Delaware Supreme Court Rules on Right to Bear Arms Outside One’s Home

The Delaware Supreme Court issued an important decision a few days ago on the right to bear arms outside one’s home. This right has at its core the right to self defense which is a natural right that every person is born with–an exalted right not shared with many of our laws. Thus, the importance of this decision and this bedrock topic transcend the corporate and commercial issues that are the typical fare of this pages.

The High Court’s ruling in Bridgeville Rifle and Pistol Club v. Small, Del. Supr., No. 15, 2017 (Dec. 7, 2017), was based on Article I, Section 20 of the Delaware Constitution which expressly provides for much broader rights to bear arms as compared to the analogue in the Second Amendment to the U.S. Constitution. Although the specific focus of the court’s opinion, which is 143-pages long when the majority opinion and the dissent are combined, was the invalidation of regulations that in substance eviscerated the right to bear arms in state parks and forests, the court’s scholarly analysis and explication of fundamental principles has far-reaching applicability. For example, the Delaware Constitution provides for the right to keep and bear arms for the protection of self, home, family, state and for recreational and hunting purposes. Those rights were added to our state constitution at Article I, Section 20, in 1987, but there has been doubt in some circles if those words really “meant what they said.”

In sum, a majority of the Delaware Supreme Court has now established in Delaware that Article I, Section 20 means, among other things, that the natural right to defend oneself, recognized in the Delaware Constitution, extends beyond the home. Although it is not an unfettered right and reasonable restrictions can be imposed, as of last week, state agencies cannot impose regulations that have the net effect of eliminating or eviscerating the right to bear arms in state parks and forests.

It would be easy to write a law review article about the 143-page decision, that was buttressed by the 2014 Delaware Supreme Court decision in Doe v. Wilmington Housing Authority, that this author also argued, but that longer article will need to wait. The Doe case, also highlighted on these pages, recognized a right to bear arms outside one’s home, but this Bridgeville decision provides more doctrinal underpinning and a more thorough analysis of the reasons why this fundamental right extends beyond the home.

The Washington Post on Dec. 8 and the News Journal on Dec. 9 carried stories on this case.

Chancery Rejects Challenge to State Contract Bid Award

A recent Delaware Court of Chancery decision rejected a challenge by an unsuccessful bidder to an award by the state of a professional services contract. This decision provides a helpful example of how difficult it remains to challenge such bid awards. Many thanks to Deputy Attorney General Larry Lewis for bringing this opinion to our attention. We are also grateful to Larry and his colleague, Deputy Attorney General John H. Taylor, for providing the following synopsis of their prevailing opinion in Protech Solutions, Inc. v. The Delaware Department of Health and Social Services et al., C.A. No. 2017-0642-TMR (Del. Ch. Nov. 30, 2017).

Background facts: In March 2017, the State of Delaware Department of Health and Social Services, Division of Child Support Services (the “Division” or the “State”) issued a Request for Proposal (“RFP”) for maintenance and operations (“M&O”) services for the Delaware Child Support System (the “System”). Ultimately, three vendors submitted bids in response to the RFP. Two of the vendors, Conduent State & Local Solutions, Inc. (“Conduent”) and Protech Solutions, Inc. (“Protech”), were the current contractor and subcontractor, respectively, for current State contract for M&O services for the System.  Protech’s staffing proposal was “significantly lower than the [Division’s] current staffing needs, from which the Division gave no indication it was considering deviating, and lower than both other bidders.”  (Mem. Op. at 16.)  Protech’s staffing proposal was based largely upon Protech’s analysis of nonpublic State data relating to the current M&O operations, which the Court determined was “in direct conflict with the information provided to the bidders by the Division.”  (Mem. Op. at 1.)

The Division ultimately rejected Protech’s bid in July 2017, and began contract negotiations with Conduent.  Protech then filed suit seeking an injunction in September 2017. Protech’s suit alleged, among other things, that the Division: (1) did not provide sufficiently definite and explicit requirements for personnel resources “such that vendors were unable to bid intelligently or on a common basis”; (2) provided Conduent with inside information about personnel resources; and (3) otherwise  acted “irrationally, arbitrarily, capriciously” by failing to put all vendors “on equal footing” with respect to the personnel resources needed for the contract.  (Petition ¶¶ 76-78.)

