Professor Stephen Bainbridge, the nationally-recognized, prolific corporate law expert, known to readers of this blog (among other reasons) for citations in Delaware court opinions to his scholarship, provides scholarly commentary and citation to multiple sources regarding the corporate law implications for the political activity of CEOs–including some who think of themselves as social justice warriors. The good professor also cites to a 2016 post on these pages by yours truly on the topic generally.
Recent Decision Clarifies Safe Harbors in DGCL § 144 for Board Action
The following article appeared in the current issue of the Delaware Business Court Insider:
Recent Decision Clarifies Safe Harbors in DGCL § 144 for Board Action
By: Francis G.X. Pileggi* and Chauna A. Abner**
The recent Superior Court decision in Toedtman v. Turnpoint Medical Devices, Inc., C.A. No. N17C-08-210 RRC (Del. Super. Ct., Jan 23, 2019), adds clarity to the case law interpreting Section 144 of the Delaware General Corporation Law (“DGCL”), 8 Del C. § 144. This case is important for the clear guidance it provides for anyone who seeks to understand Section 144(a)’s safe harbors when one or more board members are conflicted in connection with a board vote.
In Toedtman, the court discussed Section 144(a)’s three safe harbors and considered the application of two of the safe harbors to a former director’s employment agreement as a CEO. Ultimately, the court decided that even though a self-interested director entered into the agreement, the agreement was nonetheless valid because it fell within at least one of Section 144(a)’s safe harbors.
The plaintiff in Toedtman filed suit alleging, among other things, that the defendant company breached his employment agreement by terminating his employment without cause. Slip op. at 2. The company argued that the employment agreement was invalid because it was a self-interested transaction as a result of the plaintiff entering into the agreement on behalf of himself and the company. Id. at 12.
The court explained that the purpose of § 144 is “to provide ‘safe harbors’ for interested director transactions, to prevent the transaction from being void or voidable solely because an interested director was involved.” Id. at 14. Relying on a 1976 Delaware Supreme Court decision, the court explained that § 144(a)’s safe harbors prevent an agreement from being invalid solely because an interested director was involved. Id. (quoting Fliegler v. Lawrence, 361 A.2d 218, 222 (Del. 1976)).
The court summarized Section 144(a)’s three safe harbors: “First, the transaction may be approved by a majority of disinterested directors. Second, the transaction may be approved by a majority of disinterested shareholders. Third, the transaction may be shown to be entirely fair to the corporation at the time it was authorized by interested directors or shareholders.” Id.
Under the first two safe harbors, the court assesses the validity of the transaction using a two-step analysis. First, the court determines whether the transaction falls within the safe harbor, and if it does, the court will then review the transaction under the business judgment rule. Id. “The business judgment rule is a presumption that in making a business decision, the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action was taken in the best interest of the company.” Id. at 14-15.
If the transaction falls outside of the first two safe harbors, the third safe harbor applies the entire fairness standard. Id. at 15. The court explained that “the concept of fairness has two basic aspects: fair dealing and price,” id., and the burden is on the interested director to prove entire fairness. Id. The court further explained that “fair dealing” concerns the conduct of corporate fiduciaries in effectuating the transaction while “fair price” concerns the economic and financial considerations of the contract. Id. at 18. The court analyzes the fair price of the contract as of the time the transaction was approved. Id. at 21.
The court held that the employment agreement fell within the § 144(a)(1) safe harbor because it was approved by a majority of disinterested directors. Id. at 17. In reaching this decision, the court first identified who the interested versus disinterested directors were, and concluded that the plaintiff was the only interested director. Id. Next, the court noted that disinterested directors delegated to a corporate officer the board’s power to negotiate and enter into employment agreements. Id. at 16. The court explained that the delegation was a proper exercise of business judgment. Id. at 17. The court declined to replace its judgment with that of disinterested directors and held that the employment agreement was valid because the board properly delegated its authority to negotiate and enter into employment agreements. Id.
