In a recent Chancery decision involving challenges to executive compensation, Eckert v. Hightower, C.A. No. 2024-0569-MTZ (Del. Ch. March 24, 2025), the court reiterates the basic standards that determine if allegations can survive a motion to dismiss when the charter includes an exculpatory clause which requires that a majority of directors have demonstrated a breach of the duty of loyalty–that is, they have a disabling self-interest or if they acted in bad faith.

Background

  • The court recites the well-known standards that determine if allegations can survive a motion to dismiss when the charter includes an exculpatory clause which requires that a majority of directors have demonstrated a breach of the duty of loyalty–that is, have a disabling self-interest or they acted in bad faith. In the particular circumstances of this case, the plaintiff failed to establish at the pleading stage that the directors had a “controlled mindset” or that they were subjected to a “substantial likelihood of liability” based on the claims presented. Concluding that the plaintiff did not satisfy the necessary threshold, the court did not have occasion to determine on a full record whether the compensation would be tested at trial.

Highlights

  • The court restated several basis principles of corporate litigation in this context that are useful for future reference.
  • The court reviewed the pleading requirements for pre-suit demand futility and the particularity requirements of Rule 23.1. See Letter op. at 8-9.
  • The court emphasized that the 3-part demand futility test requires an analysis on a director-by-director basis of: (i) whether the director received a material personal benefit that is the subject of the litigation demand; (ii) whether the director faces a substantial likelihood of liability on any of the claims that would be the subject of the litigation demand; and (iii) whether the director lacks independence from someone who received the material personal benefit, or would face a substantial likelihood of liability on any of the claims that are the subject of the litigation. See footnote 47 and accompanying text.
  • If the answer to any of the questions is yes for at least half of the members of the demand board, the demand is excused as futile. Id.
  • Regarding the somewhat amorphous concept of whether a demand is excused because a director “faces a substantial likelihood of liability under claims that would be the subject of litigation demand,” the court discusses the various standards that apply to this fact-intensive analysis. See Letter op. at 11 to 18.
  • The plaintiffs were required to meet a high threshold to establish a non-exculpated breach of the duty of loyalty by demonstrating a transaction that benefited the controlling stockholder and by overseeing an unfair process.
  • The court described the concept of a “controlled mindset” and found that the plaintiff here did not have a controlled mindset that was tantamount to bad faith.
  • The court also discussed the nuanced challenges in successfully alleging a controlled mindset.  See  Letter op. at 13.
  • The court addressed the impact of the controlling stockholder attending some board meetings where compensation was discussed, but according to the minutes he apparently removed himself from discussions of his own compensation.
  • Lastly, the court distinguished other cases involving similar demand futility issues in connection with challenges for executive compensation and disagreed with the plaintiff’s application of those cases. See Letter op. at 15-16.

For those litigators who toil in the vineyards of pre-trial disputes over case management, and positioning issues for trial, a recent Chancery ruling is a useful tool that deserves a place in the litigator’s toolbox. The letter ruling captioned as In re Northwest Biotherapeutics, Inc. Stockholder Litigation, Cons. C.A. No. 2022-0193-JTL (Del. Ch. Feb. 14, 2025), refers to fundamental principles that govern all litigation and pre-trial proceedings in particular to ensure that litigation is guided by the most efficient procedures to present the issues in a manner than minimizes unnecessary delay and expense. This decision provides citations to authorities and learned commentary that provide guideposts and standards that can be applied in most every case.

Background

The context of this short letter ruling involved how to deal procedurally with the fact that a stockholders’ vote ratified challenged executive compensation after the court denied a motion to dismiss, but before any determination on the merits. Because of that somewhat unusual setting, the court considered several different options about the next steps it could take.

The court decided to allow the same type of limited discovery that might be available under Section 220 so as to put the plaintiffs in the same position they might be in if shareholder ratification occurred before the suit was filed.

Highlights

The decision offers gems of basic litigation and case management guidelines that I present in bullet point format:

  • Court of Chancery Rule 1 instructs the members of the court that the rules: “Should be construed, administered, and employed by the Court and the parties to secure the just, speedy, and inexpensive determination of every proceeding.”
  • Court of Chancery Rule 16(e) also contemplates that a court may: “Formulate and simplify the issues and . . . address such other matters as may aid in the disposition of the action.” The court quoted from an Advisory Committee Note to the analogous Federal Rule of Civil Procedure 16, as mentioned in the Wright and Miller treatise: “The timing of any attempt at issue formulation is a matter of judicial discretion.” Letter op at 3.
  • After sorting out the procedural imbroglio, the court allowed the plaintiffs an opportunity to amend and supplement their complaint to address the ratification vote during the pendency of this case, and denied the pending motion for summary judgment without prejudice.

Frank Reynolds, who has been covering Delaware corporate decisions for various national publications for over 40 years, prepared this article.

The Court of Chancery recently recommended that the Delaware Supreme Court deny a quick interlocutory appeal of its decision that a Sears Hometown & Outlet Stores investor is entitled to the full share of the $10 billion damages he had awarded in a breach-of-duty suit against the retailer’s controller in the matter of In Re Sears Hometown and Outlet Stores Inc. Stockholders Litigation, C.A. No. 2019-0798-JTL  (Del. Ch. March 21, 2025).

Vice Chancellor Travis Laster denied Sears Hometown controller Edward Lampert’s request for an interlocutory appeal, finding that under the high court’s landmark Technicolor opinion, Cannon Square LLC was entitled to both the payout consideration in a squeeze-out merger and the damages awarded in the shareholder suit that the investment fund had initially passed on to seek appraisal. Cede & Co. v. Technicolor, Inc., 542 A.2d 1182 (Del. 1988)

This discretionary appeal decision is the latest ruling in litigation that has spotlighted the power and duty of controllers for actions that allegedly benefit them at the expense of common shareholders. Recent Delaware legislation would make it more difficult to successfully sue controllers. 

Vice Chancellor Laster found that among other reasons for denial of this interlocutory appeal is the likelihood of a comprehensive appeal of his Feb. 13 opinion on breach-of-duty remedy damages that could produce a final ruling in the merger challenge suit. In re Sears Hometown & Outlet Stores, Inc. S’holder Litig., — A.3d —, 2024WL 5403534 (Del. Ch. Feb. 13, 2025).

Background

Former parent company Sears Holding spun off Hometown and Outlet Stores to focus on home appliances, furniture and lawn equipment in 2012 but a new parent effected a 2019  squeeze-out merger which eliminated the minority shareholders for $3.21 a share. Some shareholders filed claims for breach of duty against the controller but, Cannon sought appraisal in an action that was combined with the plenary suit in the Chancery for discovery purposes. 

Vice Chancellor Laster found that the controller had breached his duty to put the shareholders’ interests first and that the shares were worth $4.02 each or the $3.21 consideration plus $.85 in damages.  In re Sears Hometown & Outlet Stores, Inc. S’holder Litig., 309 A.3d 474 (Del.Ch. 2024), modified on reargument, 2024 WL 3555781 (Del. Ch. July 2, 2024). 

Cannon–which got nothing in appraisal because both Hometown and the parent declared bankruptcy–sought to intervene in the shareholder suit to get its share of both merger consideration and damages, but the controller said it should only get damages—not the merger consideration—and asked the high court for an immediate review of that issue.

Reasons for denial of Interlocutory Appeal

The application is untimely.

“Although this court can extend the deadline for good cause shown, Lampert has not established good cause,” the Vice Chancellor said. ”He has provided a reason that could amount to excusable neglect, but excusable neglect is not good cause.”

No substantial issue of material importance.

“[T]he substantial issue requirement is not met where no final determination was made on the merits of plaintiff’s claims,” the court wrote.  The Remedy Opinion only decided “whether the [Cannon] Fund’s recovery warranted being offset by merger consideration it never received.”  And the controller’s argument that the opinion “effectively offloads the credit risk of an appraisal proceeding onto defendants in a fiduciary action, potentially including outside directors” is “a classic attempt at a scary soundbite” because that ruling, “simply recognizes that disloyal fiduciaries owe damages to their beneficiaries.”

Appellate review before final judgment unwarranted.

An interlocutory appeal request will only be granted after an eight-factor review by the trial court and the controller meets none of the five factors on which he relies, the Vice Chancellor ruled.

No first impression issue raised.

The controller argued that the ruling wrongly allowed an appraisal arbitrageur who bought stock after announcement of the transaction to pursue appraisal and then get full damages in a plenary suit, but the vice chancellor labeled the objections “a grab bag of potential distinctions” and said “Under Technicolor, an appraisal claimant can opt for the plenary remedy at any point until final judgment. When or why does not matter.”

No trial court decision conflict.

The vice chancellor said the application of settled law like Technicolor to different facts, as here, does not create a first-impression issue and as long as the former stockholder does not receive a duplicative recovery “it does not matter whether the same former stockholder takes the lead in both actions or either action. Nor does it matter whether the plenary action proceeds as a class action.”

No new statute created requiring immediate review.

“The fiduciary defendants in Technicolor relied on the same statutory language that Lampert cites, and the Delaware Supreme Court held that the former stockholder could pursue both its appraisal claim and the plenary action to judgment,” Vice Chancellor Laster noted.  “Here again, the Technicolor decision already answered the statutory question.”

Review would not terminate the litigation.

