Delaware Court of Chancery Rule 5.1 provides the standard and an intricate series of procedures for the parties to seek “confidential treatment” to prevent pleadings filed with the court from being publicly available. The prior version of the rule referred to this procedures as “filing under seal.”  Notably, analogous procedures in federal court employ a much different standard.

A recent pair of Orders from the Delaware Court of Chancery featured the unusual shifting of fees in connection with Rule 5.1, as an exception to the American Rule where each party pays its own fees. See Robert Garfield v. Getaround, Inc., C.A. No. 2023-0445-MTZ, Order (Del. Ch. Oct. 26, 2023). This is the first of two Orders that need to be read together to put them in context. The second Order is noted below.

The Orders understandably do not feature the typically copious background facts provided in opinions, but it includes sufficient information to make the point for purposes of this short blog post.

The noteworthiness of the Orders is that they will remind counsel that under Rule 5.1, when a party disagrees about what portions of a pleading should be designated as confidential, the party harboring the disagreement does not have the right to publicize the information sought to be kept confidential—until the court rules on the issue or unless the procedures provided in Rule 5.1 are followed.

With that background, the relatively short Order deserves to be quoted verbatim: 

“It was not for Plaintiff to unilaterally decide that information Defendant has designated and redacted as confidential in its opposition could be publicized in Plaintiff’s reply.  Defendant bore the burden of designation under Court of Chancery Rule 5.1(b)(3).  Nor was it for Plaintiff to resists Defendant’s call to withdraw Plaintiff’s Reply to publicize information Defendant had designated.  Rather, Plaintiff’s recourse was to file a Motion of Challenge to the Opposition and the Reply under Court of Chancery Rule 5.1(f).

The parties shall work with the Register in Chancery to place Plaintiff’s Reply under seal.  The parties shall follow Rule 5.1’s procedures to address any remaining disagreements as to whether information in that reply was fairly designated as confidential.”

The first Order was in response to a Motion by the Defendant to place under seal the Reply of the Plaintiff in opposition to the Defendant’s Motion to File Under Seal because that Reply was wrongly filed in a publicly available manner.

In a second Order shifting fees under the bad-faith exception to the American Rule, the Court reasoned that the Plaintiff’s:

“insistence on publicizing information Defendant designated as confidential serves no plain purpose other than agitation.  I conclude the publication in the opposition to the motion to seal was in bad faith. Fees are shifted for the Motion to Seal the Opposition.”

Garfield v. Getaround, Inc., C.A. No. 2023-0445-MTZ, Order (Del. Ch. Oct. 27, 2023)

Frank Reynolds, who has been covering Delaware corporate decisions for various national publications for over 35 years, prepared this article.

The Delaware Court of Chancery, in a key ruling on the third-party beneficiary rights of merger target shareholders, has dismissed an ex-Twitter Inc. investor’s “lost premium” suit that sought a $3 million “mootness fee” after Elon Musk reversed his decision to abandon the social media giant’s purchase in Crispo v. Musk, et al., No. 2022-0666-KSJM (Del. Ch. Oct. 31, 2023).

Chancellor Kathaleen St. Jude McCormick’s October 31 opinion found plaintiff shareholder Luigi Crispo’s suit was not meritorious when filed since he never had a valid claim that he should profit by Musk’s buy decision. She said either he lacked third-party status or those rights had not yet vested during Musk’s on-again-off-again acquisition.  But she took the occasion to comprehensively clarify the parameters of third-party shareholder beneficiary rights—which might benefit M&A practitioners.

The Chancellor noted that although the facts of this case made the decision seem deceptively simple, the complexity of the underlying rights issue has the potential to form a legal “Gordian KnoI” which requires some explanation as to how it might be cut.

Background

The litigation arose out of Elon Musk’s July 2022 decision to acquire Twitter—and his change of mind less than three months later to scrub it, resulting in a suit by Twitter for specific performance, but Musk changed his mind again in October and consummated the deal on the original terms that month.  Meanwhile Crispo, who held 5,000 shares of Twitter, sued Musk and his X Holdings Inc. I and II  acquisition companies in July for breach of the merger pact and breach of duty as the controller of Twitter,

After Chancellor McCormick dismissed most of those claims and the sale closed, Crispo’s suit was considered dead, but it “sprang back to life zombie-like” she said, when Crispo claimed partial credit for Musk’s. change-of-heart and sought a $3 million award on grounds that Musk mooted plaintiff’s breach of merger charge by keeping his deal promise after all.

Meritorious mootness suit?

Chancellor McCormick said the Delaware Supreme Court has held that mootness fees are only awarded when:

i)The suit was meritorious when filed

ii) the action that produced the benefit to the corporation “was taken by the defendant before a judicial resolution was achieved;” and

iii) “the resulting corporate benefit was causally related to the lawsuit.”

“In order for a suit to be considered meritorious when filed, the complaint must have been able to have survived a motion to dismiss, whether or not such a motion was filed,” so he must prove the remaining lost premium claim was meritorious for the suit to survive, the Chancellor pointed out; but she added that plaintiff  was not a party to the Merger Agreement, so the merits of his claim hinge on the argument that he had standing to sue for breach of the agreement as a third-party beneficiary

To allege standing as a third-party beneficiary, a plaintiff must plead that:

i) “the contracting parties . . . intended that the third party beneficiary benefit from the contract,”

ii) the benefit [was] intended as a gift or in satisfaction of a pre-existing obligation to that person, and

iii) “the intent to benefit the third party [was] a material part of the parties’ purpose in entering into the contract.”

Was the investor vested?

But the Chancellor ruled that, “[T]hird party beneficiaries, however, cannot object to the alteration or termination  of the contract before their rights against the promisor have vested.’’  and Crispo’s rights had not vested.

Moreover, she said, Delaware courts are reticent to confer third party beneficiary status to stockholders under corporate contracts for a mix of doctrinal, practical and policy reasons not the least of which is that “under Delaware law, the board of directors manages the business and affairs of the corporation, which extends to litigation assets.”  That includes Delaware’s exacting presuit demand test for shareholders who seek to sue on behalf of the corporation.

Lost Premium Provision no help

The court said Section 9.7 of the Merger Agreement is a no-third-party-beneficiaries provision which comprises a blanket prohibition disclaiming third-party beneficiaries followed by three. carve-outs but none of those provide any help for the plaintive here.  In addition, the chancellor noted, the blanket prohibition states that the Merger Agreement “shall not confer upon any Person other than the parties hereto any rights or remedies hereunder[.]”

Conclusion

Finally, she said, the parties stipulated to specific performance as to “prevent” breaches of the Merger Agreement, suggesting that a breach claim seeking lost-premium damages would not accrue unless specific performance was unavailable.  The limitation necessarily implied by the Merger Agreement is that the drafters did not intend to vest stockholders with a right to enforce lost-premium damages while the company pursues a claim for specific performance, she concluded.

Former U.S. Attorney General William Barr wrote an article in today’s Wall Street Journal arguing: Delaware is at risk of losing its prominence in corporate law because of what the former U.S. Attorney General describes as the increasing infiltration into Delaware corporate law of ESG priorities, for example via Caremark claims.

Barr describes ESG as a means to inject left-leaning policy preferences into the law. It’s not a law review article, although he refers in passing to several developments that those familiar with Delaware corporate law will recognize. Whether he is correct or not in his admonition is currently a topic of debate among various sectors in the legal profession.

UPDATE: Professor Stephen Bainbridge, one of Delaware’s favorite corporate law scholars, has written an erudite response to AG Barr’s article, with copious citations and quotes from the good professor’s own extensive scholarship on the topic, as well as the publications of other leading authorities. Among the quotes in his article linked above, is one from a former Chancellor and Delaware Supreme Court Chief Justice, described as “pro-ESG”, which follows: “It is not only hollow but also injurious to social welfare to declare that directors can and should do the right thing by promoting interests other than stockholder interests.”

SECOND UPDATE: The Chancellor of the Delaware Court of Chancery, as reported in an article by Reuters, responded during a seminar to the referenced article by AG Barr, and Vice Chancellor Travis Laster also provided a rebuttal on LinkedIn, and invited AG Barr to a debate, as described in follow-up commentary by Professor Bainbridge–which includes, as usual, copious citations to his own extensive scholarship and the publications of other corporate law scholars.

The Delaware Court of Chancery recently addressed a litany of claims that the buyer of a business breached its contractual and fiduciary duties by diverting new deals that deprived the sellers from reaching milestones in the purchaser’s new entity that would have triggered increased value. 

In MALT Family Trust v. 777 Partners LLC, C.A. No. 2022-0652-MTZ (Del. Ch. Nov. 13, 2023), the court addressed a long list of claims that provide corporate litigators with a refresher course on basic claims and defenses often encountered in Delaware’s court of equity in connection with the sale of a business.

This short blog post will provide highlights by way of bullet points.

Highlights

  • The court recited the familiar elements of a claim for fraudulent inducement, as well as the specificity requirement of Rule 9(b) for fraud claims. See Slip op. at 10.
  • The court reviewed the well-settled Delaware law on the objective theory of contract interpretation.  See Slip op. at 15.
  • The court explained that the LLC agreement did not include any of the alleged express representations or warranties on which the Plaintiff’s allegations were based. Nor was the purpose clause a “representation or warranty.” See also the court’s application of the contract interpretation principle known by the Latin phrase: expressio unius est exclusio alteris. See Slip op. at 17.
  • The court observed that an LLC agreement is not required to have a “purpose clause,” but that if a purpose clause limits the scope of authorized activity of the LLC, only the company can breach that clause. In this matter, the allegations were against the individual members.  Slip op. at 17-20.
  • Court of Chancery Rule 8 allows duplicative claims in the alternative to be pled, but a nuanced approach applies when the breach of the implied covenant of good faith and fair dealing is contradicted by the expressed terms in an agreement.  Slip op. at 22-25.
  • The well-settled principle that fiduciary duties of an LLC manager and controllers of the LLC must be waived with specific clarity supported the court’s reasoning that the corporate opportunity doctrine was not waived.  Slip op. at 27-31.
  • This opinion regales the reader with a quote and citation to a reference book that should be on the shelves of every corporate and commercial litigator.  At footnote 101 of the opinion, the court cited to Justice Antonin Scalia’s book that he co-authored with Bryan Garner entitled:  Reading Law: The Interpretation of Legal Texts 126-27 (2012). In that same footnote the court also cited to Kenneth A. Adams, “A Manual of Style for Contract Drafting,” Section 13.631 (Fifth Ed. 2023). The citations were for the purpose of interpreting a clause that included the word “Notwithstanding.”  The specific quote from the Scalia book was: 

“A dependent phrase the begins with notwithstanding indicates that the main clause that it introduces or follows derogates from the provision to which it refers.” 