The court also held that the employment agreement satisfied the intrinsic fairness test in the § 144(a)(3) safe harbor. Id. at 18. As for fair dealing, the court concluded that the employment agreement followed “good corporate practice.” Id. The court also concluded that the negotiation and structure of the agreement also appeared to be fair, and there was no evidence that the plaintiff acted in bad faith. Id. at 19. Regarding fair price, the court concluded that the board authorized plaintiff’s salary and the court refused to question the business judgment of disinterested directors in approving the plaintiff’s salary. Id. at 21. The court held the agreement was valid because it was a product of both fair dealing and fair price, and was therefore intrinsically fair. Id. at 18.
The key takeaway is that DGCL Section 144 prevents an otherwise valid agreement from being invalidated solely because an interested director or shareholder was involved, as long as the challenged matter fits within one of the three safe harbors in Section 144(a).
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*Francis G.X. Pileggi is a litigation partner and Vice-Chair of the Commercial Litigation Practice Group at Eckert Seamans Cherin & Mellott, LLC. His e-mail address is fpileggi@eckertseamans.com. He comments on key corporate and commercial decisions, and legal ethics rulings, at www.delawarelitigation.com.
**Chauna A. Abner is an associate in the Commercial Litigation Practice Group of Eckert Seamans Cherin & Mellott LLC.
No Reformation for Investors Who Signed Agreement Without Reading
A recent Delaware Court of Chancery opinion is notable to the extent that it provides another example of how difficult it is to prevail on a claim for reformation of a contract. See In re 11 West Partners, LLC, C.A. No. 2017-0568-SG (Cons.) (Del. Ch. Mar. 20, 2019).
Brief Background:
This case involves a three-member LLC formed by real estate investors. Contrary to instructions given to their attorney to follow a sample agreement that the parties had previously used for a prior investment, the attorney drafted the LLC agreement to require an unanimous vote to oust members (instead of a mere majority.) Two of the three members seeking reformation of the agreement did not read the agreement before signing. Their failure to read the contract, in part, hurt their reformation claims–although they were also not able to satisfy the prerequisite for a reformation claim that there was a “specific meeting of the minds regarding a term that was not accurately reflected in the final written agreement.” (citing Glidepath Ltd. v. Beumer Corp., 2018 WL 2670724, at *10 (Del. Ch. June 4, 2018)) (The Glidepath case was one that I was involved in, and the June 2018 decision in that matter is another example of the challenges in a reformation case).
Key Takeaways:
- A reformation claim can be based on either mutual mistake or unilateral mistake. See footnote 48 and accompanying text for the elements of a reformation claim: By clear and convincing evidence, a party seeking reformation must prove:
“(1) that the party was mistaken about the contents of the final, written agreement; (2) that either its counterparty was similarly mistaken or that the counterparty knew of the mistake but remained silent so as to take advantage of the error; and (3) that there was a specific meeting of the minds regarding a term that was not accurately reflected in the final written agreement.”
- Although not expressly stated in the prerequisites, it is necessary to establish that the counterparty knew of the mistake prior to the agreement at issue being signed, if the argument is that the counterparty knew of the mistake–and remained silent.
As an aside, it’s notable that one of the potential ethical issues that was woven into the factual background of this case was that the attorney who drafted the LLC agreements at issue was not explicit about, at least in writing, whether he was representing the LLC, as an entity, that was involved–as compared to one or more of the individual three members of the LLC. There was some inconsistent testimony in the record about whether one or more of the three LLC members thought that the attorney drafting the LLC agreement was representing one or more of them individually–which of course would be problematic in and of itself.
Another side note of interest, not for its legal significance but for its relevance to current events, is the fact that at least one of the three LLC members wanted to expel another member from the LLC because of apparent anger over who the other member voted for in the 2016 Presidential Election (i.e., the victorious candidate.) See footnotes 37 to 40 and accompanying text. In light of the result of this case, that was not a legal basis to remove the member.
No Equitable Jurisdiction for This Declaratory Judgment Suit
A recent Delaware Court of Chancery opinion provides a reminder of the limited jurisdiction of Delaware’s court of equity and why not all suits for declaratory judgment satisfy the narrow subject matter jurisdiction of the Court of Chancery. See Takeda Pharmaceuticals U.S.A., Inc. v. Genentech, Inc., C.A. No. 2018-0384-MTZ (Del. Ch. Mar. 26, 2019).
