Directors may face oversight liability for not properly monitoring key drug’s clinical trial

This post was prepared by Frank Reynolds, who has been following Delaware corporate law, and writing about it for various legal publications,  for over 30 years.

The business judgment rule cannot shield Clovis Oncology Inc.’s directors from shareholder charges that they breached their oversight duty by ignoring reports that their flagship cancer-fighting drug was unlikely to pass regulatory tests, the Delaware Chancery Court has ruled in the matter styled: In re Clovis Oncology Inc. Derivative Litigation, No. 2017-0222-JRS, memorandum opinion (Del. Ch. October 1, 2019).

Vice Chancellor Joseph R. Slights’ Oct. 1 opinion allows the biopharmaceutical startup’s investors to proceed with derivative claims that Clovis lost $1 billion in value after the market learned that its directors failed to comply with regulatory protocol for Rociletinib.

He said duty-of-oversight charges have been among the hardest to prove, but the Clovis plaintiffs well-pled that their directors did not respond to red flags at a time when the company’s fate. depended largely on the outcome of a single lung cancer therapy trial.

A duty-of-care duo

The Clovis opinion, and the Delaware Supreme Court’s June decision in Marchland v. Barnhill, 212 A.3d 805 (Del. 2019), are being closely examined by corporate law specialists because together they provide a new avenue to sue for violating the duty of oversight.

In June, the Delaware Justices reversed a Chancery Court dismissal of a consolidated shareholder suit that charged the Blue Bell Creameries directors’ failure to oversee ice cream safety resulted in a deadly and costly listeria outbreak in 2015. The opinion, written by Chief Justice Leo E. Strine Jr., found the Blue Bell board “made no effort to put in place a board-level compliance system.”

That, he said, was a violation of the first part of the oversight duty spelled out in the seminal 1996 Caremark decision which said directors must set up and monitor systems to ensure that they get adequate information on whether the company is being operated properly. In re Caremark Int’l. Inc. Deriv. Litig. 698 A. 2d 959 (Del Ch. 1996).

Caremark duty, part two

Vice Chancellor Slights’ Clovis opinion was based on Marchand decision and focused on the second part of the Caremark duty: to properly monitor the systems the directors set up,

The plaintiffs claimed the Clovis directors in fact paid very little attention to the plan and protocol they set up for the clinical trial of Roci, an initially promising lung cancer treatment. In later stages though, there were ample indications that Roci would not get the U.S. Food & Drug Administration’s approval for market, Vice Chancellor Slights said.

The consolidated suit charged Clovis executives entered ineligible information in the clinical trial’s records that “allowed the company to mislead the market regarding the drug’s efficacy.”

The plaintiffs said when Clovis was later forced to enter the correct information, it was clear that Roci would not be approved, but some directors and a senior executive sold stock before the market learned the bad news.

In response to the defendants’ motion to dismiss, the vice chancellor said the duty to implement a proper oversight system and then monitor it is important, “especially so when a monoline company operates in a highly regulated industry.”

He noted that at the beginning of the clinical trial Clovis had no other drugs on the market, received no sales revenue and was entirely dependent on investor capital.

Business risk vs. oversight risk

Directors must have great latitude in making decisions on business risk, but “it is appropriate to distinguish the board’s oversight of the company’s management of business risk” from the board’s oversight of compliance with regulatory mandates, the judge said.

In refusing to dismiss the breach-of-duty charge he said he was satisfied that plaintiffs have properly pled that the directors “consciously ignored red flags that revealed a mission critical failure to comply” with the protocol and FDA regulations.

However, Vice Chancellor Slights dismissed an insider selling charge for lack of proof of scienter, finding that it is not enough that the sale took place near the time that the insider acquired non-public information.

This is especially true where the size of the trade is not abnormally large and does not represent a dramatic change in trading pattern, he said.

Based on the same findings, the Court also dismissed a charge that some defendants improperly enriched themselves from the insider selling.

Takeaways

Vice Chancellor Slights’ detailed recitation of what he found to be the Clovis directors’ failures to monitor and disclose Roci’s true test history could serve as a cautionary tale for a new, stricter Caremark era.

Or, turned around, it could provide proactive directors and their counsel with a to-do list for revising board-level control and disclosure.