The court interpreted that clause in a section involving fiduciary duties to conclude that the parties did not intend to waive fiduciary duties relating to the usurpation of “other business interests and activities.”

A recent Delaware Court of Chancery decision determined the proper members of an LLC and their respective interests pursuant to Section 18-110 of the Delaware LLC Act.  In REM OA Holdings, LLC v. Northern Gold Holdings, LLC, C.A. No. 2022-0582-LWW (Del. Ch. Sept. 20, 2023), the court determined in a post-trial opinion that at least one of the two initial 50/50 members lied while testifying during trial, but the court nonetheless reached a conclusion based on all the admissible evidence.

Although the entire decision should be read carefully for the factual context, this short blog post will only provide a few key takeaways.

Highlights

  • Despite one of the initial 50/50 members not being provided with all of the documents that described the loan terms that diluted his interest–before he signed a document agreeing to those terms–the court found that  he would still be bound by a written consent to loan terms that would admit a new member.
  • Without reference to the conduct of the counterparty who failed to provide all the terms, the member was nonetheless bound  by the documents he signed.
  • The court relied on several cases for the well-established principle that ignorance of the terms in an agreement signed and consented to is no defense to their enforceability. Slip op. at 49.
  • This basic principle that one generally is bound by the document she signs, also extends to the terms of documents incorporated by reference—even if they were not supplied prior to signing.  See footnote 274.
  • The court determined that several arguments were unavailing to prevent enforceability, including: (1) unilateral mistake; (2) fraudulent inducement; and (3) breach of fiduciary duty.
  • Regarding the breach of fiduciary duty argument, the court observed that fiduciary duties under the LLC agreement only applied to controllers or managers of the LLC, but the claimant in this case was neither.  See Slip op. at page 52-54.

Of course, there is much more to commend the reading of this entire opinion, but these bullet points were the most useful takeaways with the most widespread applicability. 

In a targeted proceeding pursuant to Section 225 of the DGCL with the limited purpose of determining whether members of the board of directors were properly removed, the Delaware Court of Chancery determined that the plaintiff did not establish its burden of proof to challenge the removal of board members. In Barbey v. Cerego, Inc., C.A. No. 2022-0107-PAF (Del. Ch., Sept. 29, 2023), the Court found that the removal of the entire board, and their replacement by a new sole director, was effective.

This gem of an opinion provides several key principles of Delaware corporate law, and corporate litigation, that can be applied in other Section 225 actions, and other litigation generally.

Very Brief Overview of Background

The factual background of this case is somewhat tortuous, but for purposes of these short highlights I will only provide a few key points for context. The case involves a corporate inversion effected through a tender offer whereby the subsidiary would swap its shares in exchange for the outstanding shares of the parent, with the goal of giving the subsidiary a supermajority of the parent’s outstanding shares.  Once that was accomplished, the subsidiary took action to remove the existing board of directors of the parent.  The subsidiary was a company formed in Japan. The parent was a Delaware corporation.

The plaintiffs challenged the removal based on the argument that the inversion was invalid.  Specifically, the plaintiffs argued that the parent purported to authorize the subsidiary to commence a tender offer at a special meeting of the board for which adequate notice was not given according to bylaws of the parent.

The key factual and legal findings of the Court for purposes of this Section 225 action were: (i) although a regular meeting did not require notice under the bylaws, a special meeting did require notice which—based on the facts presented—was not properly given, thereby making the actions taken at the special meeting void.

Nonetheless, the Court found that, even though the plaintiffs did not anticipate or address the issue of whether the inversion and tender offer even required approval by the parent’s board, board action was not required to authorize the subsidiary’s tender offer that resulted in the subsidiary becoming the majority stockholder of the parent. Therefore, the actions taken by the new majority stockholder to remove the board and appoint a new sole director were effective.

Highlights of Key Legal Aspects of the Court’s Opinion

●       Section 225 of the DGCL permits any stockholder or director to apply to the Court of Chancery to determine the validity of any election, appointment, removal or resignation of any director or officer of any corporation.  These are “in rem proceedings” which only exert jurisdiction over the corporation, and may only provide relief concerning the corporate office.  Slip op. at 15.

●       Other types of ultimate relief beyond what is necessary to determine the proper holder of a corporate office may only be obtained through a plenary action through which the court would exercise jurisdiction over affected parties. Id.

●       Notably, the party challenging the removal of a director bears the burden of proving by a preponderance of the evidence that a director’s removal was invalid.  Id.

●       In order to resolve the issues presented, the court had to determine whether a board meeting at issue was a regular meeting of the board or a special meeting of the board. Only a special meeting required notice.  There is a useful and cogent analysis of the bylaws to determine whether the meeting held was properly described as a regular meeting or a special meeting, as well as the notice requirements under the bylaws.

●       The Court instructed that:  “The production of weak evidence when strong is, or should have been, available can lead only to the conclusion that the strong would have been adverse.”  Slip op. at 20. As applied to the facts of this case, the Court determined that the dispositive original emails in their native format, with metadata, should have or could have been produced instead of a simple screen shot, which did not contain any metadata.  The Court then applied an adverse inference that: if the stronger evidence were produced, it would have been harmful to the person with the burden of proof.

●       The Court also reiterated the principle: “it is, of course, fundamental that a special meeting held without due notice to all the directors is not lawful, and all acts done at such meeting are void.”  The Court emphasized that it was only making this determination solely for the purpose of determining the proper composition of the board, and noted that unlike a plenary proceeding, the issues that a court can address in a Section 225 proceeding are limited. Slip op. at 21-22.

●       The Court explained that the burden of the proof was on the plaintiffs to determine that even if the board action was ineffective, the transaction which gave the subsidiary a majority ownership of  the parent and the ability to replace the board was still not effective.

●       The Court reasoned that the subsidiary was a separate legal entity from the parent and observed the truism that: Delaware law respects corporate separateness even when there is common ownership and even if there is total ownership and total control of one corporation by another, absent a showing of fraud or the existence of an alter-ego.  Slip op. at 23.

●       Interestingly, on a procedural but key note, neither of the companies involved entered an appearance in the case, and only one of the board members involved intervened.

Conclusion

In sum, the Court explained that the plaintiff merely focused its case on whether or not there was proper notice for a special board meeting and whether the actions taken at the meeting were void, but even though the Court found that meeting to be void, the Vice Chancellor also held that the corporate inversion making the subsidiary the majority stockholder properly authorized it to remove the all board members.

Lastly, the Court found that the plaintiff failed to timely raise the issue of foreign law under Court of Chancery Rule 44.1, therefore that argument was waived.

Frank Reynolds, who has been covering Delaware corporate decisions for various national publications for over 35 years, prepared this article.

The Delaware Court of Chancery, in a guidepost ruling on the power to bestow super-voting stock, has dismissed a shareholder’s “identity-based voting” suit over Bumble Inc.’s decision to designate ten-votes-per-share only for the stock of the relationship-nurturing software company’s CEO/founder and his financial backer in Colon v. Bumble Inc. et al., C.A. No. 2022-0824-JTL (Del. Ch. Sept. 12, 2023).

Vice Chancellor Travis Laster’s September 12 summary judgment opinion dismissed breach-of duty charges against Bumble and its CEO, finding that granting the allegedly discriminatory 10X-power voting stock did not conflict with either key provisions or rulings governing that action.  He ruled that the defendants had the right to designate a super voting stock class under the certificate of incorporation — or they could give the directors the right to make that designation at some future time.

The vice chancellor said the challenged action was not invalid because it did not violate Sections 212(a) and 151(a) of the Delaware General Corporation Law and had properly structured a dual-voting class “Up-C” company/partnership entity to enable two insiders to validly gain the control benefit of 10 votes per-share and a tax benefit.

An Up-C structure enables insiders to gain the benefits associated with a public listing without giving up the benefits associated with pass-through tax treatment. To eat that cake and still have it requires two entities: an umbrella partnership and a C corporation. It also requires that the C corporation issue two classes of stock.

Background

Defendant CEO Whitney Herd founded Bumble in 2014 as a web software company that enabled internet clients to cultivate business, friendship and romantic relationships and took it public in 2021 with the financial backing of Blackstone Inc.  Kyrstyn Colon filed suit in 2022 on behalf of all common shareholders claiming that an action that bestowed ten votes per-share on Herd and Blackstone, as the only “principal shareholders” was invalid “identity-based voting.”

Both parties sought summary judgment and Vice Chancellor Laster granted the defendants’ motion—which resulted in a decision that the vote grant was valid and the challenge must be dismissed.

A comprehensive review

The court used the occasion to comprehensively review the scope of the applicable sections of the DGCL and the parameters of the UP-C dual voting class entity structure.

The court reasoned that if the corporation will issue stock that has special attributes, then Section 102(a)(4) provides two alternatives for memorializing the special attributes in the certificate of incorporation.  One alternative is to specify the special attributes directly. The other is to empower the board of directors to bestow super-voting stock at a future time.

8 Del. C. § 151(a) generally authorizes a corporation to issue multiple classes of stock and makes clear that they may either carry default rights by implication, have some or all the default rights specified expressly in the charter, or have whatever special rights are allowed.

Section 212(a) provides that if the certificate of incorporation is otherwise silent, then each share of stock carries one vote by default. Section 212(c) also provides that if the certificate of incorporation calls for greater or lesser voting power, then references in the DGCL refer to that level of voting power.

A trio of key decisions

The Delaware Supreme Court and the Court of Chancery have approved charter provisions that allocate voting power using a formula or procedure, and the Delaware Supreme Court upheld a scaled voting structure in which the number of votes appurtenant to a share varied depending upon the total number of shares that the owner held, he said.