 “Approving the Settlement would not resolve “numerous open post-trial issues that the Court would otherwise need to decide”, even if review did settle some issues, the court said.  “A reversal of the Remedy Opinion only would result in a remand to consider the Settlement,” –even if reversal did overturn the plenary suit settlement.

Appeal fails the balancing test.

Even if some of the controller’s appeal arguments were successful, the appeal must pass a balancing test because: “There must be “substantial benefits that will outweigh the certain costs that accompany an interlocutory appeal,” the court said, ruling that: “Because there are not substantial benefits from an interlocutory appeal that outweigh its costs, Rule 42(b)(iii) instructs the trial court to deny certification.”

The Delaware Governor signed legislation last night that makes big changes to Delaware corporate law. The new law amended the corporate statute to create a definition for “controlling shareholder” and “disinterested director” as well as adding new prerequisites before a shareholder can demand corporate records. As the editor of The National Law Review’s Delaware Corporate and Commercial Law Monitor, I have curated articles from around the country that I selected from among the hundreds that have been written about this topic in the last month or so, since the legislation was proposed, in addition to articles of my own. I’m sure that much more will be written about the new changes.

A recent Chancery decision deserves a place in the toolbox of corporate litigators for its nuanced approach that highlights the difference in criteria between a Motion to Expedite Proceedings and the similar but materially different standard applied to a Motion for a TRO. In the matter styled The New York City Employees’ Retirement System v. Byrne, C.A. No. 2025-0126-KSJM (Del. Ch. March 7, 2025), the Court of Chancery addressed a pre-closing challenge to the $8 billion merger between Paramount Global and Skydance Media LLC.

Plaintiffs claim that the merger will deliver hundreds of millions of dollars in non-ratable benefits to Paramount’s controlling shareholder, Shari Redstone, who approved the merger by written consent. The merger agreement did not include a fiduciary-out, and a special committee declined to consider an all-cash offer valued at more than $5 billion above the merger price.

Procedurally, the TRO Motion was filed two weeks after the Motion to Expedite, seeking a mandatory injunction in advance of the closing to enjoin the merger from closing pending resolution of the plaintiffs’ claims. At a hearing on March 3, the court required an amended complaint to add parties to be filed by the end of the day. The newly names defendants were given until the end of the following day to file their opposition to the motions.

Due largely to the need for FCC approval, and “no insight into the timing of regulatory approval”, the date of closing appears uncertain.

Legal Analysis

To obtain expedition, a party must “articulate a sufficiently colorable claim and show a sufficient possibility of a threatened irreparable injury” absent expedited proceedings”. Slip op. at 5.

Without determining the merits of the case or even the legal sufficiency of the pleadings at this stage, the court “need only ask whether a party has asserted ‘essentially a non-frivolous cause of action.'” Id. at 6.

Despite factual defenses that might prevail, the plaintiffs met the low bar for expedition on their breach of fiduciary duty as well as aiding and abetting claims. The plaintiffs also demonstrated irreparable harm absent expedition.

Citing a case that involved a post-trial decision within a month of filing the complaint, the court observed that even if a decision was needed by a potential closing date of April 7, it would be a “break-neck pace but doable”. Id. at 7 and n. 27.

The TRO Motion was denied primarily because the court found that the harm was not “proximate enough to warrant a TRO”. Id. at 7. To obtain a TRO, a party must demonstrate: (i) the existence of a colorable claim; (ii) the irreparable harm that will be suffered if relief is not granted; and (iii) a balance of hardships favoring the moving party”. Id. Nonetheless, the court directed the defendants to give plaintiffs “advance notice–optimally no fewer than five business days–of the closing date once it is set”, so that the plaintiffs can renew their Motion for TRO if events warrant.

The court ended its decision by ordering the parties to confer and submit a proposed case schedule.

The 39th Annual F.G. Pileggi Distinguished Lecture in Law will be presented this year on March 20, 2025, at the Hotel DuPont. Named after my father, the Delaware Journal of Corporate Law at the Delaware Law School of Widener University continues to host and organize the event that brings leading corporate law scholars from around the country to share their insights. Prior Annual Pileggi Lectures have been highlighted on these pages.

This year’s lecturer will be Arthur E. Wilmarth, Jr. of the George Washington University Law School. His topic will be “The Looming Threat of Nonbank Stablecoins”.

Frank Reynolds, who has been covering Delaware corporate decisions for various national publications for over 40 years, prepared this article.

The Delaware Court of Chancery recently declined to dismiss claims that three venture capital firms disloyally caused the collapse of Get Together Inc. by hastily pulling out of the troubled social media start-up and allegedly abusing their preferred shareholder power to empty GTI’s $40 million cash reserve in Shafi v. Chien, et, al., C.A. No. 2023-1157-LWW (Del. Ch. March 3, 2025).

Vice Chancellor Lori Will allowed GTI’s founders and common shareholders to continue most of their derivative and direct claims after finding an adequate basis for claims that three directors representing the three venture capital firms on GTI’s six-director board put their interests ahead of GTI’s corporate survival.

She ruled that on a motion to dismiss for failure to make a pre-suit demand on the board, the plaintiffs have met their burden to control the suit for now because they may be able to show that a majority of the defendant directors could not make an objective decision on the suit’s merits.  

Competing histories

But the Vice Chancellor noted that while plaintiffs generally get the benefit of the doubt at this early stage of the litigation, there are two competing versions of GTI’s collapse and a more developed record could later reveal that the defendant’s is the accurate one. That version claims the founders sold three investors a large stake in the company by hiding significant development problems.

The litigation will likely be followed in boardrooms and corporate law offices because of its potential to clarify the power of venture capital and other activist investors to cause big changes in both the course and the wheelhouse of companies in which they have major stakes.  The final decision could affect the guidelines for conflicts that can arise for “dual fiduciaries” — who are officers, directors or controllers of both investor entities and their investment prospects.

Background

According to court records, plaintiffs Abraham Shafi, Krutal Desai and Genrikh “Henry” Khachatryan in 2016 founded Get Together Inc. based on a social media platform called In Real Life Inc. that purportedly enabled users to make “real life” connections.  Reports indicated major user growth. Meanwhile, RLI conducted three rounds of funding from three venture capital firms; Goodwater Capital LLC, Softbank Investment Advisers and Floodgate Fund V.

But then rumors began to circulate that much of the activity on the Get Together site was not of human origin but the work of “bots”—software that mimics human activity.  After a web trade journal published several stories looking into the rumor, the Securities and Exchange Commission launched an investigation. The VC-affiliated directors then commissioned a consultant report on the matter. 

While that investigation was getting underway, the VC directors replaced founder/CEO Shafi with an outsider who assumed the power to vote common shares in support of a move to shut down GTI/IRL. That enabled the venture capital investors to assert their preferred shareholder liquidation preference to the company’s $40 million in cash reserves—with nothing left for the common shareholders.

Who caused the collapse?

In litigation filed first in federal court in California—where the companies are located—and later in Delaware–where they are chartered—the VC directors charged that their investments were obtained by fraud and the founders claimed that although Silicon Valley startups must often navigate rough early-development seas, the VC investors panicked at the first sight of dark clouds in the future, feared for their investments and hastily seized control of the company and its assets.

Two coasts, two suits

The California action, filed by SoftBank, alleged securities fraud by Abraham Shafi who claimed they were intentionally misled by highly inflated reports of GTI’s early growth. .

In this Chancery suit, Shafi and co-founder Khachatryan on November 15, 2023, filed direct claims and derivative charges on behalf of IRL against Goodwater, SoftBank, Floodgate, their respective board representatives and Scott Kauffman, the replacement CEO they chose. 

The claims were for:

  • Count 1 – Removing Shafi, installing Kauffman, and shutting down IRL,violating IRL’s bylaws
  • Count 2 – Appointing Kauffman CEO
  • Count 3 – Against Kauffman for damaging IRL’s business
  • Count 4 – Breach of IRL’s Voting Agreement for Kauffman’s vote as a proxy for common stockholders;
  • Count 5 – Vicarious liability and respondeat superior against the VC firms;
  • Count 6 -Tortious interference with prospective economic advantage for impairing the value of stock options and;
  • Counts 7 & 8 – Defamation and false light invasion of privacy for making false statements about Shafi’s “pattern of misconduct”.

The court ruled that:

As to Count 1: The plaintiffs adequately plead that the VC Directors put their interests, and those of the VC Funds, ahead of common stockholders.

A PowerPoint with highlights of SB 21 at today’s beginning of the annual Tulane Corporate Law Institute, an event featured many times on these pages in prior years, was part of a panel presentation led William Lafferty of Morris Nichols. For the few people who have missed the tsunami of articles and commentary on the proposed changes to the Delaware General Corporation Law proposed on February 17 in the form of Senate Bill 21, which the Corporation Law Council proposed revisions to on March 3, the above PowerPoint provides an excellent overview.

Most of SB 21 amends DGCL Section 144 related to controlling shareholders and disinterested directors. The amendments to Section 220 were discussed recently on these pages. The revisions proposed on March 3 by the Corporation Law Council would make the changes to Sections 144 and 220 retroactive–except for pending litigation.

The status of SB 21 is in flux, but the Senate and the House are expected to consider it in committee and both chambers will likely vote on the bill before the end of the month. The new Delaware Governor requested the changes, so he is expected to sign it if it passes.