Termination Fee May Not be Sole Remedy for Termination of Merger Agreement

A recent Delaware Court of Chancery opinion allowed a claim to proceed based on the theory that a termination fee for a merger agreement was not the sole remedy for breach of contract.  In Genuine Parts Co. v. Essendant, Inc., C.A. No. 2018-0730-JRS (Del. Ch. Sept. 9, 2019), the court discussed a very fact-specific, contract-based reason why the termination fee was not the sole remedy for a potentially willful breach of the merger agreement.

Key Facts:

The non-solicitation provision in the merger agreement had a “fiduciary-out” which was subject to various parameters and notice requirements.  There was also a “willful breach” exception to the termination fee as a sole remedy. 

In addition, the target-company met with another suitor before signing the merger agreement despite: (i) a representation that there were no other suitors; and (ii) no notice or disclosure of that pre-agreement meeting being made.

The claims included breach of contract because the competing bid that was accepted was allegedly not a superior bid.

Highlights of Court’s Analysis:

The court explained that non-solicitation provisions are routine, and that there is no per se prohibition about a non-solicitation provision as long as there is a “safety valve” that allows for a board to consider a superior offer. See Slip op. at 23-24, and footnotes 76-78.

The court distinguished a prior Chancery decision, which had materially different terms in the applicable agreement, where the court determined that a losing bidder was unlikely to get specific performance beyond the termination fee.  See Cirrus Holding Co. v. Cirrus Industries, Inc., 794 A.2d 1191 (Del. Ch. 2001).

By contrast, the court did follow the reasoning of another Chancery decision that found, based on the terms of the contract in that case, that a termination fee was not an exclusive remedy.  See NACCO Industries, Inc. v. Applica, Inc., 997 A.2d 1 (Del. Ch. 2009).

Delaware State Bar Association Responds to Attack Ads Against Delaware Courts

Recent attack ads appearing on TV that apparently were financed by a disgruntled litigant unhappy with the results of a decision by a Delaware court, generated an unusual response from the Delaware State Bar Association. A website called Town Square Delaware provides a copy of the letter. The Delaware Business Court Insider also published an article about the attack ad, in which they quoted yours truly (condemning the misguided ad.)

Forum Selection Clauses; Delaware Law; Federal Law; Internal Affairs Doctrine; and Chancery’s Sciabacucchi Decision

For readers who follow the law regarding forum selection clauses, a recent article by Professor Joseph Grundfest should be of interest. The good professor addresses the December 2018 Court of Chancery decision in Sciabacucchi v. Salzberg (highlighted on these pages), and the intersection of Delaware law and Federal law in the context of forum selection clauses and the internal affairs doctrine. The abstract follows to his article titled: The Limits of Delaware Corporate Law: Internal Affairs, Federal Forum Provisions, and Sciabacucchi

Abstract

The Securities Act of 1933 provides for concurrent federal and state jurisdiction. Securities Act claims were historically litigated in federal court, but in 2015 plaintiffs began filing far more frequently in state court where dismissals are less common and weaker claims more likely to survive. D&O insurance costs for IPOs have since increased significantly. Today, approximately 75% of defendants in Section 11 claims face state court actions. Federal Forum Provisions [FFPs] respond by providing that, for Delaware-chartered entities, Securities Act claims must be litigated in federal court or in Delaware state court.

In Sciabacucchi, Chancery applies “first principles” to invalidate FFPs primarily on grounds that charter provisions may only regulate internal affairs, and that Securities Act claims are always external. In so concluding, Sciabacucchi adopts a novel definition of internal affairs that is narrower than precedent, and asserts that plaintiffs have a federal right to bring state court Securities Act claims. It describes all Securities Act plaintiffs as purchasers who are not owed fiduciary duties at the time of purchase. The opinion constrains all actions of the Delaware legislature relating to the DGCL to comply with its novel definition of “internal affairs.”