The vice chancellor said, “the Delaware Supreme Court and this court have approved charter provisions that allocate voting power using a formula or procedure.  In Providence & Worcester Co. v. Baker, 378 A.2d 121 (Del. 1977), the Delaware Supreme Court upheld a scaled voting structure in which the number of votes appurtenant to a share varied depending upon the total number of shares that the owner held.”

In Williams v. Geier, 1987 WL 11285 (Del. Ch. May 20, 1987), this court dismissed a challenge to a tenured voting mechanism, holding that it complied with the DGCL, the Vice Chancellor said.

And he noted that in Sagusa v. Magellan Petroleum Corp., 1993 WL 512487 (Del. Ch. Dec. 1, 1993), aff’d, 650 A.2d 1306 (Del. 1994) (TABLE), this court dismissed a challenge to a per capita voting provision that gave each stockholder a single vote, regardless of how many shares the stockholder held, and the Delaware Supreme Court upheld the dismissal.  Framed using the language of this decision, the certificate of incorporation used a mechanic conceptually similar to Providence.

“A strange move”

Contrary to the preceding analysis, the court said, plaintiff argued that the challenged provisions violate Section 212(a) of the DGCL, but the plaintiff did not rely on the text of the provision, but rather on language from the Providence decision.  The plaintiff asserts that under Providence, a corporation cannot create a mechanism in which shares of the same class differ in their share-based voting power depending on who holds them.

Relying primarily on Section 212(a) was a “strange move”, because that section does not authorize or restrict anything, the vice chancellor said. “Section 212(a) creates a default right of one vote per share, and it provides that if a charter departs from the default right, then any voting calculations required by the DGCL—such as the amount of voting power that would constitute a majority of the voting power outstanding—must use the voting power as determined by the charter.

Conclusion

The plaintiff views identity-based voting as an entrenched hierarchy and wants all stockholders to have equality of opportunity, the court said, noting that, “In many areas of the law, those noble sentiments could carry weight. They cannot overcome the plain language of the DGCL.” Nothing in Section 151(a) prohibits a provision that creates a closed set of holders who can exercise certain rights, the court ruled.

The Delaware Supreme Court issued a momentous decision recently that should be read by all those who want to know the latest iteration of Delaware law on the limits of judicial equitable review of LLC Agreements. 

Key Issue Addressed

In Holifield v. XRI Investment Holdings LLC, Del. Supr., No. 407, 2022 (Sept. 7, 2023), the Delaware Supreme Court determined that freedom of contract in the context of LLC agreements extends to “contractually specified incurable voidness.”  This 77-page decision from Delaware’s high court reviewed a 154-page decision of the Court of Chancery that was highlighted on these pages.

This is the type of decision that could justify a law review article, but for purposes of this short blog post, I will only highlight key parts of the decision that should justify a careful reading of the decision in its entirety.

Basic Factual Context

The background of the case involves complex, extensive facts, but for purposes of these brief highlights, the most important context involved whether or not the parties to an LLC Agreement could determine, in connection with an attempted transfer of interests, that failure to comply with certain conditions would make a transaction “incurably void” such that it would not be subject to judicial equitable review and remedies—even if it might result in an inequitable holding by the court.

Highlights

  • The trial court found that it was bound to uphold the “contractual incurable voidness” based on the Delaware Supreme Court’s CompoSecure II opinion.  Slip op. at 32. 
  • See footnote 82 noting that it was not an issue on appeal that, generally, the equitable defense of acquiescence is available as a defense to claims at law.
  • The Supreme Court explained why it would not reconsider its decision in CompoSecure II which the appellant and the trial court urged.  Slip op. at 43 – 44.
  • The Supreme Court provided guidance on why the primacy of freedom of contract embodied in the LLC Act supported the CompoSecure II decision—which endorsed private ordering to a degree “not available in the corporate context.”  Slip op. at 44.
  • The Delaware Supreme Court instructed that “. . . particularly in the alternative entity context, equity will not save a bad contract.”  Slip op. at 46.  See cases cited at footnotes 118 to 120.
  • The high court also provided a primer on basic Delaware law regarding contract interpretation principles.  Id. at 47.
  • The Supreme Court emphasized that the freedom of contract allowed in LLC agreements extends to “contractually specified incurable voidness.”  Id.
  • Although the Supreme Court acknowledged that there are limits to private ordering, and that Delaware courts retain an inherent measure of authority and equitable power regarding LLC agreements: equity cannot always override the plain language of an LLC agreement with respect to incurable voidness.  Id. at 47-48.
  • By comparison, corporate bylaws cannot alter the directors’ fiduciary obligations “and the attendant equitable standards a court will apply enforcing those obligations.”  Slip op. at 49.  See also footnotes 136 to 142 and accompanying text.
  • The Delaware Supreme Court emphasized that its CompoSecure II opinion “did not hold, or even suggest, that in every case where the parties used the word ‘void’, a non-compliant act will be incurably void.”  Id. at 65.  If the use of the word in some circumstances is ambiguous, a different analysis is possible.
  • The court declined to require “talismanic magic words to contract for incurable voidness in an LLC agreement.”  Id. at 66.
  • The case was remanded to address damages and recoupment.  Id. at 77.

This article was prepared by Frank Reynolds, who has been following Delaware corporate law and writing about it in various publications for more than 35 years

The Delaware Court of Chancery has allowed GoDaddy Inc. shareholders to continue their suit that claims their directors exhibited bad faith by disloyally rubber-stamping the under-valued buyout of a tax asset business that allegedly cost the web hosting company $850 million, in IBEW Local Union 481 Defined Contribution Plan and Trust v. Winborne, et al., C.A. No. 2022-0497-JTL (opinion issued) (Del. Ch. Aug. 24, 2023).

Vice Chancellor Travis Laster’s August 31 opinion refused to dismiss a pension fund’s derivative breach of duty and waste of assets charges, finding that, viewed as a whole, the suit contained enough particularized allegations supporting multiple reasons to believe the directors’ actions were not entitled to the protection of the business judgment rule or exculpation—due to indications of bad faith conduct.

The process by which the court made that determination should be of interest to corporate law practitioners.  The vice chancellor said one way to determine bad faith in this context is, if it appears that the transaction was “authorized for some purpose other than a genuine attempt to advance corporate welfare or is known to constitute a violation of positive law,” then a court can find bad faith.   Even if the defendants argue that the extreme transaction had a legitimate purpose, “if the decision is sufficiently extreme, then the court can still infer bad faith, but the decision must be so extreme that it could not be rationally explained on another basis” he said, citing. In re Orchard Enters., Inc. S’holder Litig., 88 A.3d 1, 34 (Del. Ch. 2014).

In fact, he explained, that type of pleading matches the standard for a claim for waste, defined as a decision “so egregious or irrational that it could not have been based on a valid assessment of the corporation’s best interests.” White v. Panic, 783 A.2d 543, 554 n.36 (Del. 2001).  The vice chancellor said that at the pleading stage, the test for bad faith is “whether the complaint alleges a constellation of particularized facts which, when viewed holistically, support a reasonably conceivable inference that an improper purpose sufficiently infected a director’s decision to such a degree that the director could be found to have acted in bad faith.”

Vice Chancellor Laster said that inference of bad faith was enough, for the purposes of the dismissal motion, to find that pre-suit demand is satisfied under Rule 23.1 because a majority of the defendants’ actions are not the type of breach of duty that can be exculpated.

Background

The source of the litigation began in 2015, when GoDaddy completed an Up-C IPO, a structure which the court said, “layers a parent- level corporation on top of a limited liability company that is treated as a partnership for tax purposes” and has a member interest in the LLC divided into a number of units – some of which are owned by GoDaddy and some by public and private equity investors. 

The opinion said the litigation arose from a complex transaction involving the buyout of the tax assets generated.  The complaint charged GoDaddy CFO Raymond Winborne significantly misstated the value of the tax asset, causing a multimillion liability payment that hurt GoDaddy’s value.     Windborne knew the value he stated was incorrect and so did the directors who voted for the tax asset scheme, the complaint by a union pension fund claims;

A holistic approach

In this case, the court said it “adopted a ‘holistic’ approach, compiling a “constellation” of various factors from the complaint’s allegations that together provide reason to doubt that the voting directors acted in good faith. The court listed those factors:

The first indicative factor is the stark contrast between the valuation of $175.3 million for the TRA Liability in GoDaddy’s audited financial statements and the $850 million payment in the TRA Buyout. The contrast between those figures is so glaring as to support a claim of waste and hence an inference of bad faith on that basis alone.

The second indicator of bad faith is the conflict between Winborne’s representations to the Audit Committee and Ernst & Young and his representations to the Special Committee and the Voting Directors.  For Winborne to have said one thing to the Audit Committee and Ernst & Young then said the opposite to the Special Committee and the Voting Directors supports an inference of bad faith.

In addition, there were no questions or objections from the directors regarding that wide discrepancy, the courts noted.  Indeed, such an exchange “is so one-sided that no businessperson of ordinary, sound judgment could conclude that the corporation has received adequate consideration.” the court said.

A third indicative factor is that that Winborne’s projections and analysis excluded any consideration of GoDaddy’s M&A-based business model and its effect on GoDaddy’s ability to use the Tax Asset. One of the main reasons why GoDaddy had not made any payments under the Tax Agreements and kept putting off when they would begin was because the Company engaged in M&A. The pleading-stage record supports an inference that the members of the Special Committee knew that Winborne’s projections rested on unrealistic assumptions.

It’s all how you look at it

In summary, the vice chancellor ruled that, at most, a claim for breach of the duty of care does not give rise to liability for pre-suit demand purposes but, “When viewed holistically, the complaint’s allegations support an inference of bad faith.”  Two members of management steered a process towards an outcome designed to favor the Founding Investors, aided by a Special Committee populated with the three outside directors most likely to sign off on the deal.

“Since the standard under Rule 12(b)(6) is less stringent than the standard under Rule 23.1, a complaint that survives a Rule 23.1 motion to dismiss generally will also survive Rule 23.1” he said.