Another panel at the Tulane seminar today included a former Delaware Chancellor and Chief Justice who commented–and I’m only paraphrasing: there are many other factors that are part of the analysis about whether to stay in Delaware, beyond SB 21, e.g., other aspects of Delaware law that protect shareholders.

On another panel, Ned Weinberger observed that SB 21 would overrule a long list of major Delaware decisions (referring to a list of cases compiled by Prof. Eric Talley)–including, arguably, the iconic Revlon decision. His view is that SB 21 is not necessary for Delaware to maintain its preeminence in the corporate world.

I recently attended a seminar in New York on D&O litigation developments called the PLUS Symposium. The topics lean towards the concerns of those who defend D&O cases and provide D&O coverage.

I listened to a panel entitled: “Hot Topics in D&O 2025”. None of the panel members were Delaware lawyers or members of the Delaware judiciary or the Delaware legislative branch, but they litigate in Delaware or broker D&O insurance to Delaware companies.

Naturally, the status of SB 21 was the focus of much of the panel discussion. Since the introduction of SB 21, and amendments earlier this week, an avalanche of articles have been written about the proposed changes to the Delaware General Corporation Law. See, e.g., here and here.

Highlights:

  • Like most people, the panelists don’t know for sure what impact SB 21 will have if it passes–or if it doesn’t pass–but the assumption was that if SB 21 passes it would reduce litigation in Delaware at least related to some types of cases.
  • Apparently, Texas has recently introduced somewhat similar legislation.
  • One panelist suggested that the restrictions on Section 220 demands that SB 21 would impose will reduce many plenary cases. For example, one panel member suggested that the Boeing case would not likely have been possible without all the emails, etc., the plaintiffs obtained in a prior Section 220 demand.
  • Another panelist suggested that regardless of SB 21, other aspects of litigating in Delaware, such as the CCLD division of Superior Court, would still provide benefits from being able to litigate in Delaware.
  • Another panel member saw it as ironic that the legislature was attempting to use SB 21 to counteract decisions of the judiciary–but the judiciary is apparently one of the reasons why corporate entities are attracted to Delaware.
  • The prediction of at least one panel member was that the outcome of SB 21 will be the biggest topic in the D&O world for 2025.

In the few days since the Delaware Legislature proposed Senate Bill 21 to make major changes to Delaware corporate law, there has been a veritable avalanche of commentary by the professoriate, practitioners, and journalists with their predictions of the consequences of SB 21 being enacted into law. See, e.g., article on The CLS Blue Sky Blog.

Most of the observations by leading scholars and others focus on the more glitzy proposed changes to DGCL Section 144 via SB 21, which features new definitions for “controlling shareholder” and “disinterested director”.

The fusillade of reviews of SB 21 is easily found in a online search about the newly proposed changes in Delaware law that are arguably more dramatic than the revisions to the DGCL last year, which also broke anecdotal records for the high volume of opinions shared from all corners of the corporate commentariat.

But my focus in this short overview will be on the changes to DGCL Section 220, regarding the qualified rights of a shareholder to demand corporate books and records. Not quite as sexy as the proposed amendments to Section 144, but an issue more often encountered.

Having worked as a legislative counsel drafting legislation for the Delaware Legislature about 30 years ago, I realize that the synopsis at the end of a proposed Senate Bill cannot always be relied on for precision, but the part of the synopsis of SB 21 that pertains to the amendments to Section 220 is excerpted below:

… this Act amends § 220 of Title 8 to define the materials that a stockholder may demand to inspect pursuant to a request for books and records of the corporation. The amendments also set forth certain conditions that a stockholder must satisfy in order to make an inspection of books and records. The amendments make clear that information from books and records obtained by a stockholder from a production under § 220 will be deemed to be incorporated by reference into any complaint filed by or at the direction of a stockholder on the basis of information obtained through a demand for books and records. New § 220(b)(4) preserves whatever independent rights of inspection exist under the referenced sources and does not create any rights, either expressly or by implication. New § 220(f) provides that if the corporation does not have specified books and records, including minutes of board and committee meetings, actions of board or any committee, financial statements and director and officer independence questionnaires, the Court of Chancery may order the production of additional corporate records necessary and essential for the stockholder’s proper purpose.

In order to keep my commentary as pithy as possible, I’ll resort to my favorite format of bullet points:

  • I have written over 200 articles about Delaware court decisions on DGCL Section 220 and the analogous section of the Delaware LLC Act, and have litigated countless cases on this topic. See, e.g., selection of some of my articles on Section 220.
  • Although we all know that the sister provision in the LLC Act has important differences, many court decisions have instructed that the reasoning in cases applying Section 220 can often be applicable to the analogous provision in the LLC Act–which is another opening for more commentary about the impact of SB 21 if it is signed into law.
  • Over the nearly 40 years that I have highlighted cases involving Section 220 and its LLC counterpart in various publications, I have tried to provide a neutral overview of the court decisions without my own opinion. But today I will provide my own insights based on the hundreds of cases on this topic that I have written about and litigated:
  • First, some say indeterminacy in Delaware corporate law is a benefit, not a bug, to the extent that the outcome of a case is not predictable. Notwithstanding some measure of predictability that comes from over 2 centuries of Delaware court decisions, in my view, Section 220 cases that are litigated are often a “black hole”–in the astronomical sense of entering a zone that prevents one from predicting what happens after one enters. I acknowledge that to be less than an optimistic view, but it reflects my own experience of many years.
  • Thousands of reported decisions on Section 220 provide some guidance, but even, for example, when an expert report provides a list of documents needed for the purpose of valuation, the court can still determine that the list is too long, or that the purpose of the plaintiff is not “really” valuation–after a shareholder spends a small fortune on litigation costs. Maybe SB 21 will provide some relief from this state of affairs.
  • Some regard the proposed changes to Section 220 as “raising the bar” and imposing more prerequisites for employing the statute. Maybe so.
  • Nonetheless, in my view, a welcome clarification that SB 21 brings to the table is a concrete list of documents or data that a shareholder is entitled to if the prerequisites of the revised statute are satisfied–that is, less indeterminacy.
  • The highlights of the proposed changes include: (i) a specific list of documents as compared to the current “guess work” about which documents must be produced; (ii) a three-year period prior to the request for documents that also removes the guess work about the period during which documents can be requested; (iii) codification of some requirements that the courts have imposed for years, such as allowing the condition of a confidentiality agreement prior to production.
  • The net result of SB 21 would be to give the court less discretion, though as a court of equity, the Court of Chancery will still be entitled to exercise its equitable powers.
  • I realize that there a limits to the powers of a court of equity. I weigh more of the pros and cons in the supplement below.

Supplement: The DSBA Corporation Law Council on March 3 proposed revisions to the recently debuted SB 21. The revisions to SB 21 include new proposed changes to Section 220–which are not covered in the above blog post about the original SB 21.

An updated SS1 for SB21 was passed by the Delaware Senate. A House vote, and a proposed House Amendment is scheduled for a vote on March 25, 2025.

Notwithstanding the various iterations of the legislation since it was first introduced, the commentary in this post still applies.

Professor Stephen Bainbridge, who has written extensively about proposed SB 21 within the weeks since its introduction, recently penned a scholarly analysis regarding the proposed revisions to SB 21 relating to Section 220.

I readily acknowledge up front that even the revised SB 21 would impose additional hurdles on top of the existing formidable roadblocks to the quest of a shareholder to obtain corporate books and records— to say nothing of the LLC analog. No changes to that statute have been proposed yet.

The good professor refers to the Yahoo case which involved a demand for extensive records in compliance with the Supreme Court’s repeated entreaties to use Section 220 before filing a plenary complaint. The newly proposed Section 220 might make it more difficult or impossible to obtain the same array of documents that were obtained in the Yahoo case. 

But even under the existing regime, it can often cost substantial 6-figures to litigate a Section 220 claim, which is intended to be a summary proceeding. There are published examples, e.g., the Wal-Mart case, highlighted on these pages, where each side spent millions of dollars to litigate a Section 220 claim. For nearly every Yahoo case, there are countless examples—under the existing statute, where a shareholder came up empty due to somewhat amorphous, nuanced defenses currently available.

If SB 21 is passed, companies will have more defenses to a Section 220 demand, and even with a more definite, itemized list of available documents, which I describe above as an offset to the new obstacles, many shareholders will decide that they don’t want to spend, or cannot spend, substantial 6-figures to fight for documents about a company they are invested in.

For the last 20 years, I have highlighted selected decisions from the Delaware Supreme Court and the Delaware Court of Chancery on these pages, as well as related topics, including legal ethics. Recently, the National Law Review, a publication that is over 100 years old and boasts over 2 million readers, asked me to consider sharing my blog posts as part of a new newsletter that they would publish, along with other articles on Delaware corporate law from thought leaders around the country, called the Delaware Corporate and Commercial Law Monitor. This would be a natural extension and evolution of my blog, and an opportunity to expand my reach.

Well, the first edition of the National Law Review’s Delaware Corporate and Commercial Law Monitor has just been published. I’m the Editor-in-Chief. It will be published monthly and emailed to a select few from the mailing lists the NLR has for their 25 other newsletters, as well as the existing subscribers of this blog who read these pages from all 50 states and over 70 countries.

To be clear: this blog will continue unabated. Not sure when I will find time for this new venture in addition to my full-time practice, and while continuing to maintain this blog, but thus far I’ve been able to squeeze it into nights and weekends. Comments are welcomed.

