Chancery Finds Breach of Fiduciary Duty But No Damages

In connection with analyzing claims that certain defendants aided and abetted breaches of the directors’ fiduciary duties, a recent Court of Chancery opinion provides an exemplary recitation of important fundamental principles of Delaware corporate law. The court’s decision in the case of In re PLX Technologies Inc. Stockholders Litigation, Cons. C.A. No. 9880-VCL (Del. Ch. Oct. 16, 2018), is a 136-page mini-treatise that explains key tenets of Delaware corporate law in the context of a challenged acquistion.

Brief Background:

This Chancery decision provides a cautionary tale of how a substantial stockholder who successfully waged a proxy battle to put his nominees on the board should not conduct the sale of the company in order to maximize short-term profit for that stockholder.  The major stockholder in this case made himself the Chairman of the Board and then he was appointed as the head of a special committee to consider the sale of the company.  His goal was not to satisfy Revlon duties, but to maximize his profits on his recently acquired stock.

Although no damages were proven, the court criticized how the major stockholder “gamed the system” and aided the breach of fiduciary duties.  Due to a settlement of the claims against most of the original defendants, the only remaining claim addressed in this post-trial decision is a claim of aiding and abetting breach of fiduciary duty.

Key Issues Addressed:

The court’s comprehensive analysis of the law, and thorough application of the facts, provides a textbook explanation of the fiduciary duties of directors and the applicable standards of care and standards of review that the court applies when challenges are made to the sale of a company. The specific issues related to the court’s finding that the directors breached their duty of disclosure when recommending that stockholders tender, both by (i) failing to disclose communications with a potential acquirer and its investment bank (that also was engaged by PLX); and (ii) by depicting recent projections as (falsely) being prepared in the ordinary course of business.

Highlights of Key Fundamental Delaware Corporate Law Principles:

The highlights of this decision provided below in bullet points are based on an assumption that the reader has a basic familiarity with the relevant concepts. The modest goal is to refer to the page or footnote in the Slip Opinion that an interested reader can turn to for a review of the exemplary treatment by the court of important principles.

I)  Existence of Fiduciary Duties:

  • The court provides a classic definition of the fiduciary duty of loyalty and due care owed by corporate directors–as well as the subsidiary element of good faith. See page 73.
  • The opinion recites the elements of a claim for aiding and abetting the breach of a fiduciary duty. See page 72.
  • Regarding the potential basis to question the proper motives for actions taken by those obligated to act in the best interests of others, the following quote from footnote 412 is  worth keeping handy for future reference:

    Greed is not the only human emotion that can pull one from the path of propriety; so might hatred, lust, envy, revenge, . . . shame or pride. Indeed any human emotion may cause a director to place his own interests, preferences or appetites before the welfare of the corporation.   RJR Nabisco, 1989 WL 7036, at *15

  • The court explains the context-specific formulations of fiduciary duty, for example, when a corporation is for sale. See page 74 and footnotes 412 and 413.
  • The court describes the fiduciary duty of disclosure–which is not a separate duty but rather derives from the duties of care and loyalty–for example, when directors seek action from stockholders. See page 74 and footnotes: 414 to 415.

II)  Breach of Duty:

  • The court distinguishes between the “standard of conduct” and the “standard of review” in connection with the duties of corporate directors. See page 76 and footnotes 416 to 417.
  • The court expounds on the three-tiers of review by the court of director decision-making as follows: (i) the business-judgment rule; (ii) enhanced scrutiny; and (iii) entire fairness. See pages 77 to 80 and footnote 418. The court also instructs on the situations when each of those three standards applies. See footnote 419 and accompanying text.
  • A classic definition of the business judgment rule is amplified at footnotes 420 to 423 and accompanying text.
  • The entire fairness standard is elucidated at footnotes 424 to 426 and accompanying text.
  • The court educates the reader on the intermediate standard of enhanced scrutiny at footnotes 427 through 433 and accompanying text.
  • The court recites well-settled law regarding materiality in the context of disclosure duties. See pages 80 to 81.
  • When a board of directors relies on a financial advisor, the court explains what needs to be in the summary of the financial advisor’s opinion that is provided to stockholders. See pages 91 and 92.
  • When the enhanced scrutiny standard applies, the court provides a description of what directors must demonstrate in order to satisfy their burden of proof. See page 96.
  • The plaintiff has the burden to show, in the context of proving an aiding and abetting claim, that directors acted outside the range of reasonableness. See page 96.
  • The court describes the reasonableness standard in this context. See 97 to 98.
  • The court recounts those instances when a large stockholder who is also a board member has interests that are aligned with all the stockholders, but also observes those instances when the interests of that large stockholder may diverge from those of other stockholders, for example, when that large stockholder either seeks a “quick profit” on a recent purchase of stock–or needs liquidity–as opposed to seeking the highest value in connection with the sale of the company. See page 99 to 103.
  • The court cites to several Delaware Supreme Court cases that explain when weight is given to a deal price, and a market-check for valuation purposes, and which supports the finding in this case of no damages notwithstanding the court’s holding that there was a breach of fiduciary duties. See footnotes 605 to 607 and accompanying text.
  • A useful Appendix created by the court is attached to this opinion, and includes a chart of key Delaware decisions from 1988 through 2014 with a summary of the highlights of those cases in several columns, regarding: (i) the time it took for the deal to close; (ii) amount of the termination fee involved in the case; and (iii) deal protection measures that were described in the court opinions cited in the Appendix provided by the court.

34th Annual F.G. Pileggi Distinguished Lecture in Law

The 34th Annual F.G. Pileggi Distinguished Lecture in Law (named after my father) will be presented by Professor David A. Skeel, Jr., the S. Samuel Arsht Professor of Corporate Law at the University of Pennsylvania Law School. Details about the event on November 2, 2018, are at this link, and as follows:

Hotel du Pont, du Barry Room, 11th and Market Streets, Wilmington, Delaware 19801

Breakfast at 8:00 a.m. and lecture at 8:45 a.m.

One substantive CLE credit available in DE and PA and online registration available at   delawarelaw.widener.edu/pileggi2018

For additional information or for accessibility and special needs requests, contact Carol Perrupato at caperrupato@widener.edu or 302-477-2178.

Highlights of the annual lectures for several prior years have appeared on these pages.

Chancery Imposes Anti-Suit Injunction to Enforce Forum Clause

In connection with a business divorce involving several inter-related entities and two key agreements among the parties that impacted the issues disputed, the Delaware Court of Chancery in Village Green Holding, LLC v. Holtzman, C.A. No. 2018-0631-TMR (Del. Ch. Oct. 5, 2018), enforced the forum selection clause that selected Delaware courts, and imposed an anti-suit injunction to prevent the parties from proceeding in a separate action in Pennsylvania despite the second agreement containing a forum selection clause that selected Pennsylvania courts as a forum for disputes related to some, but not all, of the numerous entities involved in the business break-up. (The nearby photo of the Roman Forum is an appropriate graphic for this post.) Many other decisions interpreting forum clauses have been highlighted on these pages over the last 13 years.

Among the several important legal principles recited by the court in this useful opinion, are the following principles highlighted by bullet points:

  • The court reiterates the familiar prerequisites that must be satisfied in order for a preliminary injunction to be granted. See page 12.
  • On a more nuanced level, the court recites the additional criteria that need to be considered by the court when there is a request for an anti-suit injunction to prevent a party from proceeding in another forum. See page 13.
  • Also discussed by the court were the enhanced or modified prerequisites that must be satisfied for a “mandatory injunction,” which requires a greater showing than one needs for a typical injunction that seeks merely to maintain the status quo.
  • The court recites the basic principle, and cites to the seminal Delaware cases supporting the general rule, that a forum selection clause is enforceable in Delaware. See pages 15 and 16.
  • The court also refers to Section 18-111 of the Delaware LLC Act which gives the Court of Chancery specific jurisdiction to interpret the rights and duties in an LLC operating agreement. See page 18.
  • Exceptions to the enforceability of forum selection clauses, such as fraud, are also discussed. See page 20.
  • The necessary element of irreparable harm required for injunctive relief was described to be established when one is forced to litigate in a forum that is contrary to the selected forum provided for in a valid forum selection clause. See pages 20 and 21.
  • Although a separate agreement between the parties in this case provided for a Pennsylvania forum for only some of the involved entities, the court enjoined the parties from proceeding outside of Delaware regarding claims involving the parties and entities that were subject to the separate agreement that contained a Delaware forum selection clause.

