The number of jurists on the Delaware Court of Chancery was recently increased from five to seven by legislation. Today, the Governor nominated the two new vice chancellors for Delaware’s equity court, and they now will be considered by the Delaware Senate. A local Delaware publication at this link provides details about the two nominees: Morgan Zurn, who is currently a Master in Chancery, and Kathaleen McCormick, a Delaware corporate litigator. (Yes, that is how her first name is spelled. Get used to it.) I expect that their confirmation hearings in the Delaware Senate will not follow the circus-like atmosphere that seems to have prevailed in the “extended” U.S. Senate committee hearings for the nominee for the U.S. Supreme Court.
For those who need to understand the prerequisites for, and limitations of, maintaining court filings as confidential, the recent Delaware Court of Chancery opinion must be read in the matter styled: In re Appraisal of Columbia Pipeline Group, Inc., Cons. C.A. No. 12736-VCL (Del. Ch. Aug. 30, 2018).
This decision describes when documents filed with the court, even if labeled “confidential” must be disclosed to the public, and pithily explains why relatively few documents filed with the court qualify for continuing confidential treatment, which in the past have been described as “filings under seal.”
The court explained that under Chancery Court Rule 5.1, and its underlying public policy reasons described with citations to many authorities, as well as constitutional principles that animate that public policy, the presumption remains that all judicial records are available to the public. Other reasons also prevented the company in this case from prevailing in its efforts to keep court records under seal, because the Company did not meet its burden of proof.
This gem of a decision includes bountiful citations to constitutional principles that form the basis for the presumption that all court proceedings are open to the public and that filings with the court are a matter of public record. See footnotes 1-10 and accompanying text.
The court’s opinion is based largely on Court of Chancery Rule 5.1(b)(2), which defines the “good cause” requirement that must be satisfied for public filings with the court to be kept confidential, as follows: good cause shall exist only if the public interest in access to court proceedings is outweighed by the harm the public disclosure of sensitive, non-public information would cause. Such information includes trade secrets and sensitive financial, business or personnel information, but does not include information that may be awkward to disclose “merely because disclosure has the potential for collateral economic consequences.” See footnotes 11-13.
Under Rule 5.1, unless the party seeking confidential treatment meets the standard for confidential treatment, the information becomes public. Columbia failed to meet those prerequisites in this case.The court did observe that there is an exception to the use restriction for information that is already public or which becomes public.
The court reasoned that there is no injustice in the public having access to information in judicial filings and potentially using that information to identify and pursue potential wrongdoing. The court quoted from Justice Brandeis who famously observed that: “Sunlight is said to be the best of disinfectants; electric light the most efficient policeman.” See footnote 16.
As a final procedural note, the court explained that Rule 5.1 does not contemplate a reply, after a motion and a response to that motion to challenge or maintain confidentiality, and therefore, the court struck the reply that was filed, although for the sake of completeness it did address the points made in that reply.
In conclusion, the court reasoned that public policy interests work against a special exception to Rule 5.1 under which non-confidential information and judicial records in an appraisal proceeding would remain confidential, simply to mitigate the risk of additional litigation for the respondent.
A recent Delaware Court of Chancery decision provides many useful statements of Delaware corporate law. The opinion in the matter of Cedarview Opportunities Master Fund, L.P. v. Spanish Broadcasting System, Inc., C.A. No. 2017-0785-AGB (Del. Ch. Aug. 27, 2018), extends to 57-pages, but for purposes of this short blog post, I intend to highlight only a few points that should be of widespread interest to corporate and commercial litigation practitioners:
· The court provided two key contract interpretation principles that are applied when construing certificates of designation such as those that define the rights of preferred stockholders. See Slip op. at 25-29. These contract interpretation principles are somewhat different in a nuanced manner than general contract interpretation principles.
· The two approaches to interpret ambiguous terms in a certificate of incorporation or certificate of designation, include: (i) contra proferentem; and (ii) although somewhat in tension with the prior method of construction, the second approach provides that the rights of preferred stockholders must be clearly expressed and will not be presumed. The “upshot of this principle is that the courts have been unwilling to recognize or read in implied rights, preferences or limitation in certificates of designations.” See footnote 100 and accompanying text.
· The court acknowledged the “potential clash of these interpretive principles” and explained how that clash can be resolved. See Slip op. at 27-29.
· Also important, is a description of how damages for breach of contract can be addressed for breach of a violation of a “right to consent.” Hypothetical negotiations have been used by the court in this context to determine damages. The court also recognized the possibility of a “consent fee” that might have been “reasonably expected” in connection with the right to consent. See footnotes 112 and 113 and accompanying text.
