Delaware will retain jurisdiction over a dissolution claim notwithstanding a mandatory New York forum selection clause, according to the recent Delaware Court of Chancery opinion in Seokoh, Inc. v. Lard-PT, LLC, C.A. No. 202-0613-JRS (Del. Ch. March 30 2021). This case involved the petition for dissolution of a Delaware LLC while litigation between the parties also was filed in New York. The LLC agreement had a deadlock provision but it was not effective for resolving the parties’ dispute. For example, there was no formula or deadline for a buyout.

Several important statements of Delaware law make this 45-page decision noteworthy (and blogworthy), as well as well-worth the time to read the whole opinion for those who need to know the latest iteration of Delaware law on the following topics:

  • Although Delaware courts generally enforce forum selection clauses, even when they require disputes to be litigated in a foreign forum–this is a notable exception: when a petition for dissolution of a Delaware LLC is filed pursuant to Section 18-802 of the Delaware LLC Act. See footnote 43. (The parties in this case agreed to the foregoing exception and the Court noted that they were correct in doing so.)
  • This opinion features a useful recitation of the factors the court will consider under Section 18-802 in order to determine if the statutory prerequisites for an LLC dissolution have been satisfied. See Slip op. at 24 to 27 and footnotes 119 to 128.

A recent blog post highlighted on these pages featured another Chancery decision addressing a deadlock in an LLC that formed the basis of a dissolution petition.

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 Delaware  Court of Chancery recently refused most of B. Riley Financial, Inc.’s motion to dismiss an ex-officer and director’s complaint for indemnification for his settlement of underlying breach-of-duty and fraud charges against him and companies he had founded and later sold to Riley in Wunderlich v. B. Riley Financial, Inc., et al., No. 2020-0453-PAF (Del. Ch. March 24, 2021).

In a March 24 letter ruling, Vice Chancellor Paul Fioravanti Jr. ruled that Riley’s dismissal bid cannot rely on the limits in its interpretation of an indemnification contract plaintiff Gary Wunderlich signed as part of his companies’ 2017 merger with that financial services firm, since it is not the only reasonable reading.

In addition, Wunderlich makes a plausible argument that Riley took over his investment and securities companies’ indemnification obligations when it made them subsidiaries, and Riley had been paying Wunderlich’s legal costs until the two parted ways in Nov. 2018 and Wunderlich was hit with a $10.5 million arbitration award, the vice chancellor said. The Chancery Court let Wunderlich continue to pursue his indemnification claim but dismissed as unripe a declaratory judgment count seeking to hold Riley separately liable for any judgment in the arbitration action.

The opinion could be of value to advancement and indemnification specialists in how it employs Delaware contract law principles to determine the scope of rights and responsibilities in the various indemnification agreements.

Background
Gary Wunderlich founded Wunderlich Investment Company, Inc. and parent Wunderlich Securities, Inc. in 1996 and sold them to Riley in May 2017 but two months later investment and merchant banking firm Dominick & Dickerman LLC brought an arbitration proceeding against Wunderlich and his two companies in the Financial Industry Regulatory Authority. At the time, he was an officer and director of his companies and Riley; Riley initially took over attorney selection and payment, the vice chancellor said.

After the April 2020 award of $10.5 million jointly and severally against Wunderlich and his companies, the claimants filed a petition to confirm the award in May and Riley petitioned to vacate it the next day in the U.S. District Court for the Southern District of New York. Meanwhile, Wunderlich, in April 2020, formally demanded that B. Riley “confirm” that it would indemnify him for “all costs, expenses, awards, losses and liabilities incurred by reason of the fact that he was an officer or director” of B. Riley, WIC, and WSI.

Riley threatened to pursue claims against Wunderlich for actions relating to the Arbitration and to recover from Wunderlich amounts Defendants paid in the Settlement Agreement, and Wunderlich filed this indemnification action in June seeking indemnification from his two companies, and Riley under the merger agreement.