Delaware Supreme Court Clarifies MFW Standard for Application of Business Judgment Review to a Merger

The issue presented to the Delaware Supreme Court in Flood v. Synutra International, Inc., Del. Supr., No. 101, 2018 (Oct. 9, 2018), was whether it was proper for the Court of Chancery to apply the MFW standard by: “(i) allowing for the application of the business judgment rule if the controlling stockholder conditions its bid on both of the key procedural protections at the beginning stages of the process of considering a going private proposal and before any economic negotiations commence; and (ii) requiring the Court of Chancery to apply traditional principles of due care and to hold that no litigable question of due care exists if the complaint fails to allege that an independent special committee acted with gross negligence.” See page 1.

The “MFW standard” was announced by the Delaware Supreme Court in Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014), which was highlighted on these pages.  That standard allowed for the deferential business judgment review that be applied to a merger “proposed by controlling stockholder conditioned before the start of negotiations on ‘both the approval of an independent, adequately-empowered Special Committee that fulfils its duty of care; and the uncoerced, informed vote of the majority of the minority stockholders.’” Id. at 644.

The high court concluded, in its majority opinion, that the interpretation of MFW standard based on the foregoing principles was correct, and cited with approval, for support of its conclusion, the high court’s previous affirmance in Swomley v. Schlecht, 128 A.3d 992 (Del. 2015) (Table).

Highlights:

Although this majority decision could be the subject of a lengthy analysis, especially in light of the vigorous dissenting opinion–which is an indication that reasonable people could easily differ on the conclusions in this case–I will provide highlights only in this short post, via bullet points, to allow a quick reference to key parts of the ruling. Those interested may read the whole opinion for a complete understanding of this important decision:

  • One of the issues in the case was whether or not the prerequisites that must be satisfied in order for the MFW standard to apply must be imposed as a condition of the deal at the absolute beginning of the negotiations–or if the imposition of those conditions at the “beginning” of negotiations can be more flexibly determined as a matter of chronology, as opposed to a “bright line test” requiring a specific point in time. See pages 9 to 21.
  • This issue arose because of the description in the Supreme Court’s initial announcement of the MFW decision that the prerequisites that must be a condition of the deal need to be announced “ab initio” which can be translated as “at inception” or “at the beginning.”
  • The court used several descriptions to explain why a more flexible approach should be used for exactly when in the chronology of a deal the conditions must be imposed, by referring to many situations where the word “beginning” does not refer to a specific point in time, such as the “beginning of a book” that extends beyond just the first word in a novel, and may at least include the first few pages of a novel, for example.
  • The court reasoned that a more flexible approach is sensible in terms of focusing on the more meaningful point in a deal when “substantive economic negotiations take place,” as in this case when a second offer letter was sent and no prior economic substantive negotiations had taken place after the first letter, but before the second offer letter was sent.
  • The second issue addressed was whether due care violations were pled in the complaint.
  • This ambiguity was raised by footnote 14 in the original MFW opinion of the Supreme Court, but which was clarified by this case which essentially nullified the dicta in footnote 14 of the original MFW opinion of the court. See pages 23 to 25, where the majority opinion in this case explains why that footnote 14 should not be relied on, and why no due care violation was adequately pled in this case.

Delaware Gun Restrictions Held Unconstitutional

This post was written by Eckert Seamans attorney Jamie Inferrera.

A Delaware court recently issued a decision reaffirming an individual’s right to keep and bear arms outside of the home. In Delaware State Sportsmen’s Association and the Bridgeville Rifle and Pistol Club v. Delaware Department of Natural Resources and Environmental Control and Delaware Department of Agriculture, C.A. K18C-05-047-JJC (Del. Super. Oct. 11, 2018), the Plaintiffs challenged a new regulation that prohibited firearms in camping areas of state parks and state forests where people sleep overnight with their families, such as lodges, as well as related restrictions that extended beyond what state statutes provide.