Frank Reynolds, who has been covering Delaware corporate decisions for various national publications for over 40 years, prepared this article


The Delaware Supreme Court recently reversed a Chancery decision to let shareholders of TripAdvisor Inc. and its parent continue their suit against their directors over their boards’ reincorporation of the world’s largest travel guidance purveyor  in Nevada—which  offers directors a higher level of protection from investor suits than Delaware, in Maffei et al.v. Palkon, et al., Del. Supr., No. 125, 2024 (Feb. 4, 2025).

Justice Karen Valihura, writing for the en banc high court, said the increased protection from breach-of-duty charges the directors and officers received through the conversion’s charter change did not give them a unique ’non-ratable’ benefit that could have  skewed their objective judgment and made the board’s decision reviewable under  the enhanced scrutiny of entre fairness — as the Chancery  Court had ruled in allowing the plaintiffs to press their suit. 

“Plaintiffs’ allegations have not satisfied the requirement of pleading a material benefit because they have not alleged anything more than speculation about what potential liabilities Defendants may face in the future,” the Justice wrote in explaining why Nevada’s more expansive business judgment rule was not a non-ratable benefit. ‘’If one focuses more broadly on the corporate governance regime beyond just litigation rights alone, then it becomes even more apparent that courts are ill-equipped to quantify the costs and benefits of one state’s corporate governance regime over another’s.”

Charter move roadmap

The high court’s ruling will be closely examined In corporate law offices and boardrooms nationwide—especially where directors are contemplating a charter change—because it effectively presents a  roadmap of how directors of a Delaware corporation could reincorporate in another state while staying under the protection of Delaware’s business judgment rule.

Background

TripAdvisor, headquartered in Massachusetts and parent Liberty TripAdvisor, headquartered in Colorado, which holds a 56 percent voting interest in TripAdvisor, in 2023 considered changing their charters from Delaware to Nevada for the increased liability protection it would provide for directors and officers.

In particular, they were attracted to the higher level of D&O liability protection that Nevada’s business judgment statute provided compared to Delaware’s version.  In addition they found research that indicated Nevada’s  business courts would “minimize the time, cost and risks of commercial litigation” and that Nevada has ”lower taxes and fees.”

The directors and officers of TripAdvisor and its parent approved the charter changes but stockholders were almost evenly divided on the issue and Justice Valihura noted that regarding the conversion of TripAdvisor the transactions designed to effectuate this change in June 2023 would have been voted down without the defendant-Controller/CEO Gregory Maffei’s votes.  The result was a shareholder suit claiming the charter change was a breach of duty because it gave the directors and officers a unique “non-ratable benefit” through the higher liability protection.

Not entirely fair?

On defendants’ motion to dismiss, the Court of Chancery held that Plaintiffs adequately alleged that Defendants will receive a non-ratable benefit in the form of reduced liability exposure and that the Complaint alleged facts supporting a reasonable inference that the Conversions were not entirely fair.

Chancery observed that “[u]nder Delaware law, a controller or other fiduciary obtains a non-ratable benefit when a transaction materially reduces or eliminates the fiduciary’s risk of liability.”  It turned down the defendants’ move for an interlocutory appeal.

The appeal

On appeal, the defendants contended that the business judgment rule applies because there is no pending or contemplated lawsuit and, therefore, Defendants are not receiving a material, non-ratable benefit.  Defendants argued for a materiality requirement because “[t]he speculative benefits afforded to fiduciaries from risk mitigation do not constitute material benefits requiring entire fairness review.”

The State of Nevada filed an amicus brief generally supporting Defendants’ position. Nevada argued that the Conversions do not confer a non-ratable benefit that would trigger entire fairness.

The high court’s opinion

 “This Court has noted that “[t]he entire fairness standard applies only if the presumption of the business judgment rule is defeated,” Justice Valihura wrote.  In the director context, “in order to rebut the business judgment rule presumption, an interest must be subjectively material to the director. In other words, the alleged benefit must be significant enough as to make it improbable that the director could perform his fiduciary duties to the shareholders.”

She noted that entire fairness is not triggered solely because a company has a controlling stockholder like Maffei .  “We conclude that, based on the pleaded allegations, Defendants will not receive a non-ratable benefit from the Conversions and, accordingly, the entire fairness standard of review does not apply, she wrote.

“In the controller context, the plaintiffs must plead that [the controller] had a conflicting interest in the Merger in the sense that he derived a personal financial benefit ‘to the exclusion of, and detriment to, the minority stockholder,” the high court ruled.

The justices’ conclusion 

Finally, the Court of Chancery rejected the idea that Delaware precedent has a temporal distinction that distinguishes between cases based on existing versus future potential liability. But the justices ruled that: “Rather, our reading of Delaware precedent persuades us that temporality is a key factor because it weighs heavily in determining materiality in this context.  And there was no pending judgment against the defendants nor any “cloud of litigation’” on the horizon where a new, stronger level of liability protection could change the future.

Justice Valihura noted that the Court of Chancery cited several cases to support the principle that “[u]nder Delaware law, a controller or other fiduciary obtains a non-ratable benefit when a transaction materially reduces or eliminates the fiduciary’s risk”, but she wrote: “we note that these cases all involved existing potential liabilities from past conduct that the litigated transactions may have extinguished.”

“Delaware policy has long recognized the values of flexibility and private ordering,” the high court concluded.  “Allowing directors flexibility in determining an entity’s state of incorporation is consistent with this Delaware policy.”

A recent Delaware Court of Chancery decision provides useful guidance regarding the requirements to preserve evidence in litigation and the potential penalties for spoliation. In the matter styled: In re Facebook, Inc. Derivative Litigation, C.A. Cons. No. 2018-0307-JTL (Del. Ch. Jan. 21, 2025), the court addressed spoliation in litigation involving allegations that Facebook sold personal information in violation of applicable obligations it had to its social media users.

I. Factual Background

Although several million documents were produced in the litigation, this decision involved a motion alleging that the COO of Facebook and one of the members of the board of directors failed to preserve their personal email accounts which were used at least occasionally for business communications relevant to the lawsuit.

II. Legal Analysis

The legal definition for spoliation is the destruction or significant alteration of evidence, or the failure to preserve evidence properly, or the improper concealment of evidence. Slip op. at 11 (citing Goldstein v. Denner, 310 A.3d 548, 567 (Del. Ch. 2024)).

Court of Chancery Rule 37(b) authorizes spoliation sanctions for failure to preserve ESI and requires that before sanctions can be imposed, it must be shown that: (1) The responding party had a duty to preserve the ESI; (2) The ESI is lost; (3) The loss is attributable to the responding party’s failure to take reasonable steps to preserve the ESI; and (4) The requesting party suffered prejudice. Moreover, in order for an adverse inference or case dispositive sanctions, the plaintiff must show that the responding party recklessly or intentionally failed to preserve ESI. Slip op. at 12.

III. When Court Should Decide Spoliation Motion

The court recited factors it will consider to determine whether to address a spoliation motion before trial or after trial. Slip op. at 13-14.

IV. When a Duty to Preserve Exists

  1. The first question under Rule 37(e) is whether ESI should have been preserved.

    The court emphasized that: “A party is not obligated to preserve every shred of a paper, every e-mail or electronic document.” Slip op. at 14-15 and footnote 51. But the party must preserve what it reasonably should know is relevant to the action. The duty applies to key people likely to have relevant data.

  2. The second step in a Rule 37(e) analysis is whether the ESI is lost. For purposes of Rule 37(e), information is lost only if it is irretrievable from another source including other custodians. Slip op. at 17.

  3. The third step in the Rule 37(e) analysis is whether ESI was lost because of the failure of a party to take reasonable steps to preserve it.

    In order to understand preservation, we must understand the components of ESI discovery.

    The court reviewed the five steps involved in ESI discovery: (i) Identification; (ii) Preservation; (iii) Collection; (iv) Review; and (v) Production. In this case the issues were identification and preservation.

(i) Identification: Taking reasonable steps to identify ESI is the first step in preserving evidence or information which should be collected and preserved. This involves locating the relevant people that have custody of the relevant ESI or the ability to obtain it, as well as the location of types of ESI. Slip op. at 18. This may involve interviewing individuals that might have information about the location of relevant ESI.

(ii) Whether there was a failure to take reasonable steps to preserve: The next step is to preserve ESI, but a party “need not preserve all documents in its possession; it must preserve what it knows and reasonably ought to know is relevant to possible litigation and is in its possession, custody, or control.” Slip op. at 19.

Importantly, the court explained that it should be “sensitive to the parties’ sophistication with regard to litigation in evaluating preservation efforts; some litigants, particularly individual litigants, may be less familiar with preservation obligations than others who have considerable experience in litigation.” Slip op. at 19 (emphasis added).

(iii) Steps Necessary to Preserve

The court distinguished between the practical steps an organization must take to preserve compared to an individual, but both must suspend routine document destruction policies. Slip op. at 20. For example, individuals must disable auto-delete functions, and also backup data for personal devices. Failure to do so may suggest they acted unreasonably. An individual must self-educate in order to learn what is necessary to prevent automatic deletion or destruction.

Applying the standards to the Facebook case, the court found that the COO was highly sophisticated as the chief operating officer and she knew what was required. She should have consulted company counsel if she had any doubts. Her failure to take steps to avoid the auto-deletion of her email was not reasonable. Slip op. at 21-22.