Sciabacucchi’s logic and conclusion are fragile. The opinion conflicts with controlling U.S. and Delaware Supreme Court precedent and relies critically on assumptions of fact that are demonstrably incorrect. It asserts that FFPs are “contrary to the federal regime” because they preclude state court litigation of Securities Act claims. But the U.S. Supreme Court in Rodriguez holds that there is no immutable right to litigate Securities Act claims in state court, and enforces an agreement that precludes state court Securities Act litigation. Sciabacucchi assumes that Securities Act plaintiffs are never existing stockholders to whom fiduciary duties are owed. But SEC filings and the pervasiveness of order splitting conclusively establish that purchasers are commonly existing holders protected by fiduciary duties. The opinion fears hypothetical extraterritorial application of the DGCL. To prevent this result, it invents a novel definition of “internal affairs” that it applies to constrain all of the Legislature’s past and future activity. But the opinion nowhere addresses the large corpus of U.S. and Delaware Supreme Court precedent that already precludes extraterritorial applications of the DGCL. It thus invents novel doctrine that conflicts with established precedent in an effort to solve a problem that is already solved. The opinion’s novel, divergent definition of “internal affairs” also conflicts with U.S. and Delaware Supreme Court precedent that the opinion nowhere considers.

Sciabacucchi is additionally problematic from a policy perspective. By using Delaware law to preclude a federal practice in federal court under a federal statute that is permissible under federal law, Sciabacucchi veers Delaware law sharply into the federal lane and creates unprecedented tension with the federal regime. Its narrow “internal affairs” definition invites sister states to regulate matters traditionally viewed as internal by Delaware, and advances a position inimical to Delaware’s interests. By propounding its divergent internal affairs constraint as a categorical restriction on the General Assembly’s actions, past and future, the opinion causes the judiciary to intrude into the legislature’s lane. And, data indicate that the opinion in Sciabacucchi caused a statistically and economically significant decline in the stock price of recent IPO issuers with FFPs in their organic documents.

In contrast, a straightforward textualist approach would apply the doctrine of consistent usage and use simple dictionary definitions to preclude any extension of the DGCL beyond its traditional bounds. Textualism avoids all of the concerns that inspire the invention of a divergent “internal affairs” definition. Textualism does not require counter-factual assumptions, conflict with U.S. or Delaware Supreme Court precedent, cause Delaware to constrain federal practice in a manner inconsistent with federal law, or advocate policy positions inimical to Delaware’s interest. Textualism also interprets the DGCL in a manner that profoundly constrains the ability of all Delaware corporations to adopt mandatory arbitration of Securities Act claims. Textualism validates FFPs in a manner that precludes the adverse, hypothetical, collateral consequences that animate Sciabacucchi’s fragile analysis, without generating Sciabacucchi’s challenging sequelae.

Keywords: Securities Act, forum selection, Delaware, jurisdiction, litigation, Section 11, charters, by-laws, internal affairs, federal forum provisions

JEL Classification: K22, K41

Suggested Citation
Grundfest, Joseph A., The Limits of Delaware Corporate Law: Internal Affairs, Federal Forum Provisions, and Sciabacucchi (September 12, 2019). Rock Center for Corporate Governance at Stanford University Working Paper No. 241. Available at SSRN: https://ssrn.com/abstract=3448651 or http://dx.doi.org/10.2139/ssrn.3448651
 

Delaware Supreme Court Instructs on Standards of Deposition Conduct

A recent Delaware Supreme Court opinion provides a tutorial on the standards imposed on Delaware lawyers when a deponent, who is the lawyer’s client, engages in inappropriate conduct during a deposition. See Shorenstein Hays-Nederland Theaters LLC Appeals, Nos. 596, 2018 and 620, 2018 (Del. Supr. June 20, 2019). My overview of the decision was the focus of my latest legal ethics column for The Bencher, the publication of the American Inns of Court, which appears in the current issue. (I’m now in my 21st year of writing that ethics column for their national publication.)

This is the first decision from Delaware’s High Court on this issue, as compared to the rather abundant guidance that has existed for many years regarding the consequences when lawyers themselves engage in errant conduct during a deposition. A prior Chancery decision from 2015 involving the parties in this case was highlighted on these pages, and provides additional factual background details about the underlying long-running, internecine imbroglio that the court was ruling on–before it addressed the deposition issues.

Bonus Supplemental Materials:

Chancery Describes Special Litigation Committee Requirements for Alternative Entities

The requirements for a special litigation committee, in the alternative entity context, that seeks recognition of its legitimacy from the court was recently explained in the Delaware Court of Chancery decision styled: Wenske v. Blue Bell Creameries, Inc., C.A. No. 2017-0699-JRS (Del. Ch. Aug. 28, 2019).