This case was based in part on the Delaware Supreme Court’s ruling in Bridgeville Rifle and Pistol Club, Ltd. v. Small, Del. Supr., No. 15, 2017 (Dec. 7, 2017) (“Bridgeville I”)(previously highlighted on these pages), where the High Court found regulations that banned firearms in all areas of the state parks to be a violation of both the Second Amendment of the U.S. Constitution, and Article I, Section 20, of the Delaware Constitution. Section 20 recognizes a right to bear arms that is much broader than the Second Amendment, and expressly enumerates the right to bear arms for the protection of self, home, family, state, as well as for recreational and hunting purposes.

In a 41-page opinion on cross motions for summary judgment, the Delaware Superior Court held that the new restrictions, while more narrowly-tailored in scope than the blanket restrictions in Bridgeville, were in part both constitutionally and statutorily invalid.

Brief Factual History

Following the Delaware Supreme Court’s decision in Bridgeville I, the State Agencies drafted emergency regulations restricting the possession of firearms in designated “sensitive areas,” which included camping areas in state parks and state forests. The Agencies developed an administrative record including public comments, a hearing officer’s report and legal responses from the Delaware Department of Justice. The Plaintiffs challenged the regulations within two weeks of the effective date.

State’s Burden of Proof

The Court noted the complex nature of the burden of proof in this case. The Plaintiffs challenged both the illegality of the regulations because of statutory preemption and the unconstitutionality of the regulations. Typically, the plaintiff holds the burden of proof challenging the legality of regulations and the regulations are presumed valid. However, when the constitutionality of regulations are challenged, it is on the agency to establish their constitutionality and the regulations are subject to intermediate scrutiny. Doe v. Wilmington Housing Authority, 88 A.3d 654, 666 (Del. 2014)(previously highlighted on these pages); Bridgeville I, 176 A.3d at 656.

Notable Principles of Law

The Court held that the Agencies’ designation of camping areas as “sensitive,” and thus further restricting individuals from carrying firearms, does not survive intermediate scrutiny.

  Right to Bear Arms

The Court noted that the straightforward language in Bridgeville I recognizing “the people’s right to have a firearm while camping overnight in a State park,” Bridgeville I, 176 A.3d at 638, presents a high hurdle to satisfy intermediate scrutiny. The Court took guidance from Bridgeville I and summarized a three-part test for determining if an area’s designation as “sensitive” satisfies intermediate scrutiny: (1) Is there a controlled entry point? (2) Are visitors screened by security? (3) Is the area supervised by law enforcement personnel or easily accessible to law enforcement and emergency responders?

The Court found that the administrative record did not support finding that the aforementioned test is met for camping areas. The Court further noted that the administrative record was void of any evidence that demonstrates that the regulations are related to achieving the Agencies’ generalized safety concern. Thus, the Court struck camping areas of state parks and state forests from the regulations.

  Fourth Amendment Rights

The Plaintiffs also challenged a portion of the regulations that would permit law enforcement officers to ask an individual for identification sufficient to undertake a background check. The Court held that “[t]hese regulations give unfettered discretion to law enforcement to stop visitors, question them and require identification without requiring a scintilla of evidence of criminal activity.” The regulations pertaining to the request for identification were held to be facially unconstitutional, whereby “no set of circumstances exist under which the [regulations] would be valid.” United States v. Salerno, 481 U.S. 739, 745 (1987). A facial challenge to a regulation is the most difficult type of constitutional challenge to mount successfully. Id. The Court struck the portion of the regulations as unconstitutional under both the Fourth Amendment and Article I, Section 6 of the Delaware Constitution.

The Court also struck down a provision of the regulations whereby the Agencies attempted to overreach their authority and recognize out-of-state concealed carry permits for visitors of state parks and state forests. The Delaware Attorney General has the sole authority to issue concealed carry permits. 11 Del. C. §1441(k). The Court held that this portion of the regulations was preempted on state statutory law grounds.

As an appendix to its opinion, the Court provided a redlined version of the regulations that showed the stricken portions that it held unconstitutional and preempted in its opinion. (A local paper published one of several articles about the case.)