· Based on the application of the foregoing principles, the motion to dismiss claims in this case was denied.
A recent ruling from the Delaware Court of Chancery provides a statement of principles that is a useful tool for the toolbox of practitioners. The decision in Alpha Holdings Inc. v. Kim, C.A. No. 2018-0283-SG (Del. Ch. Aug. 21, 2018), is a short ruling that, in essence, explains that the court expects cooperation among counsel in routine matters such as scheduling and pre-trial stipulations.
As an example, the court explained that it expects counsel for all the parties to collaborate to prepare joint submissions of pretrial stipulations, such as briefing schedules, without burdening the court with issues about what it referred to as “picayune disputes” in competing scheduling orders.
The Delaware Court of Chancery recently addressed the challenged removal of an LLC manager and the validity of written consents. In Godden v. Franco, C.A. No. 2018-0504-VCL (Del. Ch. Aug. 21, 2018), the court explained several important principles that the Delaware courts use to analyze issues in the LLC context and interpretive rules involving LLC agreements. In the process, the court provided a helpful analysis of the equitable powers of the court to fashion remedies in the context of an LLC notwithstanding the often exaggerated explanation of LLCs as creatures of contract. For example, the court cited recent scholarship from Professor Mohsen Manesh that explains why LLCs are not wholly contractual and should be described as “only partially creatures of contract.” See Mohsen Manesh, Creatures of Contract: A Half-Truth about LLCs, 42 Del. J. Corp. L. 391 (2018)(noted on these pages.) The court also cites to other exceptions to the exaggerated concept of the LLC as merely a creature of contract. See pages 15-17 and footnotes 16-22.
- An essential point in the court’s analysis is that if an LLC Agreement and the LLC Act do not address an issue, then Section 18-1104 of the Delaware LLC Act reverts to equity and rules of law for resolution. See footnotes 17-19 and accompanying text.
- The court provides basic contract interpretation principles at page 17 of the slip opinion. An important principle in both the LLC context and the corporate context is articulated as follows: A contract provision that “tends to induce” the violation of a fiduciary duty is not enforceable on grounds of public policy. See footnote 43 and accompanying text.
- A statement of law that has widespread application in the corporate and commercial context is that under Delaware law, corporate separateness is a bedrock principle. See Slip op. at 25.
- The court also provided an helpful analysis and a comparison of written consents in different contexts. Specifically, Section 18-404(d) of the LLC Act allows non-unanimous written consents of managers of LLCs, similar to DGCL Section 228(a) for corporate stockholders—but contrariwise, DGCL Section 141(f) requires unanimous written consent for corporate board action.
The Court of Chancery in a recent decision addressed the issue of whether a “put right” that a company did not have sufficient funds to honor when exercised, was enforceable against the surviving company after a merger when the surviving company had the funds needed. The Court of Chancery answered this question in the affirmative in a matter styled: QC Holdings, Inc. v. Allconnect, Inc., C.A. No. 2017-0715-JTL (Del. Ch. Aug. 28, 2018).
This opinion addresses issues that are of importance to anyone who needs to be familiar with Delaware law regarding: (i) the restrictions on the ability of a corporation to redeem its own shares pursuant to DGCL Section 160;
(ii) the obligations of a successor corporation for the liabilities of the constituent corporation in a merger pursuant to DGCL Section 259; and
(iii) the minutiae of transferring stock pursuant to DGCL Section 201 and the Delaware Uniform Commercial Code, Article 8.
Several key principles articulated in this decision should be of interest to corporate and commercial litigation practitioners, include the following:
- Law and equity disfavor forfeitures. See footnotes 19 and 20. The court also explained that it would be unreasonable to construe a “put right” as valid for “one day only” on the date of exercise, as opposed to allowing time for the corporation to accrue available funds required under DGCL Section 160.
- The court described the limitations on the ability of a corporation to redeem its shares under DGCL Section 160 as “widely known.” See footnote 21.
- Because the funds for redemption in this case were held in escrow in connection with the merger, the court found that specific performance was appropriate because a money judgment alone would not be sufficient to transfer the funds or to make the claimant whole. See footnote 44 and accompanying text.
- This holding is noteworthy on the remedy issue because in some circumstances there may not be equitable jurisdiction if the only remedy sought is money. The procedural nuances of this case provide somewhat of an exception in this context.
- The court found that “merger funds” were not “legally available” for redemption purposes under DGCL Section 160. See footnote 21 and Slip op. at 17-20.