The suit includes claims for:
•Reasonable attorneys’ fees and other expenses incurred in connection with defending against and pursuing vacatur of the Award and negotiating the terms of the Settlement
•Wunderlich’s fees and expenses incurred in this action, or “fees-on-fees.”
•A declaratory judgment obligating Defendants to indemnify Wunderlich for any contribution claim that Defendants “may seek to assert against him in connection with the Arbitration
•B. Riley’s alleged failure to tender payment in response to Wunderlich’s indemnification demand breached the Indemnification Agreement.

Declaratory judgment on contribution
The vice chancellor said “our courts will decline ‘to enter a declaratory judgment with respect to indemnity until there is a judgment against the party seeking it.’” quoting Wal-Mart Stores, Inc. v. AIG Life Ins. Co., 572 A.2d 611, 632 (Del. Ch. 2005). He said, “Defendants have not asserted a contribution action against Wunderlich, and Wunderlich does not presently owe any amounts to be paid in connection with the Settlement Agreement.” If the defendants do not assert a contribution claim against Wunderlich “judicial intervention may be unnecessary.”

Breach of the Indemnification Agreement
“Defendants principally argue that Wunderlich waived his indemnity rights when he executed the Severance Agreement,” the court said. “Central to this decision is whether the indemnification provisions in the bylaws are preserved through a carve-out in the Severance Agreement, which, in turn, requires the construction of the terms of the Merger Agreement.”

But ‘[d]ismissal, pursuant to Rule 12(b)(6), is proper only if the defendants’ interpretation[s] [are] the only reasonable construction[s] as a matter of law” and that is not the case here the court said. “Wunderlich has stated a claim for indemnification…because he has advanced a reasonable interpretation of the WIC Bylaws, the Merger Agreement, and the Severance Agreement.”

Defendants rely on Julian v. Julian for the proposition that the only rights that “arise under” a contract are those that exist within its four corners,” Vice Chancellor but “Julian is factually inapposite because the relevant language in the Merger Agreement and the Severance Agreement are different from the arbitration provision at issue in Julian. Julian v. Julian, 2009 WL 2937121 (Del. Ch. Sept. 9, 2009).

He said he cannot determine as a matter of law that the Severance Agreement only released the indemnification rights listed in the Merger Agreement to the exclusion of any indemnification rights but he doesn’t need to at this stage.

Fees on Fees
Wunderlich’s claim for fees-on-fees in enforcing his indemnification rights, need not be dismissed just because he has not identified any applicable indemnification provisions, the court said, because under Section 145 of the DGCL, “without an award of attorneys’ fees for the indemnification suit itself, indemnification would be incomplete” and Wunderlich’s indemnification requires WIC to provide indemnification “to the fullest extent permitted by the Delaware General Corporation Law”.

My colleague, Chauna Abner, and I co-wrote an article on the practical topic and the gritty details of transferring cases from the Delaware Court of Chancery to the trial court of general jurisdiction in Delaware: the Superior Court. The article appeared in the Delaware Business Court Insider, in its March 10, 2021 issue.

We hope it will be a useful guide for Delaware litigators.

 

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 Delaware Supreme Court recently made landmark rulings on choice-of-law and fraud-exclusion issues in affirming a decision that required the last of nine D&O insurers to pay its share of settlements with investors who claimed Dole Foods Co. Inc.’s CEO cheated them in a 2013 going-private buyout in RUSI Indemnity Co. Inc .v. Murdock, et al., No. 154, 2020, opinion (Del. March 3, 2021).

The high court’s March 3 en banc opinion rejected all four key arguments RUSI Indemnity Co. made in its appeal of the Superior Court’s dismissal of the insurer’s claim that it did not owe coverage for $200 million in settlements of investor breach of fiduciary duty, securities fraud and appraisal actions.  

The opinion, and several other recent Delaware director and officer insurance decisions that some insurers view as policyholder-friendly, will be closely examined by business insurers and their defense firms nationwide, possibly resulting in the inclusion of forum selection clauses and other changes in policy wording and litigation strategy. 