Over the nearly two decades that I have maintained this blog, I have written about a fair number of court decisions involving statutory dissolution. The recent Delaware Court of Chancery decision styled:  In re Neworld Energy Holdings LLC, C.A. No. 2023-0282-MTZ (Del. Ch. August 24, 2023), granted a motion to dismiss based on an arbitration clause in an LLC Agreement that the court found to require arbitration of statutory dissolution claims. 

Seminal Delaware Opinion on Arbitrablity

Relying on the seminal Delaware Supreme Court decision in James & Jackson, LLC v. Willie Gary, LLC, 906 A.2d 76, 79 (Del. 2006) (highlighted on these pages here and which this author argued before the Delaware Supreme Court), the court addressed those situations where an issue of substantive arbitrability should be determined by the court or an arbitrator.  In this decision, the court explained that the arbitration provision, which incorporated the American Arbitration Association Rules, evidenced a “clear and unmistakable intent to submit arbitrability issues to an arbitrator.”  The court determined that the agreement involved in this case provided an exception for seeking equitable relief–but that did not apply to a request for statutory dissolution. 

Additional Case Law Support

The court also found support for its reasoning in two other Delaware cases that applied the Willie Gary decision:  Blackmon v. O3 Insight, Inc., 2021 WL 868559 (Del. Ch. Mar. 9, 2021, and McLaughlin v. McCann, 942 A.2d 616, 622-35 (Del. Ch. 2008).  The court also referred to the recent United States Supreme Court decision in Henry Schein, Inc. v. Archer & White Sales, Inc., 139 S.Ct. 524, 529 (2019)(highlighted on these pages here and here), regarding the position that a court possesses no power to decide an arbitrability issue when there is clear and unmistakable evidence that the parties intended to delegate issues of substantive arbitrability to an arbitrator. 

The court also noted in closing, in support of its decision. another Chancery opinion that concluded:

“There is nothing inherent in the claim for judicial dissolution that could not be fully and fairly litigated in the context of an arbitration.” (citing Johnson v. Foulk Road Med. Ctr. P’ship, 2001 WL 1563693, at *1-2 (Del. Ch. Nov. 21, 2001)).

A recent Chancery decision addressed many important issues related to a squeeze-out merger involving an LLC in which the minority member claimed that it did not receive a fair price for its minority interest.  See Cygnus Opportunity Fund, LLC v. Washington Prime Group, LLC, C.A. No. 2022-0718-JTL (Del. Ch. Aug. 9, 2023).  There are many issues in the 48-page decision that could be the subject of an extensive review, but for purposes of this relatively short blog post I will limit my discussion to the fiduciary duties of officers, which the court described as:  having “long been an undertheorized area of Delaware law.”  Slip op at 13. 

Issue Addressed

Whether the defendant-officers breached their fiduciary duties because the company provided no or few disclosures in connection with a squeeze-out merger.  The court refused to grant a motion to dismiss on that issue.  Although there was a waiver of fiduciary duties for some, there was only an exculpation clause that applied to officers.  The LLC was structured in a manner similar to corporations with a board of directors and officers.

The Fiduciary Duty of Disclosure

This decision engages in a rather deep-dive into the public policy and historical underpinnings of the fiduciary duty of officers to make disclosures.  Slip op. at 12 through 25.

The court explained that the duty of disclosure is not a separate duty but rather a contextual manifestation of the duties of care and loyalty.  Slip op. at 13.  The court instructed that the duty of disclosure arises situationally, its scope and requirements depend on context.  The court cited to cases that refer to the recurring scenarios in which the governing principles of disclosure have been developed.

Duty to Inform

The court reasoned that the duty of disclosure is a context-specific duty, and

“no Delaware decision holds that fiduciaries do not owe any duty in the context of a transaction in which the fiduciaries unilaterally eliminate their investors from an enterprise.  I personally am not prepared to rule as a matter of law that a fiduciary can take the property of its beneficiary without some level of disclosure, even in the absence of any request for action.  To the contrary, basic fiduciary principles suggest that a fiduciary cannot do that”.

Slip op. at 18-19.

The court traces the anglicized Latin word fiduciary to its meaning as trustee-like, and also traces the origin of fiduciary duties to obligations similar to those of a trustee—and the fiduciary relationship as analogous to one between an express-trustee and a beneficiary.

The court cited to treatises and case law for the principle that a fiduciary should keep beneficiaries informed as a central aspect of a trustee’s duties at common law and:  “Even in the absence of a request for information, a trustee must communicate essential facts to beneficiaries.”  Slip op. at 19.  The court emphasized that:  “The duty to inform is not limited to trustees.  It runs through the whole law of fiduciary and confidential relations.”  Slip op. at 21.

Duty to Disclose in Context of Squeeze-Out Merger 

In the context of a squeeze-out merger, the court reasoned that:

“If the duty to inform could apply anywhere, it would apply to a transaction in which a fiduciary unilaterally effectuates a taking of a beneficiary’s interest.  In that setting, the duty of loyalty could manifest as an obligation to inform the beneficiary of the material facts surrounding the transaction, regardless of whether or not the beneficiary’s approval is required.”  Slip op. at 21.

The court further explained that even if the LLC Agreement would allow the defendants to argue that they could convert a minority interest into a right to receive the amount offered—without any explanation:  “that result would be contrary to equity.”  Slip op. at 21.

Exculpation Provision

The court discusses the exculpation provision, as contrasted with the waiver of fiduciary duties, and describes the willful conduct that is not covered by the exculpation provision. The court described those situations at the pleadings stage where the allegations of willful conduct which require insight into the state of mind, such as the intent of a person, “may be averred generally”.  Slip op at 46.  The court also observed that the degree to which a party must plead facts of this nature takes into account whether the facts lie more in the knowledge of the opposing party than of the pleading party.  Id. 

The court found that the complaint alleged facts supporting a reasonable inference that the defendants intentionally pursued a scheme to eliminate the minority at a grossly unfair price.  The court held that the difference between the transaction price and the actual value supported an inference of subjective bad faith that inferably violated the provisions of the LLC Agreement and the fiduciary duties of the officers.  The exculpation provision at this early phase of the case could not be relied upon to support a motion to dismiss.

My latest column on legal ethics for the flagship publication of the American Inns of Court, The Bencher, addresses the titular topic. During the more than 25 years that I have penned the legal ethics column, this topic may be among the most challenging. That is, do the rules of legal ethics provide any guidance on how, if at all, to respond when one is falsely accused–especially of despicable acts or statements.

Courtesy of The Bencher, my latest article is reprinted below.

Do Legal Ethics Rules Provide Guidance for Responding to False Accusations?

The Bencher | September/October 2023

By Francis G.X. Pileggi, Esquire

During the 25 years or so that I have written this ethics column, the titular topic may be the most challenging among those I have addressed. If one is falsely accused of some despicable act, with no details and no opportunity to confront the unnamed accuser, do the rules of professional responsibility suggest how a lawyer should reply? Let’s be more specific.

What if an anonymous and amorphous accusation of racist behavior, without details of specific words used or other details, is recklessly repeated without an opportunity for the accused person to confront the accuser or rebut unspecified facts? How should the ethical lawyer respond? Most lawyers, and most reasonable people, would expect that such a serious false accusation, or repeating such a false accusation, should surely be actionable in some manner.

Those who weaponize the accusation of racism for improper motives continue to make it harder for those who seek to eradicate racism where it truly exists.

Those who believe in the approach of an “eye for an eye” may seek retribution. Adherents of Stoicism might counsel a “grin and bear it” approach. Christians may counsel a “turn the other cheek” response. Others may rely on karma.

Delaware Cases

Relatedly, a Delaware Supreme Court decision found that a defamation claim based on a member of the legal profession falsely accusing a lawyer of being a racist was barred by the First Amendment guarantees of free speech and observed that “it is clear to us that Americans disagree about a long and growing list of things that to some are racist and to others are not.” Cousins v. Goodier, Del. Supr., No. 272, 2021, Slip op. at 28 (Aug. 16, 2022).

Delaware’s High Court referred to the evolving definition of racism and cited to the recently updated definition of the word in a leading dictionary that now includes systemic racism, id. at n. 103, while also noting that the term “racist” has been used so variously as to have been “drain[ed]…of its former, decidedly opprobrious meaning” and to now “fit comfortably within the immunity for name-calling.” Id. at n.104 (quoting Stevens v. Tillman, 855 F.2d 394, 402 (7th Cir. 1988)).

When an accusation is made by an unidentified person, options may be limited. In 2005, the Delaware Supreme Court reasoned in Doe v. Cahill that only in certain circumstances can one force the disclosure of the identity of an anonymous online accuser.

An activist affiliated with Harvard Law School has described Christianity as a religion guilty of systemic racism, just as many have described our criminal justice system. So what do those charges mean for Christians or those who play key roles in the criminal justice system?

ABA Opinion

The American Bar Association (ABA) Model Rules of Professional Conduct do not provide clear direction on the titular issue. In 2021, the ABA issued a formal opinion on the related topic of whether, and how, to respond to online criticism. See Standing Committee on Ethics and Professional Responsibility, Formal Opinion 496 “Responding to Online Criticism,” American Bar Association (Jan. 13, 2021).

This opinion speaks directly to lawyers faced with online attacks. The opinion focuses on the Model Rules of Professional Conduct that advise lawyers how to respond to their client, former clients, opposing counsel, and opposing counsel’s clients. The ABA recommends that in these scenarios, the lawyer either not respond to the negative posts, respond by asking the person who is posting to allow for a private discussion offline, or respond by stating that professional obligations do not permit the attorney to respond. The committee noted that any response to the negative review or comment may be counterproductive.

In sum, there is no panacea for dealing with false accusations, especially anonymous ones. One goal is not to react in a manner that would run afoul of the aphorism that two wrongs don’t make a right. Although revenge might best be served cold, a Chinese saying provides that a person who seeks revenge should dig two graves: one for the person against whom revenge is sought and one for the person seeking revenge. Life is not fair.

Francis G.X. Pileggi, Esquire, is the managing partner of the Delaware office of Lewis Brisbois Bisgaard & Smith LLP. He comments on legal ethics as well as corporate and commercial decisions at www.delawarelitigation.com.

Any litigator who has been practicing long enough will confront a challenge with a pre-trial deadline. The Delaware Bar, at least traditionally, has had a custom of freely granting reasonable requests for extensions. But in summary proceedings, where a trial is often scheduled within 90 days of a complaint being filed, special nuances need to be addressed.