Background:
This case involved an effort to obtain a declaratory judgment that would validate a defense in patent litigation pending in another forum based on a patent license. The court held that because there was an adequate remedy at law, the court did not have equitable subject matter jurisdiction for a declaratory judgment in this case, and no anti-suit injunction was available either.
Key Takeaways:
- The court explained that in order for it to entertain a declaratory judgment action, there must be an “actual controversy.” See footnotes 46 to 47 and accompanying text. Although the four elements that the court reviews in order to determine whether there is an “actual controversy” were satisfied in this case, the court dismissed the suit without prejudice because it determined that the necessary equitable jurisdiction for making a ruling on a declaratory judgment claim was lacking.
- The court provided its reasoning about why an adequate remedy at law deprived it of equitable jurisdiction. See footnotes 52 to 68 and accompanying text. The adequate remedy at law in this case was that the license defense was capable of being presented in pending litigation in another forum, and therefore an anti-suit injunction was not available based on the absence of the irreparable harm requirement.
- Importantly, the Court of Chancery in the instant opinion distinguished a 2013 Delaware Supreme Court decision in National Industries Group v. Carlyle Investment Management, highlighted on these pages, as inapplicable in this matter. The Court of Chancery distinguished the facts in that case which involved the grant of specific performance to enforce a forum selection clause and to enjoin suits pending in another jurisdiction contrary to the forum selection clause. The difference between that decision and similar decisions highlighted on these pages involving the enforcement of a forum selection clause, distinguished in this decision, was that it has been well-established in Delaware that forcing someone to litigate in another forum contrary to a forum selection clause satisfies the irreparable harm prerequisite for injunctive relief–a prerequisite not satisfied in this case.
- In this case, there was no contractual forum selection clause involved, and the request that the Court of Chancery validate a defense to be used in court in another jurisdiction failed to acknowledge that courts often apply the law of jurisdictions other than where the court is sitting.
See generally, the three traditional “buckets” that a case must “fit into” in order to trigger equitable jurisdiction, described at footnotes 42 through 45 and accompanying text.
Consent to Jurisdiction Implied by Adoption of Forum Selection Bylaw
A recent Delaware Court of Chancery decision is noteworthy for its finding that the adoption of a forum selection bylaw implied consent to jurisdiction to the extent that it required lawsuits by stockholders against the company to be filed in Delaware. See In re: Pilgrim’s Pride Corp. Derivative Litigation, C.A. No. 2018-0058-JTL (consol.) (Del. Ch. Mar. 15, 2019).
Background:
The basic facts involved a challenge to the sale of a company that was orchestrated by the controlling stockholder who needed cash. On the same day as the acquisition, the board of the nominal defendant approved a Delaware forum selection bylaw. The court discussed the applicable standard of review and other topics, but the jurisdictional issues are more notable.
Key Takeaways:
· The Court held that the controlling stockholder who appointed a majority of the board of the nominal defendant agreed to personal jurisdiction when it caused the company to adopt the Delaware forum selection bylaw—for claims covered by the forum bylaw.
· In rejecting the parent’s motion to dismiss for lack of jurisdiction, the Court explained that:
“on the same day that the Acquisition was approved, the Board voted unanimously to adopt a forum-selection bylaw, with the Director Defendants whom Parent controlled constituting a five-member majority of the nine-member Board. The bylaw made the Delaware courts the exclusive forum for breach of fiduciary litigation involving the Company. This decision holds that on the facts alleged, Parent implicitly consented to personal jurisdiction in this court for purposes of claims falling within the forum-selection bylaw.”
The court explained, however, that the better practice would be to specifically provide, when drafting contractual provisions, that personal jurisdiction is expressly agreed to in a particular form. See footnotes 5 to 8 which provide voluminous citations to authority and learned commentary on this topic.
There are many forum-selection clause cases featured on these pages, but this decision explores an aspect of forum-selection clauses that is not often analyzed directly by Delaware courts, as compared to other nuances.