Short Overview of Case:

This case involves a derivative action arising from the alleged failures of Blue Bell Creameries, Inc. (“BBGP”) as the sole general partner of the nominal defendant, Blue Bell Creameries LP (“Blue Bell” or the “Partnership”), to operate the Partnership in compliance with the governing standards of the limited partnership agreement (“LPA”). The court previously denied the motion to dismiss based on a finding that the plaintiff adequately pled demand futility. See Wenske v. Blue Bell Creameries, Inc., 2018 WL 3337531, at * 19 (Del. Ch. July 6, 2018), reargument denied, 2018 WL 5994971 (Del. Ch. Nov. 13, 2018).  After the denial of the motion to dismiss, BBGP created a committee of its board of directors that, in turn, formed a special litigation committee to manage the claims against BBGP.  As often happens, the special litigation committee moved to stay the derivative action to allow it time to conduct an investigation and make a determination.  The court observed that when properly made, such requests are often granted.  But, the court found that such a request in this case was “not proper.”

Highlights of Court’s Reasoning:

The court explained that in the context of this limited partnership structure, the sole general partner had already been determined to have a “disabling interest for pre-suit demand purposes.” Id. at * 18.

The court explained that “as a matter of agency law, a principal who delegates authority to an agent” will be deemed to maintain control over the conduct of that agent–regardless of whether the principal actually exercises control. Any conflict that disables the principal disables the agent.

Based on its prior ruling that BBGP, as principal, is not fit to decide how to manage the claims against the defendants, including against BBGP itself, the special litigation committee, as agent, is likewise disabled. Thus, the motion to stay was denied because it was brought by a special litigation committee with “no authority to bring it.”  Slip op. at 2.

Important Legal Principles Recited by the Court:

This opinion is noteworthy for the many important statements of law it recites regarding the prerequisites for a properly functioning special litigation committee, not only in the corporate context, but–more importantly–in the less often addressed alternative entity context which does not enjoy as robust a body of case law compared to the corporate context on this issue.

The following bullet points provide a sample of the more notable legal nuggets:

  • The court observed the important function that special litigation committees serve to respond to accusations of series misconduct by high officials and an impartial group of independent directors. (citing Biondi v. Scrushy, 820 A.2d 1148, 1156 (Del. Ch. 2003), aff’d, 847 A.2d 1121 (Del. 2004)).
  • The court instructed that: “A well-functioning, well-advised special litigation committee, whose fairness and objectivity cannot reasonably be questioned, can serve to assuage concern among stockholders that the company’s litigation assets are being managed properly.” (internal citations omitted) (citing Id., and Zapata Corp. v. Maldonado, 430 A.2d 779, 787 (Del. 1981)).
  • The court noted that in the Biondi case, the court denied a motion to stay because the special committee was demonstrably not independent. See footnote 13.
  • The court emphasized that a threshold issue is whether the committee was properly constituted.
  • The court cited the seminal Zapata v. Maldonado case as involving a conflicted corporate board that wrested control of a derivative claim from a stockholder by establishing a committee of independent directors to investigate the claim and determine whether to prosecute it.
  • Although the court noted that Section 141(c) allows a board to delegate all of its authority to a committee, for purposes of this case and based on a prior ruling in this case, the contrast with the context of an alternative entity was underscored by the following rationale:  “. . . the delegation of management authority by a conflicted board to an independent committee of the board, is the delegation of authority by a conflicted group of principal decision makers to a subset of unconflicted principal decision makers. There is no principle/agent relationship created in this [corporate] context.”
  • Although the Zapata special litigation committee framework may, as a general matter, serve its intended purpose in the partnership context, in this case the problem was that the court already determined that the sole general partner of the L.P. had a disabling conflict. See generally 6 Del. C. §§ 17-1011-103, and 17-403(c) (regarding the authority to determine whether to prosecute derivative actions, and unless otherwise restricted in the partnership agreement, a general partner has the power to delegate various rights).
  • But the court reasoned that: “. . . just as the special litigation committee of a corporate board must be independent to be effective under Zapata, so too must a special litigation committee of a general partner of a limited partnership be independent if it is to perform its mandate properly and with binding effect.See footnote 22.
  • The problem in this case for the committee was that in the limited partnership context, the court “does not draw a distinction between a general partner and the members of its board of directors when assessing conflicts.”
  • The court advised that a sole general partner cannot cleanse its disability by appointing new members to its board of directors, or by contracting out its authority to manage the litigation asset to third parties, because it no longer has that authority.
  • The precise issue that the court had to resolve in this case was whether BBGP, as the exclusive general partner of the limited partnership, after already having been deemed unfit to consider a litigation demand, could avail itself of the Zapata framework by establishing a special litigation committee comprised of non-general partner actors. The Court’s answer: No.
  • After distinguishing the facts in the case of Katell v. Morgan Stanley Gp., Inc. (Katell II), 1993 WL 205033, at * 2 (Del. Ch. June 8, 1993), the court reasoned that the problem for BBGP, unlike the limited partnership structure in the Katell case, was that the limited partnership in this case had no other general partner that was not conflicted. Cf. Obeid v. Hogan, 2016 WL 3356851, at * 11 (Del. Ch. June 10, 2016) (The fact that demand was excused or futile did not strip the board of its corporate power. Rather, the problem is one of member disqualification, not the absence of power in the board–in the corporate context.)
  • The court compared the analogy in the corporate context of a sole conflicted director who would be disabled from serving or creating a special litigation committee. See Zapata, 43 A.2d 787.
  • In the instant case, a defining feature of the principal-agent relationship is the principal’s inherent control over the conduct of the agent, and it is the existence of the right to control, not its exercise, which is decisive. Slip op. at 12-13.
  • Although in the corporate context the effort by BBGP in this case to appoint independent members may have been effective, because the lone general partner, as an entity, in this case has been determined to be conflicted, “there is no non-conflicted principal decision maker who can properly delegate management authority” to a special litigation committee.