Background

Since two thirds of the nation’s Fortune 500 companies are chartered in Delaware, the high court’s unanimous opinion is significant in that it endorsed rulings that:

•  Delaware law applied despite Dole’s incorporation being its only connection to the First State, while the policy was negotiated and issued in California, where the fruit giant was based and the officers and directors lived.

•  Under Delaware law, a policy provision that excludes coverage for fraudulent action by an insured does not defeat coverage

•  What RUSI calls the “Fraud/Profit Exclusion”— did not defeat coverage for the settlement of the stockholder actions

•  The “larger settlement rule,” was not improperly applied contrary to the policy’s provision governing the allocation of losses to the extent they were covered.

Justice Gary Traynor, writing for the full court, said Delaware insurance statutes specifically allow corporations “to purchase D&O insurance for liabilities arising from bad-faith conduct,” but “concluding certain conduct, including a director’s breach of loyalty sounding in fraud, is not uninsurable on public-policy grounds is notably different than placing a stamp of approval on that conduct.”

The underlying litigation

The underlying litigation stemmed from Murdock and President, COO and General Counsel C. Michael Carter’s alleged deception and fraud that enabled them to acquire the 60 percent of Dole stock they didn’t already own at an artificially low price in a going-private transaction.  In a consolidated action in the Chancery Court, a group of investors alleged fraud and breach of duty and that was combined with an appraisal action.  In a memorandum opinion after trial, Vice Chancellor Travis B. Laster ruled that Murdock and Carter had engaged in fraud and bad faith in orchestrating the unfair, self-interested transaction for an undeserved extra profit of nearly 17 percent and found the two jointly and severally liable for $148,190,590.18—or $2.74 per share—in damages.  In re Dole Food Co., Inc. Stockholder Litigation, 2015 WL 5052214, at *26 (Del. Ch. Aug. 27, 2015).

The other underlying action

Meanwhile, before the Chancery Court action was settled, another group of Dole stockholders who had sold their stock between January and October 2013, and were therefore not parties to the Stockholder Action, filed a securities class action in the U.S. District Court for the District of Delaware alleging fraud and violations of the Securities Act.  They cited references in the Chancery opinion regarding Murdock and Carter having “engaged in fraud”. San Antonio Fire & Police Pension Fund v. Dole Food Co., Inc., No. 1:15-CV-1140-SLR (D. Del. 2015).  The high court said without consent or confirmation of coverage from the insurers, Dole negotiated a settlement of the San Antonio action, under which the plaintiffs released the claims against the insureds and Dole agreed to pay or cause to be paid $74,000,000 plus interest.

The coverage actions

Eventually, after filing an unsuccessful declaratory judgment action in Superior Court, Dole’s excess insurers other than RUSI, paid the limits of their $10 million policies or settled with the insureds but RSUI pressed on with the suit and the Superior Court ordered RSUI to pay $10 million plus more than $2 million in prejudgment interest after rejecting four key arguments, and RSUI appealed.

Choice of law

The justices agreed that Delaware’s legislature intended that companies incorporated in Delaware should be governed by that state’s corporate law even if their charter was their only connection to the First State.  “The state of incorporation is the center of gravity of the typical D&O policy, including the policy under consideration here,” Justice Traynor wrote. The insureds’ legal ties to Delaware “are more significant – and therefore should be afforded greater weight — than their physical location in California.”

Public policy re: Insurability 

The high court asked itself the question ““does our State have a public policy against the insurability of losses occasioned by fraud as to vitiate parties’ freedom of contract?” and answered in the negative, noting that Delaware’s statutory indemnification provisions allow corporations to purchase D&O insurance “against any liability,” whether or not the corporation has the power to indemnify against such liability.  

The policy’s fraud exclusion

Although the Chancery Court found that the Dole officers “engaged in fraud” there was no final adjudication of that finding, especially in the District Court action.  However, the fraud finding on which the insurer relied was not in the Securities Lawsuit; it was in the Chancery Court lawsuit, Justice Traynor held.  The fact that the findings in the Chancery Court lawsuit “might have been implicated” in the resolution of the Securities Lawsuit had it not been settled “is irrelevant to a determination of whether there has been an adjudication” in the Securities Lawsuit.  A blanket prohibition, on public-policy grounds, against insuring for losses arising from a director’s or officer’s misstatements, misleading statements, or breaches of the duty of loyalty (when based on fraud) would leave many injured parties without a means of recovery.  A prohibition on insurability,  also “would leave many injured parties without a means of recovery,” which would conflict with “the public policy that favors the compensation of innocent victims,” the high court said.