Delaware Appraisal Cases Decline
Kevin LaCroix on his widely-respected blog called The D&O Diary, comments on the results of a Cornerstone Research report which found that the number of appraisal actions filed in Delaware courts declined in 2017 and 2018–compared to increases every year from 2010 to 2016. Kevin provides excellent insights and a link to the actual report from Cornerstone Research about this aspect of Delaware corporate litigation.
Chancery Finds Usurpation of Corporate Opportunity
Delaware case law is well-established regarding the aspect of the fiduciary duty of loyalty that prohibits a corporate director from usurping a corporate opportunity. A recent decision from the Delaware Court of Chancery applies that well-settled prohibition in a flexible manner to a set of facts that have apparently not been squarely addressed in prior precedent. In Personal Touch Holding Corp. v. Glaubach, C.A. No. 11199-CB (Del. Ch. Feb. 25, 2019), the court awarded damages for the breach of this subset of fiduciary duty, as well as for other breaches of fiduciary duty.
Basic Background Facts:
This case involved a co-founder who also served as a president and director of a New York-based provider of healthcare services. He was removed when the company discovered various transgressions. The former director purchased an office building in his individual capacity–secretly–even though the court found that the former director had been aware that the company was interested for several years in purchasing a similar building for its own use. The former director then offered to lease the building back to the company at what the court found to be above-market rental rates.
Key Principles of Law:
This short blog post assumes that readers are familiar with the basic principles involved with the usurpation of corporate opportunities, and will merely highlight some of the key statements of law and the court’s reasoning in this 84-page opinion.
The well-known elements of a claim based on the corporate opportunity doctrine have been stated frequently in prior Delaware cases. Those familiar with corporate litigation will recognize the following four elements of a claim for usurpation of corporate opportunity:
“(1) The corporation is financially able to exploit the opportunity;
(2) The opportunity is within the corporation’s line of business;
(3) The corporation has an interest or expectancy in the opportunity;
(4) By taking the opportunity for his own, the corporate fiduciary will thereby be placed in a position inimicable to his duties to the corporation.”
Slip op. at 36-38.
The court explained that Delaware Supreme Court decisions have referred to some of these elements in the disjunctive even though they are often quoted as being conjunctive. Specifically, proof of either the third element or the fourth element would sustain a corporate opportunity claim.
Moreover, the court decides the viability of a corporate opportunity claim by weighing the four factors in a holistic fashion and no one factor is dispositive. Id.
Key Reasoning of the Court:
- The court rejected the argument that the purchase of the office building was not in the line of business of the healthcare company involved, which historically leased office space, because the “line of business factor” was in either inapplicable or was satisfied because the company had a clear “interest and expectancy” in the opportunity. In addition to that factor having a flexible meaning, the court explained that latitude should be allowed for development and expansion of a business, and the Delaware courts have broadly interpreted the nature of the corporation’s business when determining whether a corporation had an interest in a opportunity.
- Regardless, the court found that the line of business test was not relevant where, as here, the company had a clear interest and expectancy in acquiring the building, and the opportunity presented related to an operational decision about how to expand the business as opposed to an opportunity to acquire a new business.
- The court further reasoned that even if the opportunity was not within the existing line of business, it was sufficient that the company had a “clear interest and expectancy” at the time the opportunity arose. Id. at 44-47.
- Regarding the fourth factor, the court instructed that a corporate officer or director was prohibited from taking an opportunity for his own “if the corporate fiduciary will thereby be placed in a position inimicable to his duties to the corporation.”
- The court elaborated by observing that the corporate opportunity doctrine is implicated where the fiduciary’s seizure of an opportunity results in a conflict between the fiduciary’s duties to the corporation and the self-interest of the director as actualized by the exploitation of the opportunity.” Id. at 47-49.
- The court also rejected an argument that the employment agreement of the former director allowed him to pursue other business interests outside of the company, and to devote a material portion of his time to other business interests. The court found that contractual defense to be unavailing in part because that provision did not allow the defendant to compete with the company for opportunities in which the company had an interest or expectancy. In addition, the employment agreement also prohibited the former director and president from engaging in activities which were “competitive with” the business of the company.