Bottom line: A deadline for disclosing trial witnesses will not be extended absent good cause shown. The test is not whether the other side will be prejudiced.

In the recent decision styled PVH Polymath Venture Holdings Ltd. v. TAG Fintech, Inc., C.A. No. 2023-0502-BWD (Del. Ch. Aug. 3, 2023), Magistrate in Chancery Bonnie W. David granted a Motion in Limine to bar the introduction of an expert report at trial that was submitted after the applicable deadline.

Prior Delaware decisions highlighted on these pages exemplify how seriously Delaware courts treat deadlines, especially those enshrined in a scheduling order. See, e.g., these examples. Careful readers may recall a blog post earlier this month about two decisions enforcing deadlines (coincidentally in August of all months).

In this pithy decision, the following key points are noteworthy about a deadline issue in the most common type of summary proceeding: a DGCL Section 220 case:

Highlights

  • A deadline for disclosing trial witnesses will not be extended absent good cause shown. The test is not whether the other side will be prejudiced.
  • Scheduling Orders in summary proceeding are often shorter and less detailed than their more extensive counterparts in a plenary action–but no specifically-delineated deadline for expert witnesses simply means that the deadline for all fact discovery will also include the completion of all expert discovery.
  • The Scheduling Order in this particular case included a deadline–prior to the cutoff for fact discovery–by which witness lists needed to be exchanged, as well as those witnesses to be presented by affidavit, which is not uncommon in a Section 220 trial presented “on a paper record”.
  • Rule 44.1 regarding disclosure of foreign law experts did not supersede the deadlines in the Scheduling Order.
  • The Court explained that deadlines are essential in summary proceedings and that in order to litigate efficiently: “the parties need to cooperate with one another to tee up issues for resolution. There isn’t time for ‘overly aggressive litigation strategies’ and games of ‘gotcha'”. Slip op. at 5.
  • The Court cited an example of a prior Delaware decision the precluded the use of an expert report that was not timely disclosed. See footnote 6.

Postscript: Pursuant to Chancery Rule 144(h), the parties in this matter agreed to submit this case for a final decision by the Magistrate in Chancery.

A recent Delaware Court of Chancery ruling emphasizes the importance of meeting deadlines that are part of a scheduling order, and the consequences for not following those deadlines.  In two separate Orders in the matter of Shareholder Representative Services, LLC v. Alexion Pharmaceuticals, Inc., C.A. No. 2020-1069-MTZ, Order (Del. Ch. Mar. 23, 2023), the court granted a motion to exclude an expert report when the deadline for disclosing the subject matter of expert testimony was not met.  Specifically, six days after the deadline, the identity of the expert and his CV were produced, but not the subject matter of his proposed testimony. That was not disclosed until his expert report was provided 26 days after the deadline for disclosure–on the date that expert reports were due. Neither leave to amend the scheduling order nor consent from the other parties was sought. (FYI: Orders can be cited in briefs in Delaware.)

The court relied on Rule 6(b) which allows the court “for good cause shown” in its discretion to enlarge the period of time by which the parties are required to meet a deadline:  “if requested before it [the deadline] expires, or ‘upon motion made after the expiration of the specified period … where the failure to act was the result of excusable neglect.’’’

In the explanation on the last page of the Order, the court explained that the party involved neither sought an extension before the deadline nor moved for an extension after the deadline, nor did it try to show excusable neglect.  The court noted prior decisions of the Delaware Court of Chancery have stricken an expert report that was submitted late.  See Encite LLC v. Sony, 2011 WL 156181 (Del. Ch. Apr. 15, 2011).

In a second, separate Order in the same case, the court granted a motion in limine to exclude untimely produced documents that a party tried to use as exhibits for trial because they were not produced by the deadline.  In Shareholder Representative Services LLC v. Alexion Pharmaceuticals, Inc., C.A. No. 2020-1069-MTZ, Order (Del. Ch. June 28, 2023), the court explained that the documents requested in discovery were not produced until after the discovery deadline, and were required to be produced even though the opposing party “did not press for them.”  The court cited prior decisions where the court “excluded from trial documents that an expert relied on but were not timely produced.”  See Verition P’rs Master Fund v. Aruba Networks, C.A. No. 11448-VCL (Del. Ch. Nov. 30, 2016).  In sum, the court struck the documents that were sought to be introduced as exhibits because they were responsive to requests for production and there was a failure to timely produce them. Thus, the expert was prohibited from testifying or opining on the contents of those documents.

This article was prepared by Frank Reynolds, who has been following Delaware corporate law and writing about it in various publications for more than 35 years

The Delaware Court of Chancery has ruled that the contempt sanction of a $1,000-a-day fine is an appropriate means of forcing Hone Capital LLC to comply with the Court’s previous order to advance funds for an ex-officer’s defense of Hone’s charges that she fraudulently managed an investment  fund in Gandhi-Kapoor v. Hone Capital LLC  and CSC Upshot Ventures I LLP, No. 2022-0881-JTL Opinion issued  (Del. Ch., July 19, 2023).

Among the many cases on advancement highlighted on these pages over nearly two decades, this decision is especially noteworthy for, among other things, emphasizing the public policy reasons behind advancement and the serious consequences that might follow for not fulfilling advancement obligations–as determined by the Court to be owed.

Vice Chancellor Travis Laster’s July 19 opinion granted former Hone CFO Purvi Gandhi-Kapoor’s motion to hold Hone and its CSC Upshot Ventures I LLP fund in contempt for flouting his earlier summary judgment decision that they had no excuse for their seven month-long failure to honor an advancement agreement   He decided that the circumstances justified a fine, not as a punishment, but as just enough coercion to obtain compliance with the court order when irreparable harm was on the horizon.  And the ruling warned that a receiver could be used to force compliance.

In a decision affecting corporate and insurance law specialists, the court found that although “contempt is not generally available to enforce a money judgment,” the holder of this advancement judgment need not resort to slower collection mechanisms because, “The right to advancement is a time-sensitive remedy…A lack of timely advancements prejudices the covered person’s ability to defend the underlying litigation, potentially resulting in irremediable consequences, such as an adverse judgment or a conviction.”

Background

Gandhi-Kapoor was a member of limited liability company Hone, served as its Chief Financial Officer, and had the title of Partner. At Hone, she reported to Bixuan Wu and together with Wu, managed the Upshot Fund.

For disputed reasons, the CSC Group, the parent of Hone, terminated Wu. Gandhi-Kapoor resigned, and in 2020, caused Hone to file a lawsuit against Gandhi-Kapoor in California Superior Court accusing her of breach of fiduciary duty and fraud. That action was consolidated with Gandhi-Kapoor’s California declaratory judgment suit seeking a ruling that she was entitled to a percentage of the Upshot fund’s profits as promised compensation.

The Court awarded summary judgment in April in Gandhi-Kapoor’s advancement suit against both Hone and Upshot, at which time they owed nearly $1 million in submitted fees but neither has contested any of the billed amounts nor paid anything, the vice chancellor ruled.  He said seven months had passed since Gandhi-Kapoor had made what has been found to be a valid demand for advancement.  The companies unsuccessfully argued that there was no proof of irreparable harm.

Contempt petition ruling

In response to Gandhi-Kapoor’s petition for a contempt ruling, the Vice Chancellor decided that, “Advancement provides corporate officials with immediate interim relief from the personal out-of-pocket financial burden of paying the significant on-going expenses inevitably involved with investigations and legal proceedings,” citing Homestore, Inc. v. Tafeen (Tafeen III), 888 A.2d 204, 211 (Del. 2005). The proceeding is summary, he said, because “immediate interim relief” must be provided in timely fashion to be effective since the advancement award “is also an interim monetary award, akin to an interim award of alimony or an interim fee award,” and “the covered person faces a threat of irreparable harm.”

The Vice Chancellor said Delaware entities are not required to provide advancement, but if they chose to, they may be compelled through contempt rather than collection procedings to make paymemts if:

*The companies are actually found to be in contempt, and “To establish civil contempt, [the movant] must demonstrate that the [opponent] violated an order of the court of which they had notice and by which they were bound.” Handels AG v. Johnston, 1997 WL 589030, at *3 (Del. Ch. Sept. 17, 1997). The standard of proof required in a civil contempt proceeding is a preponderance of the evidence, and there is no longer any doubt that the companies are in contempt, he ruled.

*The remedy is appropriate. “If the primary purpose of the remedy is to coerce compliance with the court’s order, then the remedy is civil in character.” But he noted, “a court is obligated to use the least possible power adequate to the end proposed.” TR Invs., LLC v. Genger, 2009 WL 4696062, at *18 n.74 (Del. Ch. Dec. 9, 2009).

The appropriate remedy

The Vice Chancellor said he could have chosen to use the court’s “broad power” to force advancement order compliance by employing a receiver to utilize the respondent companies’ assets to provide Gandhi-Kapoor the awarded funds—especially where there was a history of refusal without valid reason.  Delaware laws that govern corporations and limited liability companies alike urge the courts to endow the receiver with just enough power to effect compliance.

Vice Chancellor Laster took that limited power principle a step further.  He noted that Gandhi-Kapoor had submitted a new brief in support of immediate relief in the form of a daily fine, but he decided that at least initially, he could impose the fine without employing a receiver to do it.  He calculated that Hone gained $658 per day by retaining the money it owed to Gandhi-Kapoor for her defense so the $1K per-day fine would be an incentive to pay up.

However, considering new information from Gandhi-Kapoor indicating that Hone might be selling or restructuring to put assets out of the Court’s reach, he held the door open for the future appointment of a receiver with appropriate power to cope with that situation.

Over the last 18 years that I have maintained this blog, I have published highlights on these pages, and elsewhere, of about 190 or so Delaware decisions involving stockholder demands under DGCL Section 220 for books and records, as well as the analogue in the LLC context. Nowadays, I only highlight those I find to be especially noteworthy.  A case that meets that standard is Seidman v. Blue Foundry Bancorp, C.A. No. 2022-1155-MTZ (Del. Ch. July 7, 2023), in which the Court “regretfully” shifted fees for “glaringly egregious litigation conduct in defending against a books and records request.”