Chancery Allows Termination of Merger Agreement Based on Material Adverse Change

The Delaware Court of Chancery recently issued an epic decision that serves as a mini-treatise on several topics of importance to corporate and commercial litigators including: (1) interpretation of material adverse change clauses or material adverse effect clauses in merger agreements; and (2) the meaning and application of the phrase “commercially reasonable efforts” or “reasonable best efforts” often found in merger agreements.

The opinion in Akorn, Inc. v. Fresenius Kabi AG, C.A. No. 2018-0300-JTL (Del. Ch. Oct. 1, 2018), will be firmly ensconced in the pantheon of the most notable decisions of Delaware courts and could easily be the subject of a full-length law review article.  But for purposes of a blog post that merely attempts to highlight the key issues addressed by the court, so that interested readers might review the entire opinion if relevant to their practice, I will focus on several key aspects of the decision only.

Procedural Background:

The procedural context in which this decision was written, was expedited proceedings in which two parties to a merger agreement sought competing rulings on the meaning of the agreement. On the one hand, the seller argued that the merger agreement should be specifically enforced.  The buyer, however, filed a counterclaim that sought a ruling that it properly terminated the merger agreement based in part on the occurrence of a material adverse effect or a material adverse change, as defined in the agreement.  The purchaser prevailed in its argument that it properly terminated the agreement.

Notably, a 5-day trial was held with nearly 2,000 exhibits. A total of 16 witnesses testified, and 54 deposition were lodged.  The trial was held less than 3 months after the complaint was filed.  This 246-page opinion was issued less than one week after the final post-trial briefs and oral argument were completed.

Factual Background:

The detailed facts on which the court’s reasoning and conclusion are based are described in the first 110 pages of this decision. It would be a challenge to do the facts justice in a brief overview, but for purposes of providing the highlights of the legal principles in the case, suffice it to say that the court provided exhaustive detail about each of the factual aspects of the parties’ dispute and why one party sought to enforce the merger agreement and one party successfully argued that it was justified in terminating the merger agreement prior to closing.

Highlights of Legal Principles and Analysis by the Court:

       Material Adverse Change Clauses:

  • In a comprehensive and scholarly analysis, the court surveys the law on Material Adverse Change (“MAC”) provisions or Material Adverse Effect (“MAE”) provisions in merger agreements, including prior cases that discuss them and copious footnotes are provided with reference to specific percentages, for example, that are necessary in determining whether a MAC clause or a MAE clause should be triggered. See pages 117 to 204. The court refers to a MAC clause and a MAE clause as synonymous.
  • This decision is thought to be the first Delaware opinion upholding the termination of a merger agreement due to the occurrence of a MAC/MAE.

       Key Treatise Cited:

  • Notable is the court’s reference in footnote 558 to the many Delaware decisions that cite to the Kling and Nugent treatise on M&A agreements and M&A practice as an authoritative source for issues relating to merger agreements, such as MAC/MAE clauses and post-closing indemnification provisions.

       Is Delaware Pro-Sandbagging—or Not?

  • Importantly, the court discusses whether Delaware should be considered a “pro-sandbagging” state as it relates to the enforcement of representations in contracts when one party might know prior to closing that the adverse party’s representations are not accurate. See footnote 756 to 767 and accompanying text. But cf. Eagle Force Holdings LLC v. Campbell, in which the Delaware Supreme Court declined to affirmatively decide the issue, but questioned whether Delaware was a pro-sandbagging state. 187 A.3d 1209, 1236, n. 185 (Del. 2018); id. at 1247 (Strine, C. J. & Vaughn, J., concurring in part, dissenting in part). This case was previously highlighted on these pages.
  • Also noteworthy is a robust explanation, with citations to many authorities, that describe the factors that must be considered to determine when the breach of a contract is material. See pages 208 to 211.