The parties agreed to a standstill, pending the Court’s resolution of Protech’s expedited request for preliminary injunctive relief. Oral argument was held on November 14, 2017, following completion of expedited discovery and briefing.

Holding: The Court of Chancery denied Protech’s Motion for Preliminary Injunction, holding that Protech “fail[ed] to demonstrate reasonable probability of success on the merits of any of [its] claims.”  (Mem. Op. at 20.)   Specifically, the Court found that Protech’s arguments were “based on a misunderstanding of Delaware procurement law, misconstruction of the facts, and rather ironic allegations of use of nonpublic information.”  (Mem. Op. at 5-6.)

Court’s Reasoning: The Court first declined Protech’s invitation to follow case law involving challenges to public works contracts under the Delaware Procurement Act, 29 Del. C. § 6901, et seq. (the “Procurement Code”), and instead, the Court relied on the sections of the Procurement Code governing professional services contracts (and case law interpreting these provisions).  Although it was uncontroverted that the M&O contract sought by the Division was a professional services contract, Protech claimed that public works cases requiring RFPs to include plans and specifications extended to require professional services RFPs to specify the exact number personnel resources sought.

The Court rejected that approach and noted that beyond certain discrete mandates, “the professional services negotiation subchapter establishes only general guidelines for the procurement process: agencies are granted great discretion to shape the process to meet their needs.”  Thus, the Court held that the Division was not mandated to specify the number of personnel resources for the M&O contract.

The Court also held that Protech failed to demonstrate a likelihood of success on its claims that the Division’s actions were arbitrary, capricious or in bad faith.  First, Protech’s claim that it was disadvantaged because Conduent had received inside information was rejected by the Court because the alleged inside information was largely consistent with publicly available information.  Moreover, the Court noted that “[t]he doctrine of unclean hands may bar Protech’s claims should this litigation advance” since Protech’s own staffing proposal was the product of Protech’s unauthorized use of a nonpublic State database.  (Mem. Op. at 15 n.54.)

Second, the Court rejected Protech’s claims that the Division failed to strictly follow the terms of its RFP, holding that Protech failed to allege any prejudice from the alleged procedural deficiencies.  Finally, the Court rejected Protech’s claim that Conduent’s bid was deficient – and thus its acceptance by the Division was improper – because the alleged deficiencies were found to be immaterial and subject to waiver by the Division based on the explicit terms of the RFP.

Chancery Denies Motion to Disqualify Counsel

A recent decision of the Delaware Court of Chancery serves as a reminder of the high threshold that must be met before a motion to disqualify counsel will be granted–and why such motions are viewed with some skepticism by the court. This ruling also provides a useful guide for corporate and commercial litigators in its description of the various prerequisites for such a motion to be successful, as well as the general principle in Delaware that the trial courts are not the appropriate forum to enforce violations of the Rules of Professional Conduct for Lawyers.

In Dollar Tree Inc. v. Dollar Express LLC, C.A. No. 2017-0411-AGB (Del. Ch. Nov. 21, 2017), the court addressed a motion for disqualification of counsel by an investment bank and the defendant entities who alleged that a local Delaware law firm had represented the investment bank in connection with the challenged transaction.  That same Delaware firm (“the Firm”) represents the plaintiffs in this case alleging wrongdoing regarding the challenged transaction.  The detailed facts are essential in order to grasp a complete understanding of the determinative nuances involved.  But for purposes of this short post, which focuses on the legal principles that can be applied in future cases, I will merely refer to the irreducible minimum essential facts.

Key Facts

The defendants in this case had hired Duff & Phelps to provide a solvency analysis and render an opinion concerning the issuance of a dividend. Duff & Phelps hired the Firm for the limited purpose of advising Duff & Phelps regarding Delaware issues.  The total amount of time billed on the engagement was little more than 12 hours and the Firm’s engagement was limited to advising Duff & Phelps and providing the opinion letter for them regarding the solvency analysis.  Importantly, the Firm represented Duff & Phelps and not the defendant in this action, Dollar Express.

Shortly afterwards, the Firm represented the plaintiff in the instant matter alleging fraudulent transfer claims and illegal distribution claims under 6 Del. C. § 18-607.