The Allocation Issue

The Supreme Court said RUSI had pleaded no facts to suggest that the settlement of the Securities Lawsuit “represented an admixture of covered and non-covered losses.” Nor, it said, did the Insurer provide “an explanation of how the application of their ‘relative exposures’ allocation theory would lead to a reduction in the coverage available to the Insureds.”

Takeaways

“It is generally true that on balance policyholders will want to have their D&O insurance coverage disputes resolved in Delaware courts. Insurers? Not so much,” said Kevin M. LaCroix, an insurance law specialist who hosts the D&O Diary blog where he posted a comprehensive analysis and commentary on the RUSI opinion. https://www.dandodiary.com/2021/03/articles/d-o-insurance/del-sup-ct-rules-for-insureds-in-long-running-dole-foods-do-insurance-coverage-dispute/

He said in the crucial area of choice-of-law, the Supreme Court here gave little weight to the contract-related principles typically found to govern the “most significant relationship test”–such as where the contract was formed or where it was delivered–and instead gives outcome-determinative weight to the fact that the company involved was incorporated in Delaware.

The insurers undoubtedly will be taking up the question of whether they need to add a forum selection provision to their policies, LaCroix said.  Hopefully, the question of when and how a forum selection clause may be legally enforced will not become yet another facet of D&O litigation.

 

 

This is a short compilation of several sources that are useful references for new protocols that are either recommended or required for remote court proceedings, including remote depositions. The links below include reminders of professionalism standards and other norms that still apply in the context of these new technological developments.

Procedures for hearings via Zoom in the Court of Chancery available at this hyperlink.

Sample protocols for trials held via Zoom, or related remote methods, available at this hyperlink.

Witness protocols for trials held remotely are available at this hyperlink.

A letter decision from the Court of Chancery, in Macrophage v. Goldberg, reminding lawyers about the importance of decorous attire, even during remote court hearings, is available at this hyperlink.

A useful guide for protocols established for remote depositions conducted via Zoom, or related videoconferencing, approved in the Court of Chancery, is available at this hyperlink.

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 Delaware Chancery Court recently allowed a Facebook Inc. shareholder plaintiff to inspect the directors’ electronic communications concerning how the company ended up paying $5 billion for a 2019 board settlement with government regulators that would cover founder/CEO Mark Zuckerberg’s liability in Employees Retirement System of Rhode Island v. Facebook Inc., No. 2020-0085-JRS memorandum opinion (Del. Ch. Feb.10, 2021).

Vice Chancellor Joseph R. Slight’s February 10 post-trial opinion granted part of an investor’s motion for access to two remaining groups of board-level documents in one of the long-running books-and-records battles under Section 220 of the Delaware General Corporation Law stemming from Facebook’s record-breaking settlement of Federal Trade Commission charges over the company’s data privacy practices.

Background

The Vice Chancellor’s ruling on whether Employees’ Retirement System of Rhode Island could inspect the directors’ decision to pay $4.9 billion more than the $104 million their defense firm advised was necessary to settle liability for Facebook alone was his second in two years on the scope of discoverable documents on whether the board had overpaid to get a settlement that would shield Zuckerberg.

In Vice Chancellor Slights’ May 2019 ruling, a consolidated set of shareholders in a parallel Section 220 action seeking documents and communications relating to Facebook’s Cambridge Analytica data privacy debacle won access to other categories of board level documents. In re Facebook, Inc. Section 220 Litig., 2019 WL 2320842, at *19 (Del. Ch. May 31, 2019).