Chancery Finds Proper Purposes in Section 220 Demand in Absence of KFW Procedural Protections

Adding to the voluminous case law interpreting DGCL Section 220 that has been highlighted over the last 14 years on these pages, the recent Delaware Court of Chancery decision in Kosinski v. GGP Inc., C.A. No. 2018-0540-KSJM (Del. Ch. Aug. 28, 2019), is notable for its useful and thorough recitation of the basic requirements of a Section 220 demand and the clarity of reasoning on which it relies to reject the typical defenses presented at trial “on a paper record.”

Introductory Note:

These short highlights presume that the reader is familiar with the basic prerequisites for a successful Section 220 demand and typical challenges to a Section 220 demand. This opinion is worthwhile reading, even for veterans of Section 220 battles, due to its lucid recitation of not only the basics, but also the nuances that most Section 220 litigation centers on. Hundreds of Section 220 decisions have been featured on these pages, so at this point I only highlight those rulings on Section 220 that, in my view, offer something more than the average fare.

Brief Overview of the Case:

A Section 220 demand was made in this case to investigate possible wrongdoing in connection with a merger. The company argued that the plaintiff was not entitled to inspect books because: (1) the stated purposes for the inspection were not those of the actual plaintiff/stockholder; and (2) the company argued that the stockholder lacked a credible basis for investigating possible wrongdoing.The most useful way to highlight the memorable passages from this pithy opinion would be to provide bullet points that would allow readers to determine if they would find it helpful to read the whole opinion.

Basics of § 220:

  • The court explained that under DGCL Section 220 a stockholder is entitled to inspect the books and records of a company if she demonstrates by a preponderance of the evidence that: (1) she is a stockholder of the company; (2) she has made a written demand on the company that complies with the statutory requirements; and (3) she has a proper purpose for making the demand. Once a stockholder meets those 3 requirements, she also must establish another prerequisite: (4) to establish that each category of the books and records requested is essential and sufficient to the stated purpose.
  • In addition to those 4 requirements, there are additional nuances that must be addressed.

Nuances:

  • The nuances that must be addressed to successfully repel defenses to a Section 220 demand include a rebuttal to a frequent defense by a company that the stated purpose, which might be a well-recognized proper purpose, is “not the actual purpose for the demand.”
  • The court distinguished the recent decision in Wilkinson v. A. Schulman Inc., 2017 WL5289553, at * 2 (Del. Ch. Nov. 13, 2017), highlighted on these pages, because the facts of the instant case established that the stockholder himself was the actual motivating force behind the demand and he was not merely serving as a puppet for his lawyers.