Several months after the suit was filed, counsel for the defendant discovered that the Firm had represented Duff & Phelps regarding the solvency analysis and rendered an opinion in connection with the dividend that was being challenged in the instant lawsuit. On the same day that the Firm was asked to withdraw, the Firm implemented an internal ethical wall between those who represented Duff & Phelps and those who were involved in the instant matter — none of whom had been engaged in both representations.

The opinion includes a detailed discussion of the steps that the Firm took to prevent any confidential information from being shared. Through an investigation by its internal IT personnel, the Firm confirmed that none of the Firm’s attorneys who worked on the Duff & Phelps matter accessed information involving the instant litigation matter.

Reasons the Firm Refused to Withdraw:

The reasons the Firm refused to withdraw included the fact that the two matters were not substantially related and that no confidential information from the prior representation was shared with the attorneys involved in the instant matter. The Firm also advised Duff & Phelps that it would not be involved in any examination of Duff & Phelps’ representatives in connection with the current litigation.  Rather, any such examination would be conducted by other counsel.  The Firm also emphasized that it denied the existence of any implied attorney-client relationship between the Firm and the defendants in the instant matter.  Duff & Phelps intervened in the current action to join in a motion to disqualify the Firm.

Applicable Law

Rule 1.9(a) of the Delaware Lawyers’ Rules of Professional Conduct provides that a lawyer who has:  (i) formally represented a client in a matter; (ii) shall not thereafter represent a new client in the same or a substantially related matter; (iii) in which that new client’s interests are materially adverse to the interests of the former client; (iv) unless the former client gives informed consent in writing. There are also impermissible conflicts that cannot be waived.  Conflicts are generally imputed to a lawyer’s entire firm under Rule 1.10(a).

The basis of the unsuccessful motion to disqualify included the following allegations: (1) There was an implied attorney-client relationship between the Firm and the defendants because the Firm received confidential information from Duff & Phelps about the defendants; (2) It would be improper for the Firm to have implicitly advised the defendants on the validity of a transaction that is challenged in the current litigation; (3) The Firm’s participation in this litigation would violate the duty of loyalty owed to Duff & Phelps; and (4) The representation of the plaintiffs in this action by the Firm would require the Firm to discredit the same work it did when it advised Duff & Phelps.

Determination of the Existence of an Implied Attorney-Client Relationship:

The basic test for determining whether contacts between a potential client and a potential lawyer create an attorney-client relationship is whether it would have been reasonable for the client to believe that the attorney was acting on its behalf as counsel. See case cited at footnote 23.  For reasons explained in the opinion, the court concluded that it would not have been reasonable for the defendants to believe that the Firm was acting as their counsel in connection with the Duff & Phelps representation.

For example, the engagement agreement between the Firm and Duff & Phelps limited the representation to Duff & Phelps. In addition, the engagement between Duff & Phelps and the defendants specified that Duff & Phelps would engage their own separate counsel.

Controlling Standard Applied by the Court in Motions to Disqualify:

The controlling factor in a motion to disqualify in Delaware is whether the “challenged conduct prejudices the fairness of the proceedings.” The Delaware Supreme Court in the case styled In Re Appeal of Infotechnology, Inc., made it clear that it is not sufficient for the trial court to find a violation of the Delaware Lawyers’ Rules of Professional Conduct.  By itself that is not sufficient to warrant disqualification of counsel from an action.

Rather, disqualification is appropriate only when the challenged conduct prejudices the fairness of the proceedings. Infotechnology, 582 A.2d 215, 216-17 (Del. 1990).  In Infotechnology, the Supreme Court held that “absent conduct that prejudicially disrupts the proceeding, trial judges have no independent jurisdiction to enforce the Rules of Professional Conduct.” See cases at footnote 33 recognizing that the high threshold for succeeding in such a motion is based in part on the concern that such motions are used as procedural weapons and are often filed for tactical reasons rather than for bona fide concerns.

The Infotechnology decision also explained that the burden of proof on a non-client litigant is to prove by clear and convincing evidence:  (1) the existence of a conflict of interest, and (2) how the conflict will prejudice the fairness of the proceedings.  In this case the court did not need to determine whether a standard less than clear and convincing would apply where the moving party is a former client as opposed to a non-client that moved for disqualification.  The court found it unnecessary to decide that issue because of its conclusion that the prejudice that would be caused to the Firm if it were disqualified outweighed any concerns of Duff & Phelps.