- The court explained that when a put right is exercised, and stock is transferred to the company pursuant to DGCL Section 201 and Article 8 of the Delaware UCC, DGCL Section 259 made the successor corporation, after the merger, duty bound to redeem the shares as a contract obligation.
A recent post on the Harvard Law School Corporate Law Blog, (on which I have published several articles as a “contributing author”) recently discussed a 2008 decision by Supreme Court Justice-Nominee Brett Kavanaugh, in Pirelli Armstrong Tire Corp. Retiree Med. Benefits Tr. ex rel. Fed. Nat. Mortg. Ass’n v. Raines, 534 F.3d 779, 782 (D.C. Cir. 2008), that he wrote shortly after he joined the U.S. Court of Appeals for the D.C. Circuit. The decision addresses the often vexing issue of pre-suit demand futility in the context of a stockholder derivative suit. This may be of interest to those involved in Delaware corporate litigation if soon-to-be Justice Kavanaugh writes any decisions in the future having an impact on corporate law.
As an aside, last week I attended a luncheon event in Wilmington, Delaware, hosted by the Federalist Society, at which a former law clerk of Judge Kavanaugh provided insights into the nominee’s personality and judicial approach. Also providing commentary on the nominee was Judge Walter Stapleton of the U.S. Court of Appeals for the Third Circuit, for whom the nominee clerked (in Wilmington, Delaware), after Yale Law School and before clerking at the U.S. Supreme Court.
After hearing from his former clerk, and one of the judges that the nominee clerked for, who both recounted the personal habits and temperament and character of this future Supreme Court justice, I wondered for a fleeting moment if he should be canonized for sainthood. I know that sounds like an exaggeration, and it is, but after hearing about all the charitable endeavors he is involved in on a routine basis, in addition to the time he spends with his family and volunteering for the community, as well as his legendary work ethic and long hours at the office, and impeccable academic pedigree, plus his published scholarship, most people in any walk of like would pale in comparison. What an exemplary human being–regardless of one’s political views.
This post comes to us courtesy of Mitchell Mengden, a law student at the Georgetown University Law Center.
A recent Delaware Court of Chancery decision held that a member forced-out from a member-managed LLC was entitled to the fair value of his membership interest. In the case styled Domain Associates, LLC v. Shah, C.A. No. 12606-VCS (Del. Ch. Aug. 13, 2018), the court addressed a challenge to the payout amount of a member expelled from an LLC by the other members.
The member involved had a membership interest and made a separate capital contribution, but the other members later required him to withdraw from the LLC. This case was based on the member’s claim that he was entitled to a percentage of the company’s cash on hand that correlated with his membership interest. The company, however, took the position that the expelled member was only entitled to the value of his capital account.
The LLC sought a declaratory judgment, and the member filed a counterclaim for breach of contract asserting that the LLC Agreement did not specify the amount of payment due, and that the court should base its decision on the Delaware Limited Liability Company Act (LLC Act).
The court found that the LLC Agreement was unambiguously silent with respect to payout of a member forced to withdrawal. Because the LLC Agreement was silent with respect to payout of a member forced to withdraw, the court turned to the LLC Act to interpret the Agreement. The court noted that Section 18-604 of the LLC Act only applies to voluntary withdrawals. See footnote 140. Instead, the court relied on Section 18-1104 of the LLC Act in finding that “the rules of law and equity . . . shall govern.” See footnote 146.
In determining the fair payout amount for a member forced to withdraw, the court extended to the instant case Chief Justice Strine’s analysis in Hillman v. Hillman, 2006 WL 2434231 (Del.Ch., Aug 23, 2006), which was the subject of a cursory post on these pages. Then-Vice Chancellor Strine held that, under Section 17-1105 of the Delaware Revised Partnership Act, expelled partners are entitled to a payout “equal to the fair value of such partner’s economic interest.” See footnotes 147-49. Under the LLC Act, members are granted the freedom to shape their management structure through the company’s governing instrument. See footnotes 150-52. Because the LLC employed a member-managed model, the court found it appropriate to apply the default rule for partnerships under Section 17-1105.
1) The court reiterated that parties’ intent with respect to the payout of an expelled member is determined, at least initially, by analyzing the four corners of the LLC agreement.
2) The court noted that Chief Justice Strine’s analysis of the Delaware Revised Partnership Act in Hillman can be extended to an LLC depending on the governance structure of the LLC. In this case, because the LLC agreement does not specify the payout for an expelled member, and the LLC employed a member-managed model, akin to a partnership, the member in this case was entitled to a payout “equal to the fair value of such partner’s economic interest.”