And then there were two

The February ruling is important because the pension fund plaintiff asserted that the communications that would prove the directors breached their duty by wasting corporate assets to insulate their CEO in the settlement could now only be in two remaining categories:

1. Electronic communications from, to, or copied to a member of the board concerning Facebook’s settlement negotiations with the FTC

2. Hard-copy documents exclusively provided to, or generated by, any member of the Board relating to Facebook’s negotiations with the FTC.

Since his February ruling allowed the pension fund to inspect Facebook’s non-privileged electronic communications, if ERSI does not find the proof it seeks there, it could set up a future final Section 220 battle – likely combining all plaintiffs — over access to the final category— consisting of attorney-client privileged and attorney work-product documents.

The plaintiffs have argued that Facebook intended to make the attorney-client/work-product category the vault for all the sensitive communications and documents that exposed the directors’ plan to use corporate assets to shield Zuckerberg from personal liability. However, the Vice Chancellor said in the February ruling that as long as it is still possible that any other category of documents might contain the information the plaintiffs seek, it is too soon to open that vault.

Plaintiff “has not demonstrated good cause under the Garner fiduciary exception to the attorney-client privilege to justify compelling the company to produce privileged documents for inspection” the Vice Chancellor said in the February opinion, referring to the 5th U.S. Circuit Court of Appeals’ Garner decision that plaintiffs could not examine privileged documents until all non-privileged sources had been searched. Garner v. Wolfinbarger 430 F.2d 1093. That Garner decision and its principle were adopted by the Delaware Supreme Court in Wal-Mart Stores, Inc. v. Indiana Electrical Workers Pension Trust Fund IBEW 95 A.3d at 1278–79.

In his February opinion, Vice Chancellor Slights said he granted access to all non-privileged board communications because “the documents already produced provide no insight into why Facebook would pay more than its (apparently) maximum exposure to settle a claim.”

No penalty for confidence

According to Facebook, the documents produced prior to this litigation, coupled with Plaintiff’s own trumpeting of confidence that it could survive a motion to dismiss in a plenary action by pleading the facts it already possesses, reveals that Plaintiff has received more than “sufficient” information to fulfill its stated purposes for inspection.

But the court said, “that a stockholder plaintiff believes it has a basis in facts already known to pursue claims of wrongdoing against company fiduciaries does not mean the stockholder should be denied use of the tools at hand to develop those facts further.”

Too soon for Garner exception

“While the attorney-client privilege may be asserted by a corporation that has sought legal advice, the privilege is not absolute and an oft-invoked exception applies in suits by minority shareholders,” the court said in finding that the availability of the privilege must “be subject to the right of the stockholders to show ‘good cause’ why the privilege should not apply.”

While Garner identifies multiple factors, the court might consider when assessing whether the stockholder has demonstrated “good cause,” which focuses the good cause inquiry on three factors:

(i) whether the claim is colorable,

(ii) the necessity or desirability of information and its availability from other sources and

(iii) the extent to which the information sought is identified as opposed to a blind fishing expedition.

But the Vice Chancellor noted that whether the privileged information sought “is both necessary to prosecute the action and unavailable from other sources” has been described as “the most important” of the Garner factors. ERSRI argued but could not demonstrate the privileged information it seeks is unavailable elsewhere “because it has not seen the responsive, non-privileged electronic communications that Facebook is withholding.”

Takeaways

The court thought it was “likely that non-privileged electronic communications among board members can provide ERSRI insight into why the board decided to enter the 2019 settlement without exposing the advice of counsel upon which, at least in part, that decision was based.”

But there are two other possibilities: the board’s discussions that led to its $5 billion settlement decision are restricted to the “privileged” vault, or they somehow reached a consensus with little or no formal discussions. Either possibility could lead to a novel third Facebook Section 220 ruling in the future.

A recent Delaware Court of Chancery decision provided an exemplary analysis of when a deadlock in an LLC might be the basis for a dissolution. In Mehra v. Teller, C.A. No. 2019-0812-KSJM (Del. Ch. Jan. 29, 2021), the court analyzed case law, statutes, and learned commentary that it synthesized in a careful application to the facts of this case.