This is a “doubleheader” blog post. I will also highlight a second decision (by the same VC) also issued this month that addressed sanctions for failure to comply with post-trial obligations to produce a company’s books and records in the LLC context, as well as errant litigation conduct.

This short blog post assumes the reader is familiar with the basic principles applicable to these types of summary proceedings. 

Highlights

The complaint in the Seidman case was filed on December 14, 2022, and the trial was scheduled for Feb. 22, 2023.  (Notably, complaints in summary proceedings such as these need not be long, compared to complaints I have filed in plenary cases which were 100-pages long–not including voluminous exhibits.)

The demand in this case included requests for formal board materials and compensation consulting reports for the purpose of investigating mismanagement and communicating with fellow stockholders.  Defendants initially refused to produce a single document.  Moreover, the company refused to confirm or deny what, if any, formal board materials existed.

Errant Litigation Conduct

The court observed that the defendant offered no real reason for demanding a deposition in-person in Delaware, in light of the plaintiff being in Florida at the time, especially when the defendant initially did not press an improper purpose defense.

Despite his confirmation that he was not a member of the purported group, the company continued to claim that the plaintiff was a member of the “Jewish mafia.”  The plaintiff was offended by the ethnic slur. 

The company notified the plaintiff too late for the plaintiff to take discovery on the affirmative defense that plaintiff’s stated purpose was not his actual purpose, despite the plaintiff being entitled to take discovery on that issue—on which the company bears the burden.  See Woods Tr. of Avery L. Woods Tr. v. Sahara Enters., Inc., 2038 A.3d 879, 891 (Del. Ch. 2020).

Two days before trial, the parties submitted a Proposed Final Order and Judgment pursuant to which the company produced 60-pages of documents including the compensation consulting reports that were the focus of the initial demand.

Attorneys’ Fees

This decision, from page 14 to 24, discusses the request for attorneys’ fees of over $220,000 for the time period ending two-days before trial.  Included in the court’s analysis was the fact that the company was inappropriately defending the case on the merits of a future plenary action, despite Delaware law being clear that a books and records proceeding is not the time for a merits assessment of potential claims.

Rather, under settled Delaware law, a stockholder “who demonstrates a credible basis from which the court can infer wrongdoing or mismanagement need not demonstrate that the wrongdoing or mismanagement is actionable.”  See Slip op. at 19 (quoting AmerisourceBergen Corp. v. Lebanon Cnty. Emps’. Retirement Fund, 243 A.3d 417, 437 (Del. 2020)).  The court also observed that it was improper to refuse to state what exact formal board materials existed.  Id. at n.78. 

Key Points

The court highlighted the categories of the company’s litigation conduct that the court found glaringly egregious: (i) The plaintiff was forced to file suit to “secure a clearly defined and established right” to inspect the company’s books and records; (ii) “Unnecessarily prolonged or delayed litigation” by refusing to produce any documents; (iii) “Increased the litigation’s cost” by, among other things, insisting in bad faith on an in-person deposition leading to motion practice; (iv) “Completely changed its legal argument” in a way which would prevent plaintiff from taking discovery to which he was entitled; and (v) Multiple misrepresentations to the court.  Id. at 21-22.

Takeaways

Although somewhat egregious facts often are not easily applicable to more routine cases, this case serves as a cautionary tale for companies that are less cooperative than the courts require in responding to stockholder demands for books and records.

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Part two of this “doubleheader” blog post discusses another cautionary tale: the recent Chancery decision in Bruckel v. TAUC Holdings, LLC, C.A. No. 2021-0579-MTZ (Del. Ch. July 17, 2023). This opinion deals with contempt sanctions for failure to comply with a post-trial order for production of books and records.  This case is another example of how difficult it is sometimes for a plaintiff to achieve, even after trial, the production of books and records. 

Key Facts

This case involves the demand by a manager pursuant to Section 18-305 of the LLC Act, as well as a contractual right pursuant to the operating agreement.

The court issued multiple prior decisions in this case, cited in the opinion, that provide additional background details.

The defenses asserted by the company included an alleged lack of a proper purpose, and that the stated purpose was not the primary purpose, and that demand was deficient under 6 Del. C. Section 18-305(e).  The court noted that the contractual rights under the operating agreement did not require a proper purpose.

Reasons for Fee-Shifting

The court summarized its reasons for fee-shifting to include the following: the company resisted through and after trial, by:  (1) withholding books and records to which the manager had unfettered rights; (2) failing to identify whether formal board materials exist; (3) altering the way the board functions in an attempt to duck the company’s production obligations; (4) manufacturing weeks-long delays in conveying books and records; (5) over-designating documents and communications as privileged.

Highlights

This decision includes guidance that goes beyond books and records cases and includes reminders of well-settled Delaware law regarding obligations for the preparation of privilege logs and redaction logs.

Also notable is that the court required production of documents through the present, as an ongoing obligation, not limited to documents dated as of the trial.

In connection with forcing compliance, the court appointed a receiver from among three Delaware lawyers proposed by the parties.

The scope of the opinion was intended to address the contempt of the company and any further sanctions; whether the defendant waived privilege; and whether the defendant met its burden to show cause as to why fees should not be shifted.

The court reviewed the standards for imposing sanctions due to the violation of a court order.  See Slip op. at 16.

Date-Range

The court noted that it was “remarkable” that the defendant took the position that it did not owe documents dated after the trial, and that this position ignored the plaintiff’s statutory inspection rights as a manager and the contractual inspection rights based on the operating agreement. 

Exception to Board Member’s Full Access

In this 44-page decision, the court also reviewed the standard to determine whether the exception when a board member is “adverse” applied such that it would entitle a company to withhold from a director or a manager unfettered access to the books and records that a manager or a director would normally be entitled to obtain–especially to the extent that they are provided to other board members.  Slip op. at 25.  It did not.

Privilege Log

The court reviewed the obligations of a party preparing a privilege log, which include a prohibition on withholding entire documents that are only partially privileged.  Id. at 26.  The court also explained that attachments to otherwise privileged documents need to be separately analyzed and described to justify their privilege.

The court found that not disclosing board materials was “at the heart of this case” and defendants did not explain why a member of the board was adverse to the extent that the minutes of a board meeting should not be produced in their entirety.

The court applied the standard for shifting fees in these types of cases as recited in the Gilead case, which was highlighted previously on this blog. See also AmerisourceBergen case highlighted on these pages as another cautionary tale.

As an example of an improperly asserted defenses, the court repeatedly explained that the plaintiff had contractual rights under the operating agreement that did not require that it establish a proper purpose, especially in light of a manager having essentially unfettered statutory rights and, in this case, “unbounded contractual rights” to books and records.  See Slip op. at 36-37 and footnote 164.

Reasonableness of Fees The court observed that the plaintiff was requesting approximately $219,000 in fees and expenses–incurred merely for bringing the contempt motion.  The court requested that the plaintiffs’ counsel supplement the request for fees by including billing statements.  The court also determined that it would consider the request for fees pertaining to the contempt motion as part of its consideration of the request for fees shifted for the entire action,

Takeaways

The parties and their counsel should expect close scrutiny by the Court of Chancery, in all aspects of the litigation, both pre-trial and post-trial, to ensure that the procedural and substantive obligations of the parties and their counsel are being complied with in good faith, especially in what is categorized as a summary proceeding.

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U.S. Court of Appeals Judge Amul Thapar recently published a book entitled, “The People’s Justice:  Clarence Thomas and the Constitutional Stories that Define Him.”  This is not a book review.  Rather, I just wanted readers to be aware of this exemplary new publication.  The book should be read by those who seek to understand one of the greatest jurists to ever sit on the U.S. Supreme Court and whose opinions have an outsized impact on the law that impacts every American.

A former U.S. Attorney General described the book as a must-read for “anyone concerned about the country’s future.”

Often the subject of unfair and relentless criticism, this book explains through the examination of landmark cases and the people behind the cases how Justice Thomas’ originalist jurisprudence delivers equal justice under the law.  Justice Thomas is quoted as saying that “finding the right answer is often the least difficult problem.”  What is needed is “the courage to assert that answer and stand firm in the face of the constant winds of protest and criticism.”

The Delaware Court of Chancery recently published an opinion that provides guidance on the latest iteration of the standard that will be applied when the court considers an application for mootness fees in the context of stockholder litigation. In Anderson v. Magellan Health Inc., C.A.No. 2021-0202-KSJM (Del. Ch. July 6, 2023), Chancellor McCormick granted a fee award of $75,000 in response to a fee request of $1.1 million in connection with a stockholder class action challenging a merger agreement between Centene Corporation and Magellan Health, Inc. After suit was filed, Magellan took certain actions that included supplemental disclosures which mooted the action and a stipulation of dismissal was filed.

Basic Background Facts

The suit claimed that confidentiality agreements that contained “don’t-ask, don’t-waive” provisions impeded the process that led to the Centene deal and, because the provisions were not fully described in the proxy, rendered stockholder provisions materially deficient. Shortly after suit was filed, Magellan issued supplemental disclosures on the don’t-ask-don’t-waive provisions and waived its rights under three of the four confidentiality agreements. On the theory that the supplemental disclosures and waivers were corporate benefits, plaintiff’s counsel petitioned the court for an award of fees and expenses.

Key Aspects of Ruling

This decision was provided as a public service to non-Delaware courts applying Delaware law who may not have “access to the this court’s bench rulings” that reflect a doctrinal shift that resulted in an “overall decline in settlements and fee awards” for strike suits challenging M&A transactions in Delaware. Slip op. at 15.

The Chancellor described this opinion as a clarification “for their sake”. Id. Specifically, the Court explained that: “Often, pre-Trulia precedent pricing corporate benefits reflect inflated valuations and warrant careful review.” Id.

The Court’s analysis emphasized that precedent prior to the seminal decision in the matter of In Re Trulia S’holder Litig.,129 A.3d 884 (Del. Ch. 2016), was “less useful”. In particular, the Court added that: “Post-Trulia decisions awarding attorneys’ fees in suits challenging don’t-ask-don’t-waive provisions reflect the decline in fees awarded for non-monetary benefits in merger litigation.’ Id.