The Delaware Court of Chancery, relying on precedent, rejected a request for a TRO to enjoin future defamatory statements by one business partner against another, primarily because of constitutional principles prohibiting prior restraint of free speech rights protected by the First Amendment–especially in the procedural posture of a preliminary injunction or TRO, without a full trial on the merits. CapStack Nashville 3, LLC v. MACC Venture Partners, C.A. No. 2018-0552-SG (Del. Ch. Aug. 16, 2018).
In connection with the fallout between investors and managers of a joint venture for apartment complexes in Nashville, Tennessee–involving various Delaware entities that the court describes as “a rather baroque organizational structure”, one of the parties threatened to complain to the SEC and otherwise publicize allegations of fraud–which were denied. Although the word “extortion” was not used in the opinion, there was a threat to disseminate the allegations of fraud if certain conditions were not met by a short deadline. By the deadline, the party who was the object of the threatened defamation filed suit seeking a TRO to enjoin the defamation that was promised.
- The familiar prerequisites for a TRO were described: (i) colorable claim; (ii) likelihood of imminent, irreparable harm; and (iii) greater hardship will be suffered if the TRO is not granted. Irreparable harm is the sine qua non for this form of relief. See footnotes 37 and 38 (citing CBS Corp v. Nat’l Amusements, Inc., 2018 WL 2263385, at *3 (May 17, 2018), highlighted on these pages).
- The irreparable harm requirement was not easily met in this case because the threatened harm was the publication of libelous information that was already accessible to the public via SEC filings. Also, the filings describing the defamatory statements were included in court filings that were not filed under seal. Thus, further publication was not likely to cause irreparable harm.
- Issuing a TRO in this case would also run afoul of the maxim that equity will not enjoin a libel. See Organovo Holdings, Inc. v. Dimitrov, 162 A.3d 102 (Del. Ch. 2017), highlighted on these pages. Compare Doe v. Coupe, highlighted on these pages. (granting injunctive relief to enjoin unconstitutional use of ankle bracelets by the state.)
- The court discussed exceptions to the bar on the prior restraint of speech for “traditional trade libel”–accompanied by an independent tort supporting equitable relief. See footnotes 69 and 70 and accompanying text. Moreover, the court must first determine, typically after a developed factual record, whether or not any of the speech involved is “constitutionally protected.” Compare “tortious interference with business relations.” (cases cited and discussed in footnote 70.)
- The court also addressed the “qualified privilege” one has, depending on the state and the specific circumstances, to publish defamatory matter preliminary to, or in connection with, a judicial proceeding. The court cites to authorities that consider SEC investigations to be quasi-judicial proceedings. See footnotes 71 to 74 and accompanying text.
This is a guest post by Bernard S. Sharfman, who is the Chairman of the Main Street Investors Coalition Advisory Council and a member of the Journal of Corporation Law’s editorial advisory board
The Main Street Investors Coalition is the first organization trying to deal with a relatively new phenomenon that Professors Gilson and Gordon would call the “agency costs of agency capitalism.” Agency capitalism refers to the dominance of institutional investors as shareholders of record of the voting stock of publicly traded companies. They are the ones doing the voting not the retail investors who provide the funds. Agency capitalism has given rise to new “agency costs” that must not only be addressed by the leaders of public companies, participants in the capital markets and the Securities and Exchange Commission, but also by corporate law. Why corporate law must address these agency costs is the focus of this blog post.
The Agency Costs of Agency Capitalism
As I discussed in a recent Pensions & Investments op-ed,
[a]gency costs are generated when an institutional investor acts based on its own preferences, not the preferences of those who provide it with the funds to purchase securities. That is, there is a divergence between the objective of shareholder wealth maximization, the default objective of those 100 million plus retail investors in the United States who invest in mutual funds either directly or through retirement accounts, or are the beneficiaries of public pension funds, and the preferences of institutional investors who manage those funds. The result is that these agency costs may significantly harm the efficiency of corporate governance and lead to lower returns for investors.
In the same article, I also provided examples of when issues involving the “agency costs of agency capitalism” may arise:
These agency costs include a public pension fund disregarding the preferences of its beneficiaries and approaching shareholder advocacy and voting through the lens of shareholder empowerment, not wealth maximization. Or, when an institutional investor uses voting recommendations from proxy advisors that are based on data errors, bias (simply making the recommendation based on what a type of institutional investor wants to hear), or … a one-size-fits-all approach. In addition, when a mutual fund advisor, in its desire to bring more public pension fund assets under management, supports and votes for proxy access proposals initiated by public pension funds. Or, in order to appease shareholder activists who are part of its own stockholder base, the mutual fund adviser may be more supportive of social responsibility proposals, such as those dealing with climate change, than they would otherwise.