The court also explained that the director of the company who failed to disable his auto-delete function for  his personal emails acted unreasonably, but in his case there was no prejudice.

V. Prejudice Required

If there was no prejudice from the loss of ESI, no sanctions are imposed. Slip op. at 23. The court explained what prejudice means in this context.

The prejudice analysis requires that the requesting party provide an explanation as to why the lost ESI could have been relevant, but “the mere fact that evidence is lost is not sufficient to demonstrate prejudice; the requested party must provide a plausible explanation as to why evidence could have been relevant such that the failure to preserve is prejudicial.” Slip op. at 24.

Once the party seeking sanctions meets the initial burden, the party who failed to preserve must convince the court that the lost ESI did not result in prejudice, such as: because the material could not have been relevant, or would not have been admissible, or could not have been used by the requesting party to its advantage. Slip op. at 24.

The court explained why the loss of the COO’s emails was prejudicial—but why there was no prejudice from the emails of the board member that were lost. Slip op. at 25-27.

VI. Sanctions

The court rejected most of the requests for sanctions, and only imposed an elevated requirement for the burden of proof, as well as an award of fees for bringing the motion for sanctions. Slip op. at 29.

Frank Reynolds, who has been covering Delaware corporate decisions for various national publications for over 35 years, prepared this article

The Delaware Supreme Court recently upheld the Court of Chancery decision that Oracle Corp. founder Larry Ellison did not disloyally cause the computer software company’s directors to significantly overpay for cloud-based business software purveyor NetSuite Inc. – which he allegedly also controlled, in In re Oracle Corp. Derivative Litig., Del. Supr., No. 139, 2024 (Jan. 21, 2025). 

Writing for the full high court, in what could be the last chapter of the long-litigated 2017 merger dispute, Chief Justice Collins J. Seitz Jr. said that Chancery correctly rejected the derivative plaintiffs’ claim that Ellison wrongly withheld from the Oracle board information that would have probably affected the merger price in Oracle’s favor.  

“We note with skepticism the argument that Ellison should have made his post-closing views known during the Special Committee’s process,” the Chief Justice wrote.  “On appeal, we will not overturn the court’s conclusion that Ellison’s undisclosed post-closing plans for operating NetSuite were immaterial to the Special Committee’s evaluation and negotiation of the transaction.”  He added that there was insufficient proof Ellison could have swayed Oracle’s acquisition committee directors even if they had known about his post-merger plans for NetSuite.

The decision reaffirmed the Delaware law parameters of what personal information about post-merger plans  a corporate officer must divulge to directors in negotiations.

Background

The 2017 merger talks sparked seven years of litigation, a half dozen Chancery Court decisions and finally a ten-day trial leading to a Court of Chancery May 12, 2023 judgment that was appealed to the state high court.

Oracle shareholder plaintiffs charged in the first of several 2017 Chancery derivative suits that when Oracle founder Larry Ellison and CEO Safra Catz proposed to acquire NetSuite — which Ellison also founded and controlled — he first verbally agreed with NetSuite executives to a per-share price in the $100-to-$125 range even though that was not in the Oracle investors’ best interests.

Charges that Ellison and Catz breached duties of loyalty and candor in the merger negotiations and disclosures withstood their motion to dismiss and, in an unusual turn for a derivative suit, Oracle’s directors waived their right as the corporation’s managers, to press the claims. In re Oracle Corp. Derivative Litig., 2018 WL 1381331 (Del. Ch. Mar. 19, 2018).

In its post-trial opinion, the Court of Chancery entered judgment for the remaining defendants after concluding that the special committee negotiated the NetSuite transaction untainted by Ellison’s or Oracle management’s influence.  In re Oracle Corp. Deriv. Litig., 2023 WL 3408772 (Del. Ch. May 12, 2023.) 

The appeal

In this appeal, the stockholders contend that the lower court erred by: 

(1) allowing the SLC to withhold its interview memos from the plaintiffs; 

(2) applying business judgment review to a transaction involving an alleged controlling stockholder;

3) employing the wrong legal standard when evaluating whether Ellison misled the special committee by allegedly concealing his future NetSuite plans; and 

(4) finding that Ellison’s alleged undisclosed future operational plans were immaterial to the special committee’s evaluation and negotiation of the transaction.

The high court ruling

The high court said, under Rule 26(b)(3), to gain access to non-opinion work product, the plaintiffs must show that they have a “substantial need of the materials in the preparation of their case and that the party is unable without undue hardship to obtain the substantial equivalent of the materials by other means.” The Court of Chancery did not exceed its discretion on that issue, the Justices said.

The justices said the Court of Chancery rightly applied defendant-friendly business judgment review — not the more stringent entire fairness — to the Oracle/NetSuite transaction. Although Ellison held a substantial block of Oracle stock and was its visionary co-founder, the court decided that the plaintiffs failed to prove Ellison wielded either general control over Oracle or transaction-specific control — or that fiduciaries misled the Special Committee while considering the transaction. “We affirm its decision to apply business judgment review to the transaction.”

The answer to the control question

The control question is “a judicial conclusion that is reached after a fact-specific analysis.” The Chief Justice said the Vice Chancellor rightly found the following unchallenged facts to conclude that Ellison, as a minority stockholder, did not exercise actual control over the Oracle board:

· the Oracle board and management were not afraid to disagree with Ellison;

· Ellison neither controlled Oracle’s day-to-day functions nor dictated Oracle’s operations to the Oracle board;

· Ellison “scrupulously avoided” discussing the transaction with the Special Committee.

· Ellison neither proposed the transaction nor indirectly controlled the merger negotiations through his January 27, 2016, phone call with director Goldberg; and

· although Ellison could have controlled the transaction, he did not interfere with or actually exercise control over the transaction

The conclusion

The high court concluded that: a fiduciary may not use superior information or knowledge to mislead others by withholding material information from the board, engage in deceptive conduct, or otherwise mislead the board. If so, he has failed to act in good faith and therefore would have acted disloyally–but that was not the case here.

A recent Court of Chancery decision determined that the sale of a company initiated by the controller, a private equity fund which was also the largest equity holder in the company, did not run afoul of the business judgment rule. The decision in Manti Holdings, LLC v. The Carlyle Group Inc., C.A. No. 2020-0657-SG (Del. Ch. Jan. 7, 2025), is noteworthy for several reasons.

First, it describes in detail the factual and legal reasons why the controller that initiated the sale of the company was only subject to the business judgment rule review, as opposed to the entire fairness standard. The opinion is also notable for its description of the typical timetable for exiting from investments that is common among private equity firms.

Aside 

As an aside, after 20 years of providing highlights on this blog of Delaware corporate and commercial decisions, I have found that the most useful service I can provide via blog posts regarding 68-page post-trial decisions like this one, is to list key bullet points with references to page numbers and footnotes of the decision for those who want to spend more time doing a deep-dive into specific parts of the court’s opinion. For those looking for more verbose commentary generally, there are plenty of other more time-consuming law review articles and subscription services to read that provide lengthy ruminations.

Short Overview

This case involved The Carlyle Group, the largest equity holder in a company called Authentix, and related entities. Carlyle’s private equity fund partnership agreement provided for a fund life of 10 years—although that did not impose a contractual obligation for Carlyle in this case to exit any particular investment at that time.

The minority stockholders claimed that Carlyle’s business model required it to sell Authentix regardless of price, and that it caused the board to force a sales process that was unfair to stockholders. After a 7-day trial, the court determined that the interest of Carlyle was the same as that of the minority stockholder’s—which was to maximize the value of its investment.

The court reasoned that: (i) there was no pressure for a quick exit, nor did Carlyle conduct a fire sale; (ii) Carlyle did not extract a non-ratable benefit; (iii) that the sale was arms-length; and (iv) moreover, the court determined that the business judgment rule applied to the sale–and not the entire fairness standard.

For more factual background details, the 2 prior Chancery decisions in this case should be consulted; the citations for those 2 prior Chancery decisions are found at footnotes 50 and 208.

Highlights

  • The court provides an extensive factual description of the important details found after a 7-day trial regarding, for example, the various investors in the company and the sales process. See Slip op. at 3 to 32.
  • As a practice tip, writers of pleadings and the like who file in Chancery should observe how the court structures its opinions in terms of: using Roman numerals (I, II, III) for initial sections, and denoting the next sub-sections with capital letters (A, B, C), and then using Arabic numbers (1, 2, 3) for the next sub-sections. Careful writers should also observe the court’s abbreviations for trial exhibits and trial transcripts, as well as how the court refers to the parties’ briefs and other factual sources. See Slip op. at 3.
  • Two key basics of corporate law are always useful to repeat as a refresher: (1) Even as a controller, Carlyle as a stockholder was “free to sell its stock for its own reasons and on its own timing,” and as a stockholder, it was “owed fiduciary duties by the directors.” Slip op. at 34 (emphasis in original); (2) The court emphasized, however, that: “when acting as a controller, Carlyle itself could owe fiduciary duties to the Company and its stockholders.” Id.
  • Although the court observed that Carlyle could be liable if it used its corporate control to compete with the majority for consideration, the facts did not support the view that they did so.
  • The court also rejected the argument that Carlyle extracted for itself a form of consideration that was uniquely valuable, and also rejected the argument that the entire fairness standard applied. Slip op. at 35.
  • A useful definition of a “controller” for the toolbox of corporate litigators is the following: when a stockholder: “(1) owns more than 50% of the voting power of a corporation, or (2) owns less than 50% of the voting power of the corporation but ‘exercises control over the business affairs of the corporation.’” Slip op. at 37 and footnote 223.
  • The court also instructed that “a group of stockholders may be deemed a ‘control group’ and considered a controlling stockholder such that ‘its members owe fiduciary duties to their fellow shareholders.’” Id. and footnote 224.
  • The thorough reasoning of the court applied the extensive facts to the law in order to support its conclusion that the entire fairness standard did not apply and Carlyle did not receive a non-ratable benefit, as well as explaining why the Company conducted a fair sales process—and was not contractually bound to sell by a certain deadline. See Slip op. 39 to 67.