Supplemental Disclosures

After explaining why the waivers did not deserve a fee award, the Court focused on the value of the supplemental disclosures. Although such disclosures have been recognized as a benefit, the Court observed that: “… the standard for pricing that benefit for the purpose of awarding mootness fees warrants reexamination in view of developments in deal litigation since Trulia.” Slip op. at 16.

In response to excessive deal litigation, Delaware courts responded in several ways, including a change in substantive law. In MFW and Corwin, the Supreme Court allowed deal lawyers to invoke the business judgment rule to avoid a merits-based review under the entire fairness or enhanced scrutiny standards. See Kahn v. M & F Worldwide Corp., 88 A.3d 635 (Del. 2014) and Corwin v. KKR Fin. Hldngs LLC, 125 A.3d 304 (Del. 2015). In addition, C & J Energy Servs. Inc. v. City of Miami Gen. Empls. and Sanitation Empls. Ret. Trust, 107 A.3d 1039 (Del. 2014), “denounced the use of preliminary injunctions as a means of challenging third-party acquisitions and rerouted stockholders to ‘after-the-fact monetary damages.'” Slip op. at 17.

Importantly, moreover, “Delaware courts … began to clamp down on disclosure-only settlements.” Id. See footnote 49 and 51 collecting cases that document this change.

Delaware Public Policy

For the avoidance of doubt, the Court underscored that Delaware public policy does not encourage plaintiffs’ counsel to: “pursue weak disclosure claims with the expectation that defendants would rationally issue supplemental disclosures and pay a modest mootness fee as a cheaper alternative to defending the litigation.” Slip op. at 22.

Delaware courts have not had much opportunity to clarify Delaware policy and law on mootness fees based on supplemental disclosures because in the wake of Trulia, the “… deal-litigation diaspora spread mainly to federal courts, where plaintiffs’ attorneys repackaged their claims for breach of the fiduciary duty of disclosure as federal securities claims.” Id.

After careful reasoning and citation to scholarship on the topic and the case law developments, the Chancellor clarified that: ” At a minimum, mootness fees should be granted for the issuance of supplemental disclosures only where the additional information was legally required.” Slip op. at 23.

Going forward, the Court gave notice that it: “… will award mootness fees based on supplemental disclosures only when the information is material”. Slip op. at 24.

The Court engaged in a thorough analysis of the precise details and impact of the supplemental disclosures in this case, and what amounts have been awarded in relevant Delaware decisions. See, e.g., footnotes 81 to 84.

Money Quote and Takeaway

After an extensive review of the facts of this case and reasoning based on the applicable cases as well as public policy considerations, including the submissions by several professors who filed amici curiae briefs, my vote for the best concluding quote of the case, that also serves as a takeaway for future guidance, follows:

Where lawsuits are not worth much, plaintiffs’ counsel should not be paid much. In this case, the award represents less than the Movants’ lodestar, which should send a signal that these sorts of cases are not worth the attorneys’ time. Moreover, had Movants been required to meet the materiality standard, it seems unlikely that there would have been any award at all.

Slip op. at 35 (emphasis added).

This blog’s favorite preeminent corporate law scholar provides learned commentary on the titular topic on his eponymous blog ProfessorBainbridge.com with citations to his prior scholarship and insights by other leading corporate law professors. They do a deep dive into the implications of Coster v. UIP Cos., Inc., Del. Supr., No. 163, 2022 (June 28, 2023).

See, e.g., Prof. Ann Lipton’s commentary on the case as well as her reference on Twitter to Vice Chancellor Laster’s very recent reference to the Coster decision and its impact on the standard of review in the context of a corporate election or a stockholder vote involving corporate control.

Typically, I don’t duplicate coverage of noteworthy Delaware corporate law decisions that have already been the subject of widespread commentary such as this one that has been analyzed extensively by leading experts.

I want to thank my partner, Sean Brennecke, for his valuable contribution to this post.

The titular holding was rendered in the context of whether substantial compliance was established as a defense to a breach of contract claim in a recent decision of the Delaware Court of Chancery in the matter styled LPPAS Representative, LLC v. ATH Holding Company, LLC, et al., C.A. No. 2022-0241-KSJM (Del. Ch., May 2, 2023).

This useful decision deserves a spot in the toolbox of all commercial litigators. It addresses several noteworthy issues beyond substantial compliance, including whether the right to participate by the indemnitee as part of a right to indemnification was honored–but for purposes of this short post I will limit my highlights to only a few aspects of the decision.

The court’s discussion begins with its holding that the defendant breached the terms of the contract it entered into with plaintiff by, among other things, not including the plaintiff in discussions with a government agency, not allowing plaintiff to review and comment on filings and submissions the defendant made to a court or government agency, and otherwise failed to allow plaintiff to participate in the defense of claims for which the defendants were providing indemnification. 

In so holding, the court rejected the defendants’ arguments, including that they substantially complied with the contract’s requirements. The court discusses the substantial compliance issue primarily from pages 34 to 39 of the slip opinion.  Initially, the court observed that the parties disagreed on whether Delaware law required a party to strictly comply with the terms of a contract or whether substantial compliance was sufficient. In footnote 163 the court reviewed the cases cited by the parties on this issue although the court did not view the parties as having “meaningfully” briefed the question and noted that the limited authority cited by the parties did not fully support their respective positions.

In order to “streamline this decision,” the court assumed that the applicable standard is substantial compliance as that is the lower standard. 

Applying that assumption, the court considered whether the defendants’ failure was “material.”  The court instructed that Delaware followed the Restatement (Second) of Contracts for determining materiality in the substantial compliance context and identified five circumstances which are particularly significant, including “the extent to which the injured party will be deprived of the benefit which he reasonably expected, and the extent to which the injured party can be adequately compensated for the part of the benefit of which he will be deprived….”  See Slip Op. at 35-36.  The court added that the materiality standard is “necessarily imprecise and flexible” and must be “applied in the light of the facts of each case in such a way as to further the purpose for securing for each party his expectations of an exchange of performance.”

The court reasoned that the plaintiff was deprived of the benefit which it reasonably expected, which in this case was the ability to participate in the defense in connection with its right to indemnification and that because that benefit was intangible, “it is hard to imagine how to adequately compensate” for the breach.  Under the circumstances of this case, the court found those factors to weigh in favor of a finding of materiality.

The defendant raised, and the court rejected, five arguments in support of their claim that their breach was immaterial.  One such argument was that their obligations to include plaintiff in critical discussions was not triggered because the plaintiff did not approach the defendant and request that they enter into joint defense agreement.  In rejecting this argument, the court held that the language of the indemnification provision did not impose an affirmative duty to contact the other party to put a joint defense agreement in place. 

The court further observed that the lack of such language in the agreement suggested that “neither party alone bears the burden of first contact.”  Slip Op. at 39.

Therefore, the court concluded that the failure to propose a joint defense agreement proactively did not necessarily absolve the defendants of their own obligation to work with the plaintiff to get one in place or honor their other contractual obligations. 

A recent decision of the Delaware Superior Court cited an article that I co-authored with Chauna Abner that provides a step-by-step guide to transferring cases from the Delaware Court of Chancery to Delaware’s trial court of general jurisdiction, the Superior Court. See RiseDelaware Inc. v. DeMatteis, C.A. No. N22C-09-526-CLS (Del. Super. May 22, 2023). 

The article is cited at footnote 8 of the opinion and was previously posted on this blog.  Footnote 8 notes that the procedure for transferring a case from the Court of Chancery to the Superior Court is similar to transferring a case from the Superior Court to the Court of Chancery. 

This recent decision provides a hard-to-find, practical explanation of the procedure, which is somewhat esoteric to the extent that it is not a well-traveled path and explanations about the nuanced procedures described for transfer between trial courts are not easy to find. That point makes this opinion required reading for any Delaware practitioner that needs to know the procedural requirements for this type of case transfer. 

The opinion’s judicial guidance is especially important in light of a recent trend in Delaware Court of Chancery decisions that employ more scrutiny, often sua sponte, in the service of jealously guarding (understandably) the famously limited subject matter jurisdiction of the Court of Chancery–which, many will be surprised to know, does not always always include requests for a permanent injunction.  See, e.g. In re Covid-Related Restrictions on Religious Services, Consol. C.A. No. 2021-1036-JTL (Del. Ch. Nov. 22, 2022), highlighted on these pages.

I recently posted my latest ethics column for The Bencher which provided a short overview of the standards for judicial recusal or disqualification applicable to federal judges. The standards for state judges are similar but based on slightly different rules.

Fortunately, there are not many decisions by the Delaware Court of Chancery on the standards applicable to judicial recusal or disqualification.

A recent Chancery decision applied the same standards to a Special Master as would apply to a judge in the matter styled: In re AMC Entertainment Holdings, Inc. Stockholder Litigation, Consol. Civil Action No. 2023-0215-MTZ (Del. Ch. May 10, 2023). The Court applied Rule 2.11 and Rule 2.11(A) of the Code of Judicial Conduct for Delaware Judges. Rule 2.11 provides in relevant part that:

(A) A judge should disqualify himself or herself in a proceeding in which the judge’s impartiality might reasonably be questioned, including but not limited to instances where:
(1) The judge has a personal bias or prejudice concerning a party[;]
(2) The judge, . . . or a person within the third degree of relationship,
calculated according to the civil law system,
. . .
(c) is known by the judge to have an interest that could be substantially affected by the outcome of the proceeding[.]6

Regarding Rule 2.11(A), the Court explained that:

Our Supreme Court has set forth the standard where one seeks disqualification of a judicial officer under Rule 2.11(A)(1):

‘[T]he judge must engage in a two-part analysis to determine if recusal is warranted. First, the judge must determine whether she is subjectively satisfied that she can hear the case free of bias or prejudice concerning the party seeking recusal. Second, “even if the judge believes that he or she is free of bias or prejudice, the judge must objectively examine whether the circumstances require recusal because ‘there is an appearance of bias sufficient to cause doubt as to the judge’s impartiality.’

For those interested in this topic, I encourage a close review of this excellent application of the standards to the facts in this case

Postscript: This topic was also recently addressed in a recent article about a motion to disqualify the judge hearing the pending case involving the Disney Company and the Florida Governor.