Additional Reasoning of the Court:

The court also based its ruling on the following additional reasoning:

  • The Firm implemented an internal ethical screen on the same day that it learned of an issue being raised about its prior representation.
  • The Firm represented to the court in an affidavit that no attorney who has entered his appearance, in this action has ever accessed information about the Duff & Phelps prior representation, and the attorneys involved in that prior representation have no involvement in the present litigation.
  • The Firm represented that it will not examine Duff & Phelps in this matter.
  • Based on the foregoing, the court was comfortable that the fairness of the proceedings has not been prejudiced and that appropriate measures are in place to insure that they will not be prejudiced in the future, citing Rohm & Haas Co. v. Dow Chem. Co., 2009 WL 445609, at *3 (Del. Ch. Feb. 12, 2009) (highlighted on these pages).
  • There was no need to determine whether Rule 1.9(a) was violated, in part because based on Supreme Court authority, the trial court did not have independent power to enforce disciplinary rules regarding attorney conduct when the challenged conduct did not prejudice the fairness of the proceedings.

Takeaway: In addition to providing the applicable standards and criteria for deciding a motion to disqualify counsel, this decision provides a useful and practical reminder of the very high bar that must be satisfied before such a “disfavored” motion will be granted.

Pre-Merger Claims Stayed Based on Lack of Ripeness

The issue of ripeness is not often the basis to derail challenges to a merger, but a recent decision by the Delaware Court of Chancery provides an example of how this defense can be effectively used in corporate litigation.Image result for free photo of ripe fruit

In the matter styled In re Straight Path Commc’ns Inc. Consol. S’holder Litig., C.A. No. 2017-0486-SG (Del. Ch. Nov. 20, 2017), the Court declined to decide whether the claims were direct or directive, and deferred ruling on whether demand futility was demonstrated. Instead, the matter was stayed without prejudice to filing a motion to open the case when the facts mature. (Compare ripe fruit.)

Key facts: A faint adumbration of the minimal facts needed to put the legal principles in context includes the deal that was challenged not yet being closed at the time of the court’s holding in this matter. The plaintiffs are current stockholders of what the court described as the “to-be-acquired corporation.” The claims for breach of fiduciary duty are based on a transfer of assets to another entity controlled by the controlling stockholder–which was a condition of his support for the merger. The plaintiffs do not oppose the merger and do not seek an injunction. Rather, they challenge a side deal made with the controlling stockholder.

The claim was that the controller also threatened the members of the Special Committee and their counsel with “personal threats” of litigation and that the controller used those threats to force the Special Committee to agree to his conditions of sale. The controller’s condition of sale was to transfer assets for an unfair price to another entity the controller, along with his family, controlled. The claim is that consideration should have gone to the selling entity.

Key principles: Although the court did not make any rulings on the merits other than determining that the issues were not ripe, it noted basic corporate litigation principles that would generally be applicable. As for ripeness, the court observed:

  • “Delaware courts decline to exercise jurisdiction over a case unless the underlying controversy is ripe in order to conserve limited judicial resources and to avoid rendering a legally binding decision that could result in premature and possibly unsound lawmaking.”
  • Further, “a dispute will be deemed not ripe where the claim is based on uncertain and contingent events that may not occur, or where future events may obviate the need for judicial intervention.” See cases cited at footnotes 30-33.

Regarding the substantive claims, a ruling on which was deferred, the court related that:

  • A claim that a controller transferred to himself assets of the corporation for less than fair value is a claim belonging to the corporation. See n. 34. But a ruling on whether the claim in this case is direct or derivative would only be advisory if the merger failed for lack of the requisite regulatory approval.

Although the claims were asserted as direct, to hedge their bets the plaintiffs also made a demand futility argument. The court explained that:

  • Because directors manage the corporation, in order to obtain authority to sue on behalf of the corporation, a stockholder must establish that pre-suit demand is excused. That is, facts must be adequately pled “that raise a reasonable doubt that the directors could bring their business judgment to bear on behalf of a corporation when considering a demand.” n.41
  • “Demand is not excused simply because the proper standard of review is entire fairness solely due to an interested transaction with a conflicted controller.” n.42.
  • Sale of corporate assets at an unfair price is a quintessential derivative claim if demand excusal is demonstrated pursuant to Rule 23.1.  n.43
  • The court distinguished a case cited by plaintiffs for their argument that demand was excused because the directors did not vote to affirmatively object to or support the continuation of the instant litigation. In that situation, not present in this matter, the directors declined to exercise their power to control the litigation. n.47.