Frank Reynolds, who has been covering Delaware corporate decisions for various national publications for over 35 years, prepared this article

A recent Delaware Court of Chancery opinion clarifies how and when a majority of directors may lack independence from its CEO, and finds Rupert Murdoch’s financial or personal influence could have skewed the objectivity of another three key Fox Corp. directors as to whether a shareholder derivative suit passes Delaware’s pre-suit demand test, in In Re Fox Corporation Deriv. Litig, No. 2023-0418-JTL (Del. Ch.  Dec. 27, 2024).

In his December 27 opinion, Vice Chancellor Travis Laster rejected the defendant directors’ motion to dismiss the breach-of-duty suit. He rejected the argument that the plaintiffs failed to show that CEO/Board Chairman Murdoch’s influence swayed the judgment of his son Lachlan and two other directors, depriving the eight-member Fox board of the five objective directors it needs to make the call on the suit’s merit.

A Massey claim

The vice chancellor found that the plaintiffs alleged a viable Massey claim against CEO Murdoch and three Fox Corp. directors who supported his decision to bring deserting viewers back to Fox News’ 2020 election coverage by knowingly airing Donald Trump’s claims that his re-election victory was “stolen” by rigged voting machines.  When Murdoch refused to retract, the two suppliers of those machines – Dominion Voting Systems and Smartmatic USA – sued, and one won a $787 million settlement while the other’s suit continues, triggering the investor suit.

Those consolidated plaintiffs sought to shift the Company’s losses onto the individuals who they say caused the Company to violate the law and suffer harm.  They contend that Fox’s senior officers—including K. Rupert and Lachlan K. Murdoch—and the other directors decided to violate the law by having Fox News defame Dominion and Smartmatic. 

They argued that Chancery had ruled in the Massey case that any board decision to profit by violating the law—as was the case here—is automatically a breach of the directors’ duty of loyalty.  In re Massey Energy Co., 2011 WL 2176479, *20 (Del. Ch. May 31, 2011).

The derivative suit decision

The investor suit decision set out the demand test standard to decide whether “the board in place when the complaint was filed had a majority of directors who could make an independent and disinterested decision about whether to assert the claims articulated in the complaint” including:

(i) Did the director receive a material personal benefit from the alleged misconduct that is the subject of the claim?

(ii) Does the director face a substantial likelihood of liability on the claim?

(iii) Does the director lack independence from someone who received a material personal benefit from the alleged misconduct that would be the subject of the claim or who would face a substantial likelihood of liability on the claim.

Pre-suit demand review

The vice chancellor said his required director-by-director examination for demand purposes need not go further than the question of CEO Murdoch’s liability for deciding to air false content for profit and the three directors’ willingness to support an illegal action out of loyalty to him.  He said Murdoch controlled Fox through the Murdoch Family Trust, which owns 43.4% of Fox’s powerful Class B voting shares, so the motion to dismiss hinged on whether there was proof that his son Lachlan Murdoch and fellow directors Charles Carey and Jaques Nassar supported that decision because of their financial or personal ties to him.

Lachlan

Vice Chancellor Laster said, “First, he is not independent because he is Murdoch’s son. Second, he is not disinterested. If anything, the claim against Lachlan is stronger, because Lachlan engaged in more frequent communication with director Suzane Scott, his direct report, about Fox News and its content, and he regularly texted comments to Scott about Fox News’ coverage.”

Carey

The court said Carey is an example of the axiom that, “Longstanding business affiliations, particularly those based on mutual respect, are of the sort that can undermine a director’s independence. Directors who owe their success to another will conceivably feel as though they owe a ‘debt of gratitude’ to the individual.” 

The court noted that, “The relationship between Carey and Murdoch is inferably closer than what the Delaware Supreme Court found adequate in Match”, referring to the decision in  In re Match Gp., Inc. Deriv. Litig., 315 A.3d 446, 472 (Del. 2024).

Nassar

Regarding the independence of Nassar, the court said, “In addition to pleading longstanding business affiliations, a complaint may plead facts providing reason to doubt a director’s independence by pointing to shared, membership in “elite and selective clubs,” but “the complaint pleads a constellation of facts” that goes beyond what was sufficient in BGC, referring to the Court’s decision in In re BGC P’rs, Inc., 2019 WL 4745121 (Del. Ch. Sept. 30, 2019).

In summary

The court said that while Delaware-chartered companies have wide latitude as to how to make money, “What a corporate fiduciary cannot do, however, is make a business judgment to cause or allow the corporation to break the law. “Delaware law does not charter law breakers.” as the Massey decision explained.

Sean Brennecke, a partner in the Delaware office of Lewis Brisbois, prepared this post.

In LKQ v. Rutledge, 2024 WL 5152746 (Del. Supr. 2024), the Delaware Supreme Court recently responded to questions certified by the United States Court of Appeals for the Seventh Circuit by confirming that the Supreme Court’s ruling in Cantor Fitzgerald, L.P. v. Ainslie, 312 A.3d 674 (Del. 2024)—that forfeiture-for-competition provisions are not reviewed for reasonableness—was not limited to provisions in limited partnership agreements.  2024 WL 5152746, at *6.  While the Court’s decision itself may not be surprising, it is notable for two reasons.

First, the Supreme Court held that “[i]t may be the case that forfeiture-for-competition provision which required a claw back is so extreme in duration and financial hardship that it precludes employee choice by an unsophisticated party and should be reviewed for reasonableness,” thus leaving open the possibility that Ainslie may not apply to every forfeiture-for-competition provision.  Id. at *6.  The Supreme Court did not expand on its holding, citing Court rules which limit responses to certified questions to addressing “issues of law based on stipulated facts.”  Id. at *6.

Second, the LKQ decision provided a helpful and concise summary of the current state of forfeiture-for-compensation provisions, including

  • Delaware embraces the employee choice doctrine under which “courts do not review forfeiture-for-competition provisions for reasonableness so long as the employee voluntarily terminated her employment.”  Id. at *5.
  • “A restricted stock unit agreement stands on different footing than underlies non-competition covenants because it does not restrict competition of a former employee’s ability to work.” Id. at *4.
  • Forfeiture-for-competition provisions are conditions precedent to paying future distributions and not liquidated damages.  Id. at *5.
  • Unlike restrictive covenants, forfeiture-for-competition provisions are not enforceable through injunctive relief and do not deprive the public of the employee’s services.  Id. at *5
  • “[R]estraint of trade policy implications are diminished—if it does not vanish—for forfeiture-for-competition provisions.”  Id.

While the Supreme Court’s decision in LKQ suggested—but did not hold—that there may be circumstances in which a forfeiture-for-competition provision is reviewed for reasonableness, until the Court makes that express ruling Ainslie remains good law and the LKQ opinion offers helpful guidance on how to apply it.

This is the 20th-anniversary edition of Francis Pileggi’s annual list of key corporate and commercial decisions of the Delaware Supreme Court and the Delaware Court of Chancery. This year’s list does not attempt to include all important decisions of those courts that were rendered in 2024, and eschews some of the cases already extensively discussed by the mainstream press or legal trade publications. This list highlights 20 of the notable decisions that should be of widespread interest to those involved in corporate and commercial litigation or those who follow the latest developments in this area of Delaware law.

The National Law Review published this year’s annual review today at the following link and we appreciate them making it available to all our readers: 20th Annual Review of Key Delaware Corporate & Commercial Decisions.

The titular topic was the subject of my latest ethics column for The Bencher, the flagship publication of the American Inns of Court. I have been writing the ethics column for over 25 years, during which I have written many articles on the topic of judicial recusal, some of which are linked in this article, hyperlinked above.

Two recent letter decisions provide practice tips from the Chancellor for Chancery practitioners regarding coordinating with non-Delaware lawyers working on Chancery cases, as well as nuances of contacting chambers for scheduling purposes. In the matter styled In re SwervePay Holdings Acquisition, LLC, C.A. No. 2021-0446-KSJM (Del. Ch. Oct. 21, 2024), the court provided instruction for non-Delaware lawyers working with Delaware lawyers as follows:

  • The court advised that non-Delaware lawyers should “allow the Delaware attorneys to advise on all aspects of [the] matter, including the relevant deadlines, the need to meet them, and the need to extend basic courtesies like brief extensions when requested.”
  • “… it also bears reminding that non-Delaware attorneys should not dump their brief on their Delaware friends at the last minute.”

See generally Guidelines for Practicing in the Court of Chancery published by the Court.