My latest ethics column for The Bencher, the publication of the American Inns of Court, on the titular topic, is reprinted below courtesy of the publisher. I have been writing an ethics column for The Bencher for the last 25 years.

Before I provide an overview of the basic standards that apply to inform the decision about whether a judicial officer should recuse himself or herself, or otherwise be disqualified from presiding over a particular lawsuit, I want to share some practical wisdom I have learned from several judges with whom I am close to personally—but before whom I would never appear in a courtroom to argue a case.

When a reasonable person familiar with the relevant facts earnestly believes that an issue of a judge’s impartiality might reasonably be raised in a pending lawsuit, that person should explore an appropriate informal means of presenting that issue to the presiding jurist. That approach provides an informal opportunity to the judicial officer to make his or her own assessment of the issue in an appropriate manner that might make a formal motion unnecessary.

This topic is covered in books dedicated solely to judicial disqualification, as well as in heavily footnoted law review articles, but this short ethics column is only intended to cover the highlights. Over the past 25 years of publishing these ethics columns I have, in a few instances, touched on topics that are related to the standards that regulate the judicial branch. See, e.g., Francis G.X. Pileggi, “Fifth Circuit Orders Recusal of Trial Judge,” The Bencher (July/August 2011); Francis G.X. Pileggi, “Professionalism and Judges,” The Bencher (July/August 2015) (describing earlier behavior of attorney as indication of judicial demeanor as a later member of court); Francis G.X. Pileggi, “Resources for Judicial Ethics Research,” The Bencher (January/February 2022).

Applicable standards include Canon 2 of the Code of Conduct for United States Judges, which provides that a judge should avoid impropriety and the appearance of impropriety in all activities. Canon 2(A) states that “[a]n appearance of impropriety occurs when reasonable minds, with knowledge of all the relevant circumstances disclosed by a reasonable inquiry, would conclude that the judge’s honesty, integrity, impartiality, temperament, or fitness to serve as a judge is impaired.” (emphasis added).

The rubric to avoid even the appearance of impropriety applies to both professional and personal conduct. The federal statute that governs judicial conduct requires that: “Any justice, judge, or magistrate judge of the United States shall disqualify himself in any proceeding in which his impartiality might reasonably be questioned.” 18 U.S.C. § 455(a).

“[T]he test for recusal under § 455(a) is whether a reasonable person, with knowledge of all the facts, would conclude that the judge’s impartiality might reasonably be questioned.” In re Kensington Int’l, Ltd., 368 F.3d 289, 296 (3rd Cir. 2004)(emphasis added). See generally 12 Moore’s Federal Practice-Civil § 63.35 (2022). (Although mere friendship, for example with counsel, ordinarily is insufficient to warrant recusal, unusual circumstances may require recusal.)

Section 144 of Title 18, unlike Section 455, refers specifically to the appearance of a lack of impartiality as it relates to parties—as compared to counsel. See generally Geyh, Alfini, & Sample, 1 Judicial Conduct and Ethics § 4.07[3], Matthew Bender & Co., 2020). The Comment to Rule 2.3 of the Delaware Judges’ Code of Judicial Conduct notes that manifestations of bias or prejudice can include epithets, slurs, references to personal characteristics, or threatening, intimidating, or hostile acts.

The public policy animating the disqualification rules is the need to inspire public confidence in the public perception that the due process requirement of a fair trial before a fair tribunal appears to be provided to all parties and their counsel in litigation. The emphasis is on how the circumstances appear to a reasonable person with knowledge of the relevant facts—not whether actual lack of impartiality can be proven. See, e.g., Richard E. Flamm, Judicial Disqualification: Recusal and Disqualification of Judges § 5.1, at 104 (3rd edition, Banks & Jordan, 2017).

Notwithstanding the applicable standards, appropriate efforts to informally seek the recusal of a judge, and if necessary, formal motions to disqualify, should only be pursued in those rare circumstances when one’s duty to the client, as well as broader duties, make it absolutely necessary.  Even then, they should be brought reluctantly, only after thorough research, careful analysis, extensive soul-searching, confidential vetting with colleagues, and with conscientious consideration of all the aspects and ramifications of such an unpleasant process.

Francis G.X. Pileggi, Esquire, is the managing partner of the Delaware office of Lewis Brisbois Bisgaard & Smith LLP. He comments on legal ethics as well as corporate and commercial decisions on his blog. He is the author of American Legal Ethics: A Retrospective from 1997–2018 (Outskirts Press 2018).

This post was prepared by Andrew J. Czerkawski, an associate in the Delaware office of Lewis Brisbois, who is scheduled to be sworn in to the Delaware Bar in December 2023

          In Hoffman v. First Wave Biopharma, Inc., 2023 Del. Ch. LEXIS 378 (Del. Ch. Sep. 27, 2023), the Delaware Court of Chancery determined that board actions did not trigger a fellow director’s mandatory advancement right.

Background

          Hoffman served on the board of directors of First Wave Biopharma, Inc. (the “Company”). After a soured acquisition, the target’s stockholder representative sued the Company.  The resulting settlement discussions contemplated the Company paying the stockholder representative $1.5 million.

          During the relevant period, the Company’s board discussed and decided to raise an additional $4 million, not planning to tell the public for some months. Yet, a former stockholder nevertheless learned of the planned equity raise and leveraged that information to increase the settlement amount with the stockholder representative by another $1 million.

          The Company’s board concluded that Hoffman, the Plaintiff, leaked the information.  Though the board “had no concrete evidence,” the board drew this conclusion because (i) the planned equity raise remained non-public information and (ii) only Hoffman “had a positive relationship” with the former stockholder.  In turn, and out of fear of further leaks, the board established a committee comprising all the directors except Hoffman.

          Disagreeing with his exclusion, Hoffman retained counsel and exchanged a series of correspondence with the Company, including a Section 220 demand, ultimately resulting in an indemnification and advancement request.  Though it produced responsive book and records, the Company claimed the Plaintiff breached his fiduciary duties and denied any indemnification or advancement.  The captioned litigation ensued.

Arguments

          Neither party disputed that the Plaintiff’s director status afforded him certain mandatory advancement rights under a separate indemnification agreement with the Company.  But only defined “covered proceedings” triggered that right. The issue was whether an “investigation” and an “inquiry” was conducted in order to trigger a covered proceeding.

          The Plaintiff contended that because the Company concluded he leaked the non-public information and therefore breached his fiduciary duty, “the [Company] necessarily must have conducted an ‘investigation’ and/or ‘inquiry’ into [the Plaintiff’s] actions.”  Thus, the Plaintiff contended, because the Company conducted either an investigation and/or inquiry, the Company triggered the Plaintiff’s mandatory advancement right. The Company contended “it never undertook an investigation or inquiry into [the Plaintiff’s] conduct.”

Court’s Analysis and Findings

          The Court determined that the board took no steps to confirm the belief that the Plaintiff leaked the information and found that “the Company did not investigate or otherwise conduct an inquiry into [the Plaintiff].”  The Court ultimately held that because “the Company directors started from the conclusion that [the Plaintiff] leaked” the non-public information, the Company’s actions were “corrective actions from that conclusion, not investigative actions undertaken in reaching that conclusion.”  Thus, because the Company only took “remedial, not investigatory” actions to assuage their fear of further leaks, the board’s response fell “short of an ‘investigation’ or ‘inquiry’ sufficient to trigger [the Plaintiff’s] advancement rights.”

          The Court, as it often does, turned to dictionary definitions in order to ascertain the plain meaning of the words “investigation” and “inquiry.”  Relying on these definitions, the Court denied the Plaintiff mandatory advancement, holding: these definitions require “more positive action, pomp, and procedure than one individual’s immediate deductive conclusion based on known facts.”

Takeaway

       The Plaintiff might have succeeded in procuring advancement from the Company if the language setting forth the events triggering his advancement right included broader categories.  For instance, if the clause included “conclusion, accusation, or contention of the Company,” then the board’s actions, though falling short of “investigation” or “inquiry,” would nevertheless still likely rise to the level of a “conclusion, accusation, or inquiry” sufficient to trigger the mandatory advancement right. 

This post was prepared by Andrew J. Czerkawski, an associate in the Delaware office of Lewis Brisbois, who is scheduled to be sworn in to the Delaware Bar in December 2023.

In Tilton v. Stila Styles, LLC, 2023 Del. Super. LEXIS 772 (Del. Super. Ct. Sep. 19, 2023), the Delaware Superior Court found an advancement claim unripe.

Tilton served as the sole manager of Stila Styles, LLC, a single-member Delaware LLC (the “Company”).  When the Company’s sole member removed her as manager, the Plaintiff challenged her removal in the Court of Chancery, lost, appealed, and lost again.

Tilton, the Plaintiff, sent the Company completely redacted legal fee invoices.  The Company in turn requested unredacted copies. The Plaintiff sent back partially redacted copies but on the same day filed a complaint against the Company seeking in the Superior Court, inter alia, her outstanding fees and expenses the Company did not advance pending the appeal of the Court of Chancery suit.

The Court determined that the Plaintiff “prematurely” sought a judgment on the pleadings and brought an “unripe” advancement claim.  In doing so, the Court admonished: “Rather than provide [the Company’s] counsel with an opportunity to determine the reasonableness of [the Plaintiff’s] advancement requests, [the Plaintiff] precipitously sought court intervention.”  The Court further advised: “[t]hese are the exact sort of litigation tactics that unnecessarily burden the Court and vitiate what would otherwise be a good faith petition for judicial relief.”

 Finding the advancement claim “unripe,” the Court instructed that “[the Plaintiff’s] counsel frustrated any viable process to resolve the advancement requests in good faith by providing partially redacted invoices the same day that they filed the instant action, seeking payment of those entries.”  The Court ordered the parties to meet and confer on the advancement claim because “[w]hether the entries themselves are reasonable or not is a factual dispute, and until the parties meet and confer on a good faith basis to resolve the advancement demands, moving for judgment on the pleadings is not ripe, and hence, improper.”

Takeaways: First, before filing a complaint, the party seeking advancement should provide the board with invoices redacted only as necessary to preserve any privilege.  Second, the party seeking advancement should wait until the board responds, or, if the board returns no timely response, the party seeking advancement should wait a reasonable amount of time in which a board could otherwise respond.