In sum, the court stayed the litigation and deferred ruling on the direct v. derivative issue as well as the demand excusal issue until the facts ripened.

Commentary from the Delaware Bench on Contractual Alternatives to Fiduciary Duties

Useful insights from the Delaware Bench were provided on the topic of contractual definitions, or limitations, on fiduciary duties in LLCs and LPs at a recent seminar. The program was moderated by Catherine Dearlove of the Delaware Bar.  Other panel members included Chief Justice Leo Strine, Jr. of the Delaware Supreme Court.  The program was designed to be interactive.

One of the attendees was former Vice Chancellor Donald Parsons.  He and the Chief Justice engaged in what apparently was an unplanned colloquy about recent decisions involving “safe harbor” provisions in alternative entity agreements that provide for protection from claims when a transaction was conflicted — if certain conditions are met for a safe harbor even though all fiduciary duties have been waived in the alternative entity agreement.  The panel discussion I attended in Washington, D.C. on Friday, November 17, 2017, at the American Bar Association’s Fall meeting of the Business and Corporate Litigation Committee was entitled:  “Bespoke Governance:  What Institutional Investors Need to Know about Contractual Alternatives to Fiduciary Duties”

These highlights from the seminar are not a transcript nor does this short blog post claim to be an authoritative record of what one current and one former member of the judiciary, and others,  actually said at the seminar, but rather it attempts to provide a good faith paraphrasing of some of the key points made that might be of interest to readers of this blog.

The following bullet points are especially noteworthy:

  • By way of introduction, references were made to sections of the Delaware Limited Liability Company Act and the Delaware Limited Partnership Act that expressly allow for maximum freedom of contract and for the waiver of all fiduciary duties, although the implied covenant of good faith and fair dealing cannot be waived.
  • At least one school of thought, however, supports the view that one cannot be exculpated for bad faith liability. One judicial officer on the panel noted that there is no “neutral faith,” but rather the lack of good faith equals bad faith.
  • Unlike the Delaware General Corporation Law, there is no mandatory indemnification default provision in the LLC Act or the LP Act as there is in DGCL § 145.
  • The Chief Justice noted that recent Delaware Supreme Court decisions have upheld basic principles of contract interpretation, especially in the context of waivers of fiduciary duty, including the following: (1) Waivers need to be clear in order to be enforceable; (2) The implied covenant is not a panacea for inartful drafting of every stripe. See, e.g., Brinckerhoff decision highlighted on these pages.
  • Recent cases have applied the doctrine of contra proferentem when there is ambiguity in the agreement.
  • There was a robust discussion about alternative entity agreements with provisions that provide as follows: “One is not liable if:” and then several categories of conduct are described as not resulting in liability. One judicial officer present at the seminar said that those clauses should be interpreted to mean that one is liable unless the conduct fits within the enumerated described categories that follow the phrase “… not liable if:” …”
  • A current member of the Delaware judiciary and a former member of the Delaware judiciary engaged in a debate of sorts, along with others, regarding a comparison of recent Delaware Supreme Court decisions and prior Chancery decisions which described interpretations of “safe harbor” provisions of alternative entity agreements. It would be fair to say – from this spectator’s perspective — that there was a lack of unanimity among the persons engaged in the discussion on that topic.

Chancery Denies Rule 5.1 Motion to Maintain Confidentiality of Pleadings

This post was prepared by Brian E. O’Neill, Esq. of Eckert Seamans.

The Court of Chancery recently denied a motion to maintain the confidentiality of redactions in the public version of the complaint and briefs related to the defendants’ motion to dismiss. In Oklahoma Firefighters Pension Retirement System v. Corbat, C.A. No. 12151-VCG (Del. Ch. Nov. 15, 2017), Vice Chancellor Glasscock analyzed Rule 5.1’s factors to balance the harm caused by disclosure with the public’s right to monitor court proceedings.