Special Observation:

  • A welcome and refreshing acknowledgement from the court in this case was provided in a footnote where the court observed that Section 220 jurisprudence in Delaware is both complex and sprawling. See footnote 67.

Proper Purposes – More Nuances:

  • The court defined a proper purpose as one that “reasonably relates to the stockholder’s interest as a stockholder.” See footnotes 72 and accompanying text. The stockholder has the burden of proof to demonstrate that proper purpose by a preponderance of the evidence.
  • The court explained that although it is a proper purpose to investigate mismanagement, in order to prevail on that basis, a stockholder must “present some evidence that establishes a credible basis from which the Court of Chancery could infer there were legitimate issues of possible waste, mismanagement or wrongdoing that warrant further investigation.” See footnote 75.
  • The court explained that the credible basis standard is the lowest possible burden of proof and requires a plaintiff to demonstrate “only some evidence of possible mismanagement or wrongdoing to warrant further investigation.” See footnote 77.
  • The court explained that the “threshold may be satisfied by a credible showing, through documents, logic, testimony or otherwise, that there are legitimate issues of wrongdoing.” See footnote 79.
  • An important observation by the court in this decision was in connection with the interface between a failure of a company in connection with a merger to satisfy the trigger for the business judgment standard of review announced in Kahn v. M & F Worldwide Corp., 88 A.3d 635 (Del. 2014)(hereinafter MFW). Namely,  the court noted that its decision in the instant case “merely concludes that the absence of MFW procedural protections might contribute to a credible basis.”
  • That basis for the court’s finding, of a credible basis is an important contribution to Section 220 jurisprudence.
  • The court also noted that a recognized proper purpose under Section 220 is to investigate questions of director disinterestedness and independence, such as uncovering cronyism in the process of nominating directors. See footnotes 113 to 114 and accompanying text.
  • The court also recognized the well-established case law that regards valuation of one’s shares as a proper purpose for the inspection of books and records. See footnote 118.

Chancery Addresses Prerequisites for Prima Facie Duty of Loyalty Claim

A recent Delaware Court of Chancery decision addressed claims that the CEO of a closely-held company breached the duty of loyalty in connection with unauthorized personal expenses charged to the company, and other actions, while he managed the company–that were not consistent with financial management in the best interest of the company. That decision, in Avande, Inc. v. Evans, C.A. No. 2018-0203-AGB (Del. Ch. Aug. 13, 2019), is most noteworthy for its recitation of the well-established principles of the duty of loyalty imposed on corporate directors and officers, as well as describing the burden of proof for such a claim, and the prima facie showing necessary to warrant the burden allocation.

Well-Known Articulation of Fiduciary Duties:

Although these well-worn corporate law principles have been repeated on these pages over the last 14-years on many occasions, they are such fundamental bedrock tenets that form the foundation of corporate law that they cannot be repeated too often.

The court explained that:

The duty of loyalty requires that a corporate fiduciary act with undivided and unselfish loyalty to the corporation and there shall be no conflict between duty and self-interest. If corporate fiduciary stands on both sides of a challenged transaction, an instance where the directors’ loyalty has been called into question, the burden shifts to the fiduciaries to demonstrate the ‘entire fairness’ of the transaction.  In a typical self-dealing transaction, the fiduciary is the recipient of an allegedly improper personal benefit, which usually comes in the form of obtaining something of value or eliminating a liability.

See footnotes 104 through 106 for citations to underlying cases included in the original quote.

The court explained that once entire fairness applies, the defendants must establish to a court’s satisfaction that the transaction was the product of both fair-dealing and fair-price. See footnote 107.

The court added:

The duty of loyalty includes a requirement to act in good faith. To act in good faith a director must act at all times with an honesty of purpose and in the best interest and welfare of the corporation.  A failure to act in good faith may be shown, for instance, where the fiduciary intentionally acts with a purpose other than that of advancing the best interest of the corporation, where the fiduciary acts with the intent to violate applicable positive law, or where the fiduciary intentionally fails to act in the face of a known duty to act, demonstrating a conscious disregard for his duties.