Two central issues were addressed by the court:

(1) whether there was a failure to achieve votes necessary for board action; and

(2) whether the board deadlock was “genuine” or merely manufactured to force the appearance of a deadlock. See Slip op. at 48.

This 75-page opinion by Vice Chancellor Kathaleen St. Jude McCormick deserves to be read in its entirety, but the key takeaways, in my subjective view, that make this decision especially noteworthy are the following:

(1) The court’s comprehensive and detailed analysis that examines the two determinative issues should be read by anyone who needs to determine whether circumstances of a particular case satisfy the definition of deadlock for purposes of seeking a dissolution. See Slip op. at 48 to 58.

(2) Especially important are footnotes 243 and 244, which explain why the deadlock in this situation was not disingenuous, and was not merely pre-planned for strategic purposes.

(3) The court illustrates why it refused to invalidate the dissolution based on equitable grounds. This explanation by the court provides guidance to address the common defense that the person seeking dissolution is not doing so equitably. See Slip op. at. 69 – 75.

A recent Delaware Court of Chancery decision recited the standards applied in Delaware to determine when to stay a case or allow it to proceed when similar litigation between the same parties is proceeding in another state. In AG Resources Holdings, LLC v. Terral, C.A. No. 2020-0850-JRS (Del. Ch. Feb. 10, 2021), the court addressed the titular topic in a 24-page decision that  provided a careful chronology of the litigation between the parties in Louisiana as well as detailed background facts.

But for purposes of this short blog post, I will provide highlights of what I regard, quite subjectively, as the most noteworthy takeaways from this ruling that would have the broadest application to corporate and commercial litigators in Delaware:

This decision provides guidance for what standards will be applied when a motion to stay or dismiss under Rule 12(b)(3) is filed–depending on which of the following circumstances are in play:

  • If the Delaware case was clearly the first-filed case, compared to the related case pending in another forum. See Slip op. at 8 and n. 19. (apply Cryo-Maid factors giving due deference to the plaintiff’s choice of forum.)
  • If, however, the Delaware action follows the filing of a similar action elsewhere, “the court applies the discretionary McWane standard that allows the court to defer more readily to the court in which related litigation was first filed”. Id. and n. 20.
  • If the pending cases both outside and in Delaware are filed at about the same time, the court applies the “forum non conveniens analysis by applying the factors set forth in Cryo-Maid.” Slip op. at 9 and n. 21 That is, less emphasis in such a situation is placed on the priority of filing.

Two nuanced variations on the above three situations require more careful analysis. For example:

  • When litigation is contemplated and one party files a DJ action in an attempt to preempt the filing by the opposing party in a different forum, the court’s analysis “requires a closer look”. Slip op. at 10 and n. 25.
  • Also, when the issue involves the internal affairs of a Delaware entity or issues arising under a Delaware entity’s constitutive documents, Delaware courts may have a greater interest in retaining the matter. Slip op. at 20 and n. 45.

All of the foregoing assumes that there is not a controlling, mandatory forum selection clause (as compared, for example, to a merely permissive forum selection clause). In such a situation, reference should be made to the many cases highlighted on these pages analyzing the enforceability of mandatory forum selection clauses. (Just make sure there is no delay in the enforcement of such a clause.)

 

 

 

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 Delaware Supreme Court recently revived an investor’s derivative challenge to a merger of energy companies, finding he retained standing because he sufficiently pled a direct claim attacking the fairness of the deal itself for undervaluing his claim against the controlling partner of one of the merger mates in Morris v. Spectra Energy Partners (DE) GP, LP, No. 489, opinion issued (Del. Supr. Jan. 22, 2021).

The justices unanimously reversed the Chancery Court’s dismissal of plaintiff Paul Morris’ charges that Spectra Energy Partners L.P. unitholders were shortchanged in a merger with Enbridge, Inc. because SEP’s controller failed to include the worth of a $661 million projected recovery from Morris’ suit. Morris v. Spectra Energy Partners (DE) GP, LP, 2019 WL 4751521 (Del. Ch. Sept. 30, 2019).

The high court remanded the case for the Chancery Court to decide whether to use a motion to dismiss or for summary judgment to resolve the matter.