Background: The defendants, Citigroup, Inc. and some of its directors and executives, argued that the unsealing of the redacted portions of the complaint and briefings was not mandated because the public had little interest in the sealed contents.  The defendants also argued that the unsealed information would disclose internal compliance efforts, which could pose harm to the financial security of the U.S., and that the unsealing would deter management and employees from providing candid advice to the board of directors.

Analysis: The Court found that unsealing of the information was warranted under the Rule 5.1 analysis.  The Court noted that “[t]he public, particularly the Delaware public, has a strong interest in the workings of a Delaware entity and its compliance with substantive law.”  Vice Chancellor Glasscock then noted that in light of the public’s interest in the unsealing of the information, the Court must determine “whether confidentiality is nonetheless in the interest of justice, because the harm of disclosure outweighs that public interest.”

The Court found confidentiality was no longer required, noting that some of the redacted communications were seven years old, and therefore stale. The Court found that the redacted information appeared to be embarrassing to management, but ruled that embarrassment is an insufficient basis to support renewed confidentiality under Rule 5.1.

Holding: In denying defendants’ motion for preserving confidentiality of the filings, the Court ordered their Delaware counsel to review the redactions within twenty days and to “designate for continued confidentiality only those that involve current procedures, revelation of which poses a substantial risk to the goal of safeguarding the U.S. financial system from illicit activity.”  The Court also ruled that it would review any remaining redactions after the twenty day review period to determine whether continued confidentiality was justified.

Takeaway: Chancery will closely scrutinize requests to maintain confidentiality of court filings in order to determine if the high threshold set by Rule 5.1 has been met.

Court Rejects Pre-Trial Restrictions on Expert Testimony

A recent short letter ruling by the Delaware Court of Chancery provides a useful tool for the toolbox of commercial and corporate litigators regarding pre-trial arguments to exclude the testimony of an expert who has prepared a report, even though in the Court of Chancery motions in limine to obtain pre-trial rulings on such evidentiary issues are not as meaningful as they would be for a jury trial. Great Hill Equity Partners IV, LP v. SIG Growth Equity Fund I, LLLP, C.A. No. 7906-VCG (Del. Ch. Nov. 13, 2017). See also prior decisions in this litigation that have been highlighted on these pages for more background details.

Overview: A motion in limine was denied without prejudice to object at trial to exclude consideration of expert evidence on two issues: (1) whether the expert, who relied on a recitation of facts upon which his opinion was based, should have been precluded from testifying about the facts which allegedly were “cherry-picked and self-serving.”  The court determined that it was able to separate the testimony at trial that was based on second-hand comments — as opposed to first-hand facts.  In addition, the court reasoned that the expert would be subject to cross-examination, where any deficiencies or any inaccuracies on the facts relied upon for the expert opinion can be scrutinized.

The second issue is whether the expert should be precluded from opining on subjective knowledge or intent of individuals that would be outside the scope of the area of expertise of the expert. The court concluded the risk of that danger could be dealt with by objections at trial.

The court relied on Delaware Rule of Evidence 702 which requires that expert opinion be based, among other things, on “sufficient facts or data . . ..” The court also relied on precedent for the view that subjective testimony about the subjective intent of a plaintiff regarding damages is not admissible as expert testimony under DRE 702. See Hoechst Celanse Corp. v. Nat’l Union Fire Ins. Co. of Pittsburgh, PA, 1994 WL 721624 at *1 (Del. Ch. Apr. 20, 1994).

Chancery Rejects Section 220 Demand Post-Trial

A recent post-trial opinion from the Delaware Court of Chancery serves as another example to support the view that demands for books and records pursuant to DGCL Section 220 are not for the faint of heart.

In Wilkinson v. A. Schulman, Inc., C.A. 2017-0138-VCL (Del. Ch. Nov. 13, 2017), the Court denied a request for books and records in a decision supported by copious citations to precedent, based largely on the conclusion that even though the demand may have satisfied the requirement for a “proper purpose” on its face, in reality the true purpose was one crafted by counsel for the stockholder–but that the stockholder himself did not appear too familiar with. During the stockholder’s deposition, it was revealed that the stockholder was not conversant with the details of the demand, or its purpose–and that the stockholder served as a plaintiff in seven other lawsuits for the same law firm that pursued the instant case.