See footnotes 1 through 111 for citations to cases within that quote.

Key Cases Discussed by the Court:

The court addressed a line of cases beginning with the decision of the Court of Chancery in Technicorp Int’l II, Inc. v. Johnston, 2000 WL 713750, at * 2 (Del. Ch. May 31, 2000), regarding the issue of the prima facie showing necessary to shift the burden of proving the fairness of challenged expenses.

In the Technicorp case, the Court of Chancery found after a trial that two individuals had “systematically looted” over a 12 year period two companies that they exclusively managed and controlled and for which they had access to the corporate records such as to minimize or avoid the risk of being held accountable.  In that case, the plaintiffs made a prima facie showing to warrant the allocation of the burden of proof.

The court addressed four other cases that applied Technicorp with different results, in deciding whether to order an accounting or to allocate to a fiduciary the burden of demonstrating the fairness of a series of disputed transactions.  Those cases were Carson v. Hallinan, 925 A.2d 506, 536-37 (Del. Ch. 2006), in which the court found after trial that 2 fiduciaries who exercised exclusive control over the company funds and used them for personal benefits and never documented expenses, required an accounting to determine the extent of the misallocation and damages.

In Sutherland v. Sutherland, 2010 WL 1838968, * 4 (Del. Ch. May 3, 2010), the court found that the plaintiff did not establish a prima facie showing, and thus did not require them to account for funds.

In Zutrau v. Jansing, 2014 WL 3772859, at * 27-28 (Del. Ch. July 31, 2014), the court refused to shift the burden under Technicorp or Carlson, reasoning that the plaintiff did not make a prima facie showing that the challenged charges were improperly incurred.

The fourth case was CanCan Development, LLC v. Manno, 2015 WL 3400789, at * 16 (Del. Ch. May 27, 2015), where the court allocated to the fiduciary the burden of accounting for compensation and expenses that were self-interested transactions.  Although the court noted that these expenses would be subject to the business judgment rule in most situations, based on the facts of that case, the court found that the fiduciary bore the burden at trial to establish the propriety of the disbursements regarding the self-interested transactions.

The court summarized those cases discussed above as showing that:

“This court may place on a fiduciary the burden to demonstrate the fairness of a series or group of expenditures, or may order an accounting of such expenditures, where–as in Technicorp, Carson, and CanCan–a plaintiff has made a prima facie showing based on a substantial evidence that the expenditures in question are self-interested transactions.  The fiduciaries exercise of control over the corporation’s funds and records is a factor to be considered in the analysis.  Where, by contrast, a plaintiff has failed to make such a prima facie showing–as in Sutherland and Zutrau–the court has refused to shift the burden of proof to the fiduciary or to order an accounting.  In that event, potentially problematic transactions should be examined individually.”

The Court concluded in the instant case that an accounting was warranted for at least a portion of the amounts disputed.

Chancery Praises Motion for Reargument Before Denying It

A recent Delaware Court of Chancery opinion is noteworthy for its many quotable judicial words of wisdom about motions for reargument pursuant to Rule 59(f).  In Manti Holdings, LLC v. Authentix Acquisition Company, Inc., C.A. No. 2017-0887-SG (Del. Ch. Aug. 14, 2019), the court described a meritorious motion for reargument as a “useful tool if used as designed, to forestall a final opinion in which the judge has disregarded matters of law or fact, or has inadvertently failed to respond to an argument of counsel.”

More Quotable Words of Wisdom, re: Motions for Reargument

  • Motions for reargument are described in this decision as: a tool that “generally serves best left in the sheath . . ..” The court finds them rarely useful and more often a waste of cost and effort by the litigants and the court for no purpose.
  • The court acknowledged that the rare well-founded motion for reargument is “beneficial to the system of justice–and the time and effort of both bench and appellate judges–as well as to the client.”

On a substantive level, the court observed that the DGCL does not explicitly prohibit contractual modification or waiver of appraisal rights, nor does it require a party to exercise its statutory appraisal rights. See 8 Del. C. § 262.  Such a modification or waiver would supplement the DGCL, and is not inconsistent with, nor contrary to, the DGCL. See Slip op. at 10.