- The court applied the entire fairness test because the former director was on both sides of the transaction involving a lease of the building to the company, and also because the director received a personal benefit from the transaction that was not received by the shareholders generally. Id. at 53.
- The court also explained that charging the company an above-market rate for rent was unfair self-dealing and a breach of the duty of loyalty–regardless of whether the former director acted in subjective good faith.
As a side note, the court also found a separate breach of fiduciary duty as a result of the former director engaging in a “letter-writing campaign” over a several month period in which the former director sent harassing and disturbing anonymous letters to board members, employees and the lender of the company which caused harm to the company by hurting morale and causing distraction–in addition to attempting to sabotage the company’s relationship with its primary lender. Slip op. at 76-83.
Delaware Courts and Legal Ethics
A recent decision by the Delaware Court of Chancery provides an example of those rare instances where the court refers a violation of legal ethics to the Office of Disciplinary Counsel for investigation, as compared to the court itself determining the appropriate penalty. See Charter Communications Operating LLC v. Optymyze, LLC, et al., C.A. No. 2018-0865-JTL, letter (Del. Ch. Mar. 5, 2019)
Some readers are surprised to read about Delaware court opinions which explain that the Delaware courts do not view their primary role as enforcers of the Rules of Professional Conduct unless violations of those rules “prejudicially disrupt judicial proceedings” or “threaten the legitimacy of judicial proceedings.” See, e.g., Crumplar v. Superior Court, 56 A.3d 1000, 1009 (Del. 2012), highlighted on these pages. Other cases have used the phrase “interfering with the administration of justice.” See, e.g., Lendus LLC v. Goede, highlighted on these pages.
Rather, the Office of Disciplinary Counsel (ODC), a branch of the Delaware Supreme Court, is the proper venue for investigating and enforcing violations of legal ethics. In the Charter case linked above, the court was considering violations of Rule 11 when the counsel involved withdrew. The court explained that there might be some cases where it would continue to address a Rule 11 issue even after counsel withdrew, but the ODC is well equipped to investigate attorneys and recommend appropriate action.
Legal ethics is a topic covered by these pages because it not only applies to Delaware corporate and commercial litigation, but it also permeates virtually every aspect of legal practice. See, e.g., my recently published book on legal ethics highlighted on these pages.
Indemnification Claim Not Ripe Until Final Adjudication
A recent decision by the Complex Commercial Litigation Division of the Delaware Superior Court in Winshall, et al. v. Viacom International, Inc., C.A. No. N15C-06-137 EMD CCLD (Del. Super., Feb. 25, 2019), ruled that a claim for indemnification was not ripe until a final adjudication, after appeal, was decided. In a matter involving a claim for indemnification for attorneys’ fees based on a finding of a breach of a merger agreement by the Court of Chancery, which was affirmed by the Delaware Supreme Court, the Superior Court held that a subsequently filed indemnification claim was not barred by the statute of limitations because the claim did not become ripe until the affirmance by the Delaware Supreme Court. See Slip op. at 17-19.
The indemnification claim for “losses” which was defined in the agreement to include attorneys’ fees, was based on the Court of Chancery’s prior finding of a breach of agreement. The court also discussed several rebuttals to a statute of limitations argument and how they applied to the facts of this case. Id. at 22.
Supreme Court Denies Motion to File Amicus Brief
Ameliorating the relative paucity of case law on the prerequisites for successfully motioning the Delaware Supreme Court for approval to file an amicus curiae brief, is a recent Order in the matter styled In re Verizon Insurance Coverage Appeals, Nos. 558, 560, 561, 2018, Order (Del. Feb. 21, 2019). The Delaware Supreme Court via this Order denied a motion to file an amicus brief by a trade association because the proposed amicus brief: (i) addressed an issue not raised in the Opening Brief; (ii) was duplicative of the Opening Brief; and (iii) did not offer unique supplemental assistance to the court.
A specific Delaware Supreme Court rule addresses motions to file an amicus brief, but does not provide much amplification. In this Order, Delaware’s high court cited Turnbull v. Turnbull, 644 A.2d 1322, 1324 (Del. 1994), regarding prerequisites for filing an amicus brief beyond what is stated in the court rule.
