vice Chancellor expressly rejected the defense that “they-only-want-to-sue” as a reason for not producing documents requested–that could be used for other reasons.

       Scope of Documents for Production–including Emails:

  • The Court describes the scope and conditions and details for the production of documents that were ordered to be produced. The Court also ordered a Rule 30(b)(6) deposition to determine “what types of documents exist and who has them.”
  • Citing for support to prior Section 220 decisions (after distinguishing others), this opinion requires the production of emails among board members, even if those emails are on a non-corporate email account. See, e.g., Palantir decision.
  • Both the Court of Chancery and the Delaware Supreme Court in prior decisions on Section 220 have quoted from a law review article that Francis Pileggi co-authored, here and here, on the topic of electronically-stored information (ESI) that should be produced pursuant to a Section 220 demand.

Candor to the Court

In my recent ethics column for The Bencher, the publication of the American Inn of Courts (that I have been writing for over 20 years), I discuss the duty of candor to the court that lawyers have, and how that interfaces with the duty of confidentiality owed to clients.

Motion to Disqualify Granted Under Rule 1.9

A recent decision of the Delaware Superior Court featured an unusual ruling in Delaware: A motion to disqualify counsel was granted based on a conflict of interest under Rule of Professional Conduct 1.9, relating to prior representation of a client.

Why the Decision is Notable:

Although the facts in the 21-page decision styled Sun Life Assurance Company of Canada v. Wilmington Savings Fund Society, C.A. No. N18C-08-074  PRW-CCLD (Del. Super. Dec. 19, 2019), are somewhat unique, and not likely to be often repeated, the court’s opinion is a useful reference that should be in the toolbox of litigators because it provides copious citations to Delaware court decisions that address the standards applicable to motions to disqualify counsel based on a conflict of interest, as well as reciting the familiar and well-established “high-threshold” that must be met because motions to disqualify counsel are looked upon with disfavor.

This ruling is a reminder that it is not sufficient for purposes of disqualifying counsel that a Rule of Professional Conduct be violated. Rather, for purposes of disqualifying counsel, the conflict must be “so extreme that it calls into question the fairness of the proceeding.” See Slip op. at 4 and accompanying footnotes.  Other cases and articles on these pages dealing with motions to qualify are available via these hyperlinks.

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