Procedural Aspects:

In this particular opinion, the court focused on the issues that the parties emphasized during oral argument and did not address a predicate issue that was largely missing from the oral argument. The court acknowledged that the omitted issue was fairly raised in the briefing and this opinion rectifies that omission. Nonetheless, however “well-taken” the motion for reargument was, the court found it necessary to deny the motion.

Chancery Refuses Jurisdiction for Defamation Claim

A recent Court of Chancery decision is one of several relatively recent rulings that clarify the limited scope of equitable relief that is available for defamation claims as a narrow exception to the general rule that equity will not enjoin a libel. The opinion in Preston Hollow Capital LLC v. Nuveen LLC, C.A. No. 2019-0169-SG (Del. Ch. Aug. 13, 2019), should be required reading for anyone seeking to include a defamation claim in a complaint filed in the Delaware Court of Chancery.

For purposes of this short blog post, the most useful method to extract the nuggets without providing all the factual details, is to craft bullet points for the important principles that guide the court in determining whether its circumscribed jurisdiction will allow a particular claim to fit within the narrow exception to the general rule that equity lacks jurisdiction over a request to enjoin common-law defamation.

The single issue that this opinion addresses is whether statements made by one business competitor against another to third parties that the plaintiff believes to be slander, allows that party to seek equitable relief by means of an injunction to prevent future potential defamatory utterances.

General Principles Limiting the Jurisdiction of Chancery over Claims Involving Defamation:

  • The court began the opinion with the equitable maxim that “equity will not enjoin a libel.”
  • The court observed that generally speaking, because of the implications on speech of the application of remedies, legal or equitable, to tortious speech, slander and libel “are seen as denizens of the Superior Court, and are subject to the findings made there by juries regarding the speech of their peers.” The principle was recently affirmed in a case in which Chancery dismissed a defamation claim subject to transfer to the Superior Court. See Perlman v. Vox Media, Inc., 2019 WL 2647520 (Del. Ch. June 27, 2019).
  • A single case in Delaware supports the so called “trade-libel exception” to the rule that Chancery will not exercise jurisdiction over a request to enjoin a libel: J.C. Pitman & Sons, Inc. v. Pitman, 47 A.2d 721 (Del. Ch. 1926). That opinion was recently the subject of a scholarly analysis in: Organovo Hldgs., Inc. v. Dimitrov, 162 A.3d 102 (Del. Ch. 2017).
  • The instant Preston Hollow Capital opinion explains that the Pitman case stands for the general rule that equity lacks jurisdiction over a request to enjoin common-law defamation, but an exception applies:

“… in a limited subset of cases, however, when a separate tort (in Pitman, the tort of unfair business competition) is alleged where relief at law is insufficient, and where the equitable remedy sought is, incidentally, an injunction of a ‘trade libel’–that is, a libelous statement to consumers that falsely disparages a plaintiff’s goods or services. In such a case, the matters may be within this Court’s jurisdiction, because the underlying behavior being examined without a jury is not mere speech, but involves other tortious activity where tradition and constitutional considerations do not require the findings of a jury. Further, this Court may enjoin that tortious behavior, even if the injunction incidentally enjoins the trade libel. In other words, under Pitman, where this Court has jurisdiction over business torts, it may, in an appropriate case, enjoin their threatened continuation, even if the injunction suppresses speech. In this case, for instance, the plaintiff has adequately pled tortious interference with business relations; if it proves that claim, it may seek equitable remedies, as appropriate.”

Slip Op. at 3.

  • The Court emphasized that it did not read Pitman to support a separate count of common-law slander, nor does Pitman support the kind of forward-looking suppression of new defamatory statements of the variety sought.
  • The Court dismissed the defamation claim subject to transfer to Superior Court. But cf. n.3 (referring to Chancery’s “clean-up doctrine).

Bonus Quotes that Can Be Used In Almost Any Legal Writing:

  • This opinion includes several “turns of phrases” that qualify as exemplary literature that can be used in almost any legal writing. The Court referred to law, and especially equity, as “a creature of nuance and fine-but-significant gradations, and pithiness, like garlic, may both enhance the savor of a discourse, and at the same time mask its subtle flavors.”
  • The foregoing quote was from the beginning of the opinion, in the context of describing maxims of equity as legendarily pithy expressions of general Chancery practice.
LexBlog