Takeaway: There are many other examples that we have highlighted on these pages over the past nearly 13 years, that demonstrate that Section 220 cases are often hotly litigated and it is not rare to incur the cost of a trial, as in this matter, and “come up dry” in terms of not proving the right to obtain documents from the corporation. Thus, the economics of a Section 220 demand favor those whose stake in a company makes it economically rational to pursue such a claim. See, e.g., Section 220 cases highlighted previously.

Chancery Denies Motion for Stay Based on Pre-Indictment Criminal Probe

This post was prepared by Brian E. O’Neill, Esq. of Eckert Seamans.

The Delaware Court of Chancery recently denied a motion to stay proceedings, which was filed by five defendants who had been served with subpoenas by the Federal Bureau of Investigation in connection with a criminal probe. In A. Schulman, Inc. v. Citadel Plastic Holdings, LLC,  C.A. No. 12459-VCL (Del. Ch. Nov. 2, 2017), Vice Chancellor Laster addressed the defendants’ motion to stay proceedings for ninety days, and their request to hold a status conference at the expiration of the ninety-day stay.

Background: The underlying civil litigation involved claims for breach of contract and fraud.   The defendants moved to dismiss the complaint, which motion was denied.  The parties then engaged in voluminous discovery practice over sixteen months.  The matter was scheduled for trial in March 2018.  On October 3, 2017, the FBI served the five individual defendants with subpoenas to produce records in connection with a criminal investigation.

The five individual and numerous corporate defendants in the Court of Chancery litigation were all represented by the same firm. After service of the FBI’s subpoenas, the five individual defendants requested a ninety day stay, citing their need to retain separate counsel due to the criminal investigation.  Plaintiffs consented to a postponement of the depositions of the five individual defendants, but otherwise objected to the motion for stay.  [Parenthetically, a Section 220 Chancery decision on November 13, 2017, involving the plaintiff companies was highlighted on these pages].

Analysis:  The Court noted that although the defendants requested a ninety day stay of proceedings, “in reality they seek an indefinite stay.”  The Court also noted that “Delaware courts have not articulated a specific test to apply when analyzing whether to stay a civil case in light of a pending criminal investigation.”  Absent controlling precedent, Vice Chancellor Laster turned to the relevant test articulated by the United States Court of Appeals for the Third Circuit.

The Third Circuit has identified two overarching issues to guide a trial court’s analysis of whether to stay a civil action due to the pendency of a related criminal case. The two issues are:  (1) “the status of the criminal case, including whether the defendants have been indicted” and (2) “the extent to which the issues in the criminal and civil cases overlap.”

Guided by those two overarching principles – status of the criminal case and its overlap with the civil action – the Third Circuit then looks to the balancing of five factors. The five factors are:

(1)     the interest of the plaintiff in proceeding expeditiously with his case and any potential prejudice it may suffer from any delay;

(2)     the burden upon the defendants from going forward with any aspects of the proceedings, in particular any prejudice to their rights;

(3)     the convenience of the court and the efficient management of judicial resources;

(4)     the interests of any non-parties; and

(5)     the interest of the public in the pending civil and criminal litigation.

Vice Chancellor Laster noted that the grant of a total stay in a civil action is an “extraordinary remedy.” Upon its review of the two guiding principles, the Court found that the criminal matter was in its earliest stages (pre-indictment) and noted that civil stays are infrequently granted at that point.   As to the issue of overlap, the Court found that “the defendants have not made a meaningful showing on that point”.  Moreover, the Court noted that the defendants failed to attach the FBI subpoena to their motion for stay, and failed to present meaningful information during an off-the-record discussion with the Court.

After weighing the merits of each the five factors, the Court concluded that the motion should be denied. The Court found that the criminal investigation “remains at a nascent stage” and that the grant of the requested stay “would reward individuals who engaged in more serious wrongdoing by enabling them to use a threatened (but not yet commenced) criminal proceeding as a shield against a longstanding civil case.”  Accordingly, the Court denied the five individual defendants’ motion for a stay.

Takeaway: Litigants seeking to stay civil proceedings based on the pendency of a related criminal matter must satisfy a five-factor test, and must articulate the extent of overlap between the civil litigation and the criminal matter.  Moreover, there is less likelihood of obtaining a stay of the civil action before an indictment has been issued.