       Commercially Reasonable Efforts and Reasonable Best Efforts:

  • In what may be the most comprehensive analysis in a Delaware decision of the meaning of the phrase “commercially reasonable efforts” and similar phrases such as “reasonable best efforts,” the court discussed the meaning of these contractual standards and their variations, as well as how they should be interpreted and applied. See pages 212 to 220.
  • The court compares the differences, if any, between these similar standards, with citations to treatises, cases and articles that discuss them. See pages 213 and 214, as well as footnotes 788 to 800.
  • See generally Professor Bainbridge’s analysis of this topic with citations to many authorities. (The corporate law scholarship of Professor Stephen Bainbridge is often cited by Delaware courts.)  See also several Delaware decisions highlighted on these pages that also discuss the topic.
  • In its analysis of this topic, the Court of Chancery cites to the Delaware Supreme Court opinion in Williams Companies v. Energy Transfer Equity, L.P., highlighted on these pages. The Delaware high court explained in that decision that it: “did not distinguish between” the two phrases, “commercially reasonable efforts,” and “reasonable best efforts,” but rather the court described those phrases as both imposing “obligations to take all reasonable steps to solve problems and consummate the transaction.” (quoting Williams, 159 A.3d at 272). See also footnote 808, and accompanying text.

Delaware Aspects of New California Law Requiring Female Corporate Directors

A recent California law that requires public companies with their primary executive offices in California to have a minimum number of female directors, has been analyzed by nationally-prominent corporate law expert Prof. Stephen Bainbridge, who addresses several aspects of this new legislation–including how it fares when one applies the reasoning in several seminal Delaware court decisions on the internal affairs doctrine, for example.

I predict ample litigation around this new law, and the above-linked article would be an excellent starting point for anyone who needs to prepare a brief or a memo on the topic.

Chancery Rules on Two Covenants Not to Compete

In the first of two decisions on the same day addressing two separate covenants not to compete, in Lyons Insurance Agency, Inc. v. Wilson, C.A. No. 2017-0092-SG (Del. Ch., Sept. 28, 2018), the Delaware Court of Chancery explained the essential elements for enforceability of a non-competition provision in an agreement. The second case highlighted below deals with the interfacing and tension between California law and Delaware law on this topic. Many other decisions involving covenants not to compete, or non-competition agreements, in general have been highlighted on these pages over the last 13 years. 

Brief Overview:Related image

The Lyons case involved a rather lengthy procedural history, but for purposes of this brief blog post the most notable facts involved an employee of an insurance agency who attempted to bring his “book of business” to a new agency notwithstanding a covenant not to compete.  A Pennsylvania court had granted an injunction to prevent the enforcement of the covenant not to compete, but after that injunction expired in two years, the employee left for another insurance brokerage.  The Lyons Insurance Agency sued to enforce the covenant not to compete that it had made the employee sign before he joined a third employer–which he joined in just over two years.

Notable Procedural Aspect:

The court in this case refused to grant a preliminary injunction because of a liquidated damages provision which raised questions about irreparable harm. This decision was presented on cross-motions for summary judgment.

Noteworthy Principles of Law:

This decision includes the familiar prerequisites under Delaware law for the enforcement of a covenant not to compete. See page 14.  The three basic elements familiar to most readers are that a covenant not to compete under Delaware law must: (1) be reasonable in geographic scope and temporal duration; (2) advance a legitimate economic interest of the party seeking its enforcement; and (3) survive a balancing of the equities in order to be enforceable. See footnote 85.

Notable about this case is the nuance involving the geographic scope of the territorial area that was restricted under the applicable clause. See page 15.

The employee argued that the covenant was not enforceable because the geographic scope was undefined and too broad. The court disagreed.  The most important aspect of this nuanced issue is that the court relied on prior case law to enforce non-competition agreements that limited activity that “competes” with a former employer, which is enforceable, as opposed to a provision that seeks to limit activity that is “merely similar to” the business of a former employer—which is not enforceable, even when a geographic area is not specified. See footnote 91.

The court also discussed the truism under Delaware law one cannot be liable for aiding and abetting a breach of contract. See footnote 115. The court also discussed the elements for tortious interference with contractual relationships. See footnote 116.

Lastly the court discussed the remedies available in this case, which required further clarification of factual issues by the parties. This decision includes many practical statements of law that have broad application for those who labor in the field of commercial litigation.