Agency costs of agency capitalism reflect a divergence from the institutional investor’s fiduciary duty to act exclusively in the best interests of those who provide it with funds to manage, namely retail investors. How these new agency costs impact corporate law is through both a court’s understanding of a board’s fiduciary duties and what it means when there is a shareholder vote.
Agency Costs of Agency Capitalism and the Board’s Fiduciary Duties
According to Leo Strine, Chief Justice of the Delaware Supreme Court, “broadly, directors may be said to owe a duty to shareholders as a class to manage the corporation within the law, with due care and in a way intended to maximize the long run interests of shareholders.” That same understanding is found when we generalize the dicta of former Chancellor William Chandler in eBay Domestic Holdings, Inc. v. Newmark:
Having chosen a for-profit corporate form, … directors are bound by the fiduciary duties and standards that accompany that form. Those standards include acting to promote the value of the corporation for the benefit of its stockholders. The “Inc.” after the company name has to mean at least that. Thus, I cannot accept as valid … a corporate policy that specifically, clearly, and admittedly seeks not to maximize the economic value of a for-profit Delaware corporation for the benefit of its stockholders – no matter whether those stockholders are individuals of modest means or a corporate titan of online commerce.
This directive to maximize shareholder wealth comes not from statutory corporate law but through the board of directors’ fiduciary duties as applied by the courts. According to the Delaware Supreme Court in NACEPF v. Gheewalla, “The directors of Delaware corporations have ‘the legal responsibility to manage the business of a corporation for the benefit of its stockholder owners.’ Accordingly, fiduciary duties are imposed upon the directors to regulate their conduct when they perform that function.”
Most importantly, the Gheewalla court also said,
When a solvent corporation is navigating in the zone of insolvency, the focus for Delaware directors does not change: directors must continue to discharge their fiduciary duties to the corporation and its stockholders by exercising their business judgment in the best interests of the corporation for the benefit of its stockholder owners.
Arguably this statement was made under the presumption that institutional investors were meeting their own fiduciary duties. But what if the facts demonstrate that the board is faced with institutional investors who are generating agency costs? That is, the institutional investors are demanding that the board act to satisfy their own preferences, as stockholders of record, rather than the preferences of those who provide them with the funds to purchase the company’s stock?
Such a fact pattern calls for a change in how a board’s fiduciary duties are understood. If not, then the board will always be under pressure to adhere to a duty to institutional investors who may be violating their own fiduciary duties. Boards should not be forced to be complicit in this breach.
In order to rectify this problem, it is recommended that the statement in Gheewalla be modified with the following italicized language:
When a solvent corporation is navigating in the zone of insolvency, the focus for Delaware directors does not change: directors must continue to discharge their fiduciary duties to the corporation and its stockholders by exercising their business judgment in the best interests of the corporation for the benefit of its stockholder owners and the investors and beneficiaries such ownership represents.
Such language would help empower a board to say no to those institutions creating agency costs by providing it with the argument that to do otherwise would be a breach in the fiduciary duties it owes to the retail investors whose interests the institutional investor is actually representing, such as mutual fund shareholders or public pension fund beneficiaries.
Agency Costs of Agency Capitalism and Shareholder Voting
The Delaware Supreme Court said in Crown Emak Partners, LLC v. Kurtz, “[w]hat legitimizes the stockholder vote as a decision-making mechanism is the premise that stockholders with economic ownership are expressing their collective view as to whether a particular course of action serves the corporate goal of stockholder wealth maximization.”
This is a beautiful statement, but what if the premise is wrong? It is quite possible that courts will from time-to-time face fact patterns where the agency costs of agency capitalism make it clear that the premise does not hold. If so, what is a court to do? Should a court determine that the shareholder vote is no longer legitimate to the extent that the votes provided by institutional investors generating agency costs must be thrown out? This is an issue that the courts need to identify and address.
Former Chancellor William T. Allen was prescient when he stated in the famous 1988 Delaware Chancery Court case of Blasius Industries, Inc. v. Atlas Corp., that “[i]t may be that we are now witnessing the emergence of new institutional voices and arrangements that will make the stockholder vote a less predictable affair than it has been.” However, it is doubtful that he was including in this “less predictable affair” language the additional uncertainty and, most importantly, the inefficiency created by the agency costs of agency capitalism. It is now up to corporate law to respond.