In Anchorage Police & Fire Retirement Systems, et al. v. Adolf, C.A. No. 2024-0354-KSJM (Del. Ch. Oct. 22, 2024), the Chancellor provided protocols for nuances of scheduling that might be regarded as unwritten rules and insights into how the court schedules hearings.

The court instructed that hearings are scheduled on motions in 90-minute blocks. The court added that if a party needs more than 90 minutes to present a motion “that it is incumbent on that party to request more time through a motion or letter on the docket filed in advance of a hearing.” Slip op. at 2.

The court also informed the parties that when calling chambers for scheduling, the litigants should assume that the Chancellor’s assistant “has a better understanding” of the Chancellor’s schedule, and simply because there is nothing on the docket does not mean that the Chancellor is available at that time.

Most indemnification cases involve successfully defending claims, but a recent Delaware Court of Chancery decision granted indemnification for the successful pursuit of a books and records action, in Gentile v. GPB Capital Holdings, LLC, C.A. No. 2024-0165-PAF (Del. Ch., Nov. 27, 2024).

This decision is noteworthy because it explains the broader scope of indemnification that is possible based on the terms of an operating agreement for an alternative entity. This should be compared with the more typical fact pattern for an indemnification claim, such as that involved in a recent Chancery decision addressing another post-closing dispute, highlighted on these pages on the same day as this blog post was published.

Brief Overview of Background

This case involved the sole member, Gentile, and during the relevant period the sole manager, of an LLC who successfully pursued a books and records action in connection with obtaining information necessary to prepare and file the tax returns of the LLC.

Although the facts in this case are somewhat sui generis, the court’s interpretation of the indemnification provision in the LLC agreement is still noteworthy for the broader application of its reasoning. In this case, the sole member and manager was displaced by a receiver appointed by a federal court in connection with civil and criminal proceedings against the sole member brought by the U.S. Securities and Exchange Commission as well as the U.S. attorney for the Eastern District of New York.

Gentile successfully pursued a books and records complaint under Section 18-305 of the Delaware LLC Act to obtain records necessary to prepare his tax returns and those of the LLC, in his role as the “Tax Matters Partner” of the LLC. [The implementing order in the post-trial decision for the books and records case was signed on November 29, 2023, but the parties did not enter into a stipulated confidentiality order to implement the post-trial decision until May of 2024.] In February of 2024, Gentile filed the instant indemnification action.

Highlights

The indemnification provision in the LLC agreement had five key parts. It provided that, to the “fullest extent permitted by applicable law”: (i) a covered person is entitled to indemnification from; (ii) any loss; (iii) by reason of any act by such covered persons; (iv) in good faith on behalf of the company; and (v) in a manner reasonably believed to be within the scope of authority conferred on such covered person.

  • The court applied that provision to the facts of the case and found that the plaintiff was a covered person. The court then analyzed whether the loss was “ by reason of” an act by the covered person.
  • The court applied by analogy the cases in the corporate context holding that an action meets the “by reason of” standard “if there is a nexus or causal connection” between any of the underlying proceedings in one’s official capacity, regardless of one’s motivation for engaging in that conduct. Slip op. at 9. The court found that Gentile established a causal connection between the books and records action and the obligation to prepare the tax returns of the LLC.
  • As the Tax Matters Partner of the LLC, and the sole member, the court determined that Gentile was the only individual permitted to certify and file the tax returns of the LLC, citing a federal statute that provides the general rule that an entity is disregarded for tax purposes as an entity separate from its single owner. Slip op. at 11. The LLC agreement also provided that the Tax Matters Partner has the power to file tax returns. Id.
  • Importantly, the court emphasized that as long as Gentile acted in a “manner reasonably believed to be within the scope of authority conferred on him by the LLC agreement” it was reasonable for him to believe he had the authority to file the tax returns. Slip op. at 12.
  • A key issue was whether or not Gentile was required to show that he acted in good faith. The court reasoned that an indemnification agreement in an alternative entity that grants mandatory indemnification “to the fullest extent permitted by law,” as the agreement here does, means that mandatory indemnification is required when the party “has been successful . . . on the merits or otherwise, without having to show good faith.” Slip op. at 13.
  • Notably, notwithstanding the provision that included a good faith requirement in the agreement, the court determined that because the claimant was successful on the merits in the books and records action, he is not required to make a showing of good faith to be entitled to indemnification. Id.
  • In determining “success on the merits,” the court explained that it “looks strictly at the outcome of the underlying action” and that despite imposing some restrictions as part of the books and records decision, the court ruled in favor of Gentile. Id.
  • The court’s analysis of what is meant by “success on the merits” is useful when someone does not win 100% of the relief requested.
  • It’s also noteworthy for purposes of the conclusion that good faith need not be shown when there is success on the merits–in light of the provision involved in this case. Slip op. at 13-14.
  • Lastly, the court applied the truism that when one is found entitled to indemnification, it follows that “fees on fees” for pursuing indemnification are also granted. Slip op. at 17-18.

The analysis, in the context of a post-merger dispute, of the nuances of an indemnification provision and whether or not escrow funds should be released was the subject of a recent Delaware Court of Chancery decision in Reddy v. 2nd Chance Treatment Centers, LLC, C.A. NO. 2024-0193-SKR (Del. Ch., Dec. 12, 2024). Sitting by designation, Judge Sheldon Rennie of the Superior Court addressed the multiple claims that were the subject of a motion to dismiss. The decision examines closely the various provisions related to the notice requirements and the types of claims that would trigger the indemnification provisions as well as the requirements for releasing the escrow funds.

For purposes of this short blog post, I highlight the legal standards for declaratory judgment in the context of an indemnification provision, as well as the ability to seek specific performance to obtain the release of escrow funds. (I note in passing that some decisions over the y have raised questions about whether the payment of money as the type of requested relief renders the Court of Chancery’s equitable jurisdiction unavailable.)

Highlights

  • The requirements for declaratory judgment are always useful to recall. In Delaware, “parties to a contract can seek declaratory judgment to determine any question of construction or validity and can seek a declaration of rights, status or other legal relations thereunder.” See Slip op. at 20 and footnote 106 and accompanying text.
  • The court recited the four prerequisites for a declaratory judgment request to be justiciable: (1) It must be a controversary involving the rights or other legal relations by the party seeking declaratory relief; (2) It must be a controversy in which the claim of right or other legal interest is asserted against one who has an interest in contesting the claims; (3) The controversy must be between parties whose interest are real and adverse; (4) The issue involved in the controversy must be ripe for judicial determination. Id. at footnote 107.
  • The court found that there was an actual and present controversy about terms of the relevant contracts and whether the escrow fund should be released. Slip op. at 20-21.
  • After discussing the basics of the objective theory of contracts that Delaware follows, the court examined the specific provisions and nuances of the indemnification provisions involved. Id. at 21.
  • The court refused to inject into the agreement an obligation to provide information beyond the provision in the agreement that one of the parties keep the other apprised. Slip op. at 22-23.

Specific Performance

  • A place in the tool box of litigators should be found for the court’s statement of the law that a decree of specific performance is the appropriate form of relief to compel the release of funds from an escrow account. Slip op. at 29.
  • After reciting the elements that must be proven “by clear and convincing evidence” to obtain specific performance, the court held that in this matter the plaintiffs lacked an adequate remedy at law in part because the terms of their agreement provided that “irreparable damage will occur in the event that any of the provisions of this agreement were not performed in accordance with their specific terms. . . .” Slip op. at 29.
  • The court also disagreed that the requested relief of specific performance was premature. The court read the provisions of the agreement to provide that the escrow agent was not obligated to retain any amounts when no specific amount was set forth in the notice of claim.
  • The court denied the motion to dismiss as to this count which specifically sought to require the buyer to enter into a joint release instruction to the escrow agent to release the escrow funds held for indemnification purposes.

In an expedited post-trial decision, the Delaware Court of Chancery recently determined who the proper managers were of an LLC, as well as the validity of the removal of a manager, pursuant to the summary proceedings provided for in Section 18-110 of the Delaware Limited Liability Company Act. In St. Peters, L.P. v. Bold On Boulevard LLC, C.A. No. 2024-0653-MTZ (Del. Ch. Nov. 19, 2024), the court provided a detailed factual recitation of the terms of the operating agreement formed for the development of a large apartment complex.

Highlights

Interested readers should review the important factual details, but for purposes of this short blog post I wanted to highlight a few noteworthy aspects of the decision.