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The second Chancery decision on September 28, 2018 involving a covenant not to compete was styled NuVasive, Inc. v. Miles, C.A. No. 2017-0720-SG (Del. Ch., Sept. 28, 2018).  This second Chancery decision on the same date involving a covenant not to compete was most noteworthy for its discussion regarding choice of law principles.  This case should be contrasted with a prior Chancery decision in the matter of Ascension Insurance Holdings, LLC v. Underwood, in which a choice of law analysis was applied to prevent the application of Delaware law based on California public policy preventing the enforcement of a covenant not to compete.

By contrast, the instant decision in the NuVasive matter applied a new California law, that was enacted after the Ascension case was decided, now known as Section 925 of the amended California Labor Code.  Section 925 as amended exempts from the California law that restricts importing the law of another state for covenants not to compete, those instances where the employee is “represented by legal counsel in negotiating the terms of the choice of law provision in the covenant not to compete.” See page 2.  In this case, the former president and COO of NuVasive was represented by counsel in the negotiation of the choice of law and forum provisions of the employment agreement at issue.  Although Section 925 is not retroactive under California law, the court found that the California legislature strongly expressed the public policy of California which in this case allowed the enforcement of the choice of Delaware law by the parties, as well as the choice of Delaware forum.

Noteworthy Aspects of NuVasive, Inc. Decision:

  • In a parallel action, a California court upheld the Delaware forum provision prior to this decision in NuVasive.
  • The Court of Chancery in this matter based its analysis not only on the new exception under California law to the enforcement of the law of other states for covenants not to compete, but also the Restatement (Second) of Conflicts of Laws § 188 (1971). See also footnote 46. Based on the court’s analysis, the court found that in the narrow circumstances of this case where an employee had legal representation during the negotiation of a covenant not to compete, the public policy of California was not violated, nor did it violate comity, to uphold the parties’ choice of Delaware law and Delaware forum under the circumstances allowing for the enforcement of a covenant not to compete in this case.
  • Because this decision only involved the issue of what state’s law would apply, the court did not decide the actual enforceability issue at this time.

Chancery Remedies Fraudulent Inducement in Formation of New Entity

A recent Delaware Court of Chancery decision provided remedies in connection with the formation of a business entity by two entrepreneurs based on the court’s finding that the equity, and employment agreement, given to one of the businessmen was based on fraudulent representations. Trascent Management Consulting, Inc. v. Bouri, C.A. No. 10915-VCMR (Del. Ch. Sept. 10, 2018), contains a practical statement of principles and analysis for those engaged in corporate and commercial litigation.

Overview of Court’s Holding:

The court found that the defendant not only fraudulently induced the formation of the limited liability company and his employment agreement, but also made numerous false statements during the litigation. As a remedy, the court rescinded the employment agreement and declared the limited liability company agreement unenforceable by the defendant.  The court also awarded some attorneys’ fees and costs as a penalty for bad faith litigation conduct.

The 75-page long opinion provides copious factual details that are necessary to understand the factual basis of the court’s reasoning and decision, but for purposes of a short blog post, I will highlight the key statements of law that have the most widespread applicability to corporate and commercial litigation practitioners.

Noteworthy Legal Principles in Court’s Decision:

  • The court listed the elements of “fraudulent inducement”, which are identical to the elements of common law fraud. See pages 36-37.
  • The court described a 2-part test that is used to determine if an entity can assert fraud claims for fraud committed prior to, but related to, its formation. See page 38.
  • The court explained the nuances within the definition of misrepresentation, including liability for “half-truths” as well as the duty to correct misleading impressions. See pages 45-46.
  • The court also discussed the aspects of the following elements of fraud: (i) when a statement is intended to induce action (pages 49-50); and (ii) when a statement is justifiably relied on. (page 51).

Remedies:

  • Rescission as a remedy was found to be appropriate for an agreement that was fraudulently induced. See page 57.
  • The court explained that a fraudulently induced agreement may be either voidable or unenforceable at the option of the innocent party. See page 59.
  • The court also discussed the rare application of the bad faith litigation conduct exception to the American Rule, in connection with the court’s decision to make a partial award of attorneys’ fees in this case. See pages 64 to 67.
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