Significance

The decision is noteworthy because the en banc court used the so-called Primedia test as a way to determine when a derivative plaintiff qualifies for an exception to the general rule that he loses his standing to continue his suit against his directors or controller if his stock is eliminated in a stock-for-stock or cash-out merger. In re Primedia, Inc. Shareholders Litigation. 13 67 A.3d 455 (Del. Ch. 2013).

The Primedia test, taken from a 2013 Chancery Court merger opinion, applies to claims challenging a merger because the equity owners are not being fairly compensated for the value of material derivative claims. To establish standing, the plaintiff must allege a viable derivative claim that:

  • Was material to the overall merger transaction,
  • Will not be pursued by the buyer, and
  • Is not reflected in the merger consideration.

“Under Primedia’s three-part test, which applies to claims alleging an unfair merger because the price does not reflect the value of derivative claims, the plaintiff must allege a viable derivative claim assessed by a motion to dismiss standard,” Chief Justice Collins J. Seitz Jr. wrote for the high court.

“The standing inquiry has assumed special significance in the area of corporate law,” the Chief Justice said, noting its pivotal role in merger challenge suits. “Classifying a claim as either direct or derivative bears directly on standing and is in many ways outcome-determinative in post-merger litigation.”

Background

After a $3.3 billion “roll up” of minority-held units that was part of a merger between Enbridge and Spectra, former SEP investor Paul Morris lost standing to litigate an alleged $661 million derivative suit on behalf of SEP against general partner Spectra Energy Partners (DE) GP, LP. Morris filed a new class action complaint that alleged the Enbridge/SEP merger exchange ratio was unfair because SEP GP agreed to a merger that did not reflect the material value of his derivative claims. The Court of Chancery granted SEP GP’s motion to dismiss the new complaint for lack of standing. In re Primedia, Inc. Shareholders Litigation. 13 67 A.3d 455 (Del. Ch. 2013}.

Double discount doubted

The Chancery Court held that to have standing, the plaintiff’s suit must reflect the public unitholders’ beneficial interest in the derivative litigation recovery. The court discounted the worth of the $661 million derivative suit to $112 million and then further reduced it to $28 million to reflect a one-in-four chance of prevailing in the litigation. Finally, the court compared the $28 million to the $3.3 billion merger transaction and found it immaterial to the $3.3 billion merger and dismissed it.

Thus, the court granted SEP GP’s motion to dismiss for lack of standing without reaching SEP GP’s alternative argument that Morris failed to state a claim for relief. During the litigation, and with the motion summary judgment pending, Enbridge acquired SE Corp in a stock-for-stock merger, eliminating Morris’ stock, becoming SEP GP’s ultimate parent and controller of SEP.

The appeal

Morris’ appeal argued that if the Chancery Court had accepted his well-pleaded factual allegations as true and drawn all reasonable inferences in his favor, it would not have discounted the potential value of the claim to the point that it was immaterial to the merger value. The high court found that Morris properly alleged that former public unitholders were harmed because “SEP GP has allowed Enbridge to engineer the Roll-Up Transaction on terms that were patently unfair and unreasonable to SEP and its public unitholders, and that could not have been approved in good faith by the New Conflicts Committee or the SEP GP Board.”

Two errors

The justices found as to the main issue on appeal, that the Chancery Court had erred twice, in that:.

1. It “strayed from the proper standard of review” under the Primedia test and Morris did retain standing for his claim because “it was ‘reasonably conceivable that the [SEP) general partner acted in subjective bad faith,” and

2. Even if it was proper to discount the $661 million in damages alleged in the complaint to reflect the public unitholders’ interest in the derivative recovery, the court should have compared the $112 million pro rata interest in the derivative claim recovery to the public unitholders’ 17% proportional interest in the merger consideration.

“If the plaintiff has alleged a viable derivative claim, where it is reasonably conceivable that the claim is material when compared to the merger consideration and could result in the damages pled in the complaint, the plaintiff has satisfied the materiality requirement at the motion to dismiss stage for standing purposes,’’ the justices decided.