Chancery Grants Dispositive Motion on Earn-Out Claims

A recent Court of Chancery decision granted a motion for judgment on the pleadings on several claims relating to post-closing earn-out payments due in connection with an acquisition.  In GreenStar IH Rep, LLC v. Tutor Perini Corporation, C.A. No. 12885-VCS (Del. Ch. Oct. 31, 2017), the court found that the terms of the agreement were unambiguous and that the facts alleged were sufficient to enter judgment on three of the eight counts in the complaint that sought damages and declaratory judgments relating to the failure of the buyer to make earn-out payments as required by the merger agreement.

Background:  This case involved the sale of GreenStar Services Corporation to Tutor Perini Corporation.  The agreement provided for a right to receive post-closing earn-out consideration in the event certain pre-tax profit milestones were achieved.  The motion for judgment on the pleadings that this opinion decided, related to those parts of the complaint which asserted breach of contract claims for failure to make the earn-out payments in the third, fourth and fifth years after closing.  The court determined that based on a review of the applicable agreement and the facts alleged in the complaint that the seller was entitled to earn-out payments as a matter of law based on the clear and unambiguous terms of the agreement.  The court also determined that the buyer was not entitled to any offset based on any alleged wrongdoing in the counterclaims.  The court also rejected claims for fraud based on the failure to plead with the necessary particularity.

The relevant provisions in the merger agreement provided for the calculation of the earn-out payments based on pre-tax profit.  The agreement defined pre-tax profit as the amount calculated and included in a pre-tax profit report compiled in accordance with GAAP.  If the pre-tax profit report was not objected to, then the parties would be bound by it for purposes of calculating the earn-out.  If there was an objection to the pre-tax profit report, there was a procedure in the agreement providing for binding arbitration.

Analysis:  The court recited basic contract principles including the truism that when, as in this matter, the language of an agreement is unambiguous, the court is bound by the language within the agreement.  See cases cited at footnotes 50 and 51.

The court read the agreement as unambiguously providing for the calculation of the earn-out payments due based on the pre-tax profit reports.  When, as in this case, there was no objection to those reports, the parties agreed that those reports would be binding in terms of determining the amount of the earn-out payments that were due.

The court specifically rejected the argument of the buyer that the unambiguous provisions of the agreement regarding the binding nature of the report should be subject to a condition that the report would not be binding if the buyer either failed to properly calculate the pre-tax profit or if the buyer allegedly relied on inaccurate financial statements. The court rejected that argument in part, because it would allow the buyer to unilaterally determine when the pre-tax profit report was not considered binding.

Likewise, in rejecting that argument, the court also rejected the argument that the implied covenant of good faith and fair dealing should allow for an implication that the report would only be binding if it was determined to be accurate.

Implied Covenant of Good Faith and Fair Dealing:  The court defined the limitations of the implied covenant of good faith and fair dealing, which will not be used when contract language could have easily been drafted to expressly provide for the allegedly missing terms and when the existing contract speaks directly to the issue in dispute.  Stated differently, the covenant exists solely to fulfill the reasonable expectations of the parties, and to avoid arbitrary frustrations of the parties’ bargain, but in order for the implied covenant to apply, the obligation asserted and the obligation to be implied must not contradict the purposes reflected in the express language of the contract.

Holding: In sum, the court found that there were “no gaps to be filled” and that the court would not imply a term that is inconsistent with the intent of the parties as evidenced by the express terms of the agreement.  See footnote 70 and cases distinguished therein.

Also notable is the court’s rejection of the argument that the existence of 13 affirmative defenses made it premature to grant a motion for judgment on the pleadings.  Cases cited in footnotes 72 through 74 supported the court’s reasoning that the “rhythmic incantation of multiple affirmative defenses, each revealed in a single sentence, cannot, alone, defeat an otherwise well-supported motion for judgment on the pleadings.”

Takeaway Although most earn-out disputes involve genuine issues of material fact that might make a dispositive motion more challenging, where there are purely contractual interpretation issues that are subject to unambiguous terms, this decision may help to support an effort to seek a pre-trial ruling on at least some of the contract issues in an earn-out dispute.

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