  • Section 18-110 allows for the Court of Chancery to hear and determine the validity of any “admission, election, appointment, removal or resignation of a manager of a limited liability company, and the right of any person to become or to continue to be a manager of a limited liability company.” It also provides for a summary proceeding limited to determining issues that “pertain to the validity of an action to elect or remove a manager.” Slip op. at 13.
  • The court recited the truism that Delaware is contractarian, and in this context, the court observed that notice provisions and cure provision are recognized as important contract terms. Slip op. at 14.
  • In my view, the most noteworthy aspect of this decision is the comparison of different provisions in the operating agreement, some of which provided that consent could not be unreasonably withheld—but other provisions did not include that “exception” to the right to consent.
  • Specifically, some provisions requiring consent before an action could take place, allowed the party whose consent was necessary to: “grant or withhold consent in such member’s sole discretion, unless otherwise stated,” in one section. Likewise, another section allowed the “absolute independent right to grant, deny, withhold or condition any requested consent or approval based on its own point of view, but subject to the implied covenant of good faith and fair dealing.” Slip op. at 19-20.
  • The court observed that the implied covenant of good faith and fair dealing “is omnipresent: one need not speak its name, even once, to make it appear.” Slip op. at 20.
  • The court, citing other cases, observed that consistent with the implied covenant, the party whose consent is required retains the freedom not to give approval if granting consent was not in its own commercial interest. Slip op. at 20. See footnotes 94-95 and accompanying text.
  • Notably, some sections of the agreement specifically provided that consent could not be “unreasonably withheld,” but the other sections at issue did not have such a restriction. Id.
  • To put a sharper point on it, the court expressly rejected the argument that consent could not be withheld unreasonably—unless the agreement imposed that express condition.
  • The court emphasized that: “the court should not read a reasonableness requirement into a contract entered into by two sophisticated parties nor imply an obligation inconsistent with the parties’ express agreement.” See footnotes 98-99, and accompanying text.
  • This interpretation was bolstered by other consent provisions in the same agreement which did include the commonplace condition that consent not be unreasonably withheld. Slip op. at 21-22.
  • Nonetheless, the court held that it was neither unreasonable nor arbitrary under the circumstances of this case for consent to be withheld. Slip op. at 22.
  • Another noteworthy aspect of this decision was the court’s discussion of interim fee awards based on fee-shifting provisions in the parties’ agreement. The court discussed the circumstances in which interim fee awards may be appropriate, but that there was no exigency or other special circumstance demonstrated in this case that would warrant them. See Slip op. at 25-26.

Frank Reynolds, who has been covering Delaware corporate decisions for various national publications for over 35 years, prepared this article

The Delaware Court of Chancery recently declined to revise its January post-trial decision that the Tesla Inc. directors’ more than $55 billion pay package for CEO Elon Musk was a breach of duty that must be rescinded — despite what the electric carmaker’s board called a ratifying shareholder approval vote, in Tornetta v. Musk, et al. C.A. No. 2018-0408-KSJM (Del. Ch. Dec. 2, 2024).

Chancellor Kathaleen McCormick’s December 2 opinion rejected the director defendants’ plethora of objections to her January post-trial decision that the pay plan was a waste of corporate assets and could not pass the entire fairness test. That allowed plaintiff Richard Tornetta to continue his ultimately successful derivative suit seeking recission of Musk’s record-setting stock grant.  

She awarded the investor plaintiff a $345 million fee in cash or stock, limiting the amount only because of the windfall rule exception.

In the December opinion, the Chancellor had occasion to address myriad novel arguments and legal theories because, “The large and talented group of defense firms got creative with the ratification argument, but their unprecedented theories go against multiple strains of settled law” in four ways, each of which could defeat defendants’ motion.

Four flawed fault theories fail

“First, the defendants have no procedural ground for flipping the outcome of an adverse post-trial decision based on evidence they created after trial.

“Second, common law ratification is an affirmative defense that must be timely raised, which means that, at a minimum, it cannot be raised for the first time after the post-trial opinion.

“Third, what the defendants call “common law ratification” has no basis in the common law—a stockholder vote standing alone cannot ratify a conflicted-controller transaction.

“Fourth, even if a stockholder vote could have a ratifying effect, it could not do so here due to multiple, material misstatements in the proxy statement.”

Fee limited by Windfall Rule

The Chancellor said the suit brought about the rescission of the $55-plus billion grant, which might theoretically generate a multi-billion fee by the usual way of calculating awards in successful derivative plaintive suits based on the value of the savings for the stockholders.  But here, the “eyepopping” result of that method must yield in this way, because the multi-billion amount at issue is a windfall no matter the methodology used to justify it.” 

”To reach a reasonable number”, she said, ”this decision adopts the defendants’ approach and uses the $2.3 billion grant date’s fair value to value the benefit achieved,” and that results in the $345 million fee using a “conservative” 15% rate. 

Background

The litigation arose from a 2018 board plan to grant Musk nearly the top amount of stock compensation he would be eligible to receive since he allegedly achieved all the performance goals in his contract at Tesla –resulting in the largest executive compensation award in the history of public markets and a six-year shareholder derivative suit battle.  Tornetta charged the directors — and Musk as controlling shareholder – breached their fiduciary duty through the grant,

Chancellor McCormick ruled on January 30 that the grant was a conflicted transaction and thus did not qualify for the protection of the defendant-friendly business judgment rule. C.A. No. 2018-0408-KSJM, Docket (“Dkt.”) 294, Tornetta v. Musk, 310 A.3d 430 (Del. Ch. 2024), 

Investor, not court, approval 

After she ruled in January that the suit could continue due to the directors’ possible conflict, and ordered rescission, plaintiff moved for a fee award.  Defendants sought revision of the ruling after obtaining a shareholder majority vote approving the compensation package — which they claimed was a ratification that met the requirements of entire fairness.

Were there other grant options?

The Chancellor noted that, “Contrary to how some have read the Post-Trial Opinion, the court did not find that the Board should have paid Musk nothing. There were undoubtedly a range of healthy amounts that the Board could have decided to pay Musk. Instead, the Board capitulated to Musk’s terms and then failed to prove that those terms were entirely fair.”

She also noted that, “Tesla did not issue any stock in connection with the Grant, and so rescission will not result in the return of any stock to Tesla’s treasury.  Rather, rescission terminated Tesla’s obligation to issue restricted stock and revoked Musk’s right to exercise the options.

What’s the difference in relief?

Additionally, she pointed out that although defendants’ briefing challenged the law supporting the rescission order, by the time the case reached oral argument, ‘defense counsel made “very clear” what they were seeking, stating: “This motion does not seek to vacate the Court’s factual findings or its legal conclusion. The only relief we are seeking at this point is that the Court modify the remedy set forth in the opinion.”  But that requested remedy would, in effect, result in reversing the January ruling, she said.

And she pointed out that Musk’s sway over Tesla was such that the directors agreed two weeks after the January decision to grant his wish to move the company’s charter to what he said on social media was the more corporate friendly environment of Texas.

Newly created, not newly discovered evidence

As to whether the Court should consider the purported ratifying effect of the shareholder approval vote on the grant’s ability to meet the entire fairness test, the Chancellor made a key distinction: Defendants urged the court to apply the more movant-friendly standard of Rule 54(b). But Rule 54(b) is “a poor fit at this procedural posture”, she said, because “judgment did not contain factual findings and in the context of representative litigation, the Delaware Supreme Court has held that “[a] judgment on the merits is not final until an application for an award of attorneys’ fees has been decided.”

Conclusions

Chancellor McCormick concluded that “Whether to permit a party to assert a late-raised defense is a matter of judicial discretion where the court must take into account the potential for prejudice to the other party.  This court has allowed a party to raise an affirmative defense based on a stockholder vote that occurred during litigation. But she said, “no court has ever allowed a party to deploy stockholder ratification as a defense after the close of fact finding, with one possible exception that did not apply here.” 

 Besides, the director’s proxy was misleading, and a shareholder vote alone cannot ratify a conflicted transaction, she ruled.

Aimee Czachorowski, an attorney in the Delaware office of Lewis Brisbois, prepared this post.

Chancellor McCormick’s recent letter decision in Floreani, et al. v. FloSports, Inc., C.A. No. 2023-0684-LM-KSJM (Del. Ch. Oct. 31, 2014), illustrates the pitfalls of non-compliance with the technical requirements of a Section 220 demand by a stockholder for corporate books and records.

The Chancellor summarized the statutory form-and-manner requirements–as well as those imposed by case law–that must be complied with when making a Section 220 books and records request, as follows:

“Breaking it down, Section 220(b) requires that a demand: (1) be in writing, (2) be under oath, (3) state the stockholder’s purpose, and (4) be directed to the corporation at its registered agent or principal place of business. (5) If the stockholder is not a record holder, then the demand must be accompanied by documentary evidence of beneficial ownership of the stock. (6) If the demand is sent by an attorney, then it must be accompanied by a power of attorney. That’s four form-and-manner requirements that apply in all circumstances and two that apply in certain circumstances. The form-and-manner requirements are not onerous, but they are strictly enforced.”

The Court further noted that an “implied condition of the fifth and sixth form-and-manner requirements” is that the demand must “identify the stockholders on whose behalf [the demand] is sent.”

Concluding that three separate demands made under Section 220 were deficient, the Court granted the defendant’s exceptions to the Master’s report. Notably, Section 220 requires a five-day waiting period after the demand–before filing suit.

But here, the five-day waiting period was not complied with when plaintiffs made their third demand; plaintiffs made a motion to amend the same day they served the demand, although they waited an additional five days after the demand to serve the proposed amended complaint. The Chancellor found that the motion to amend, made before the statutory five-day window closed, did not comply with the requirements of Section 220(c).   

Vice Chancellor J. Travis Laster of the Delaware Court of Chancery and Professor Elise Bernlohr Maizel recently published a law review article entitled Discovery as a Compliance Problem, available at this hyperlink, 50 J. Corp. L. 53 (2024), which should be read by all lawyers involved in commercial litigation in Delaware.


Highlights include the following bullet points:

  • Civility expectations, and a reminder that the duty of a lawyer to the Court supersedes the duty to a client. See pages 73-77.
  • There is no such thing as “local counsel” in Delaware. That is, Delaware counsel will be held responsible for all court filings and all positions taken–even if out-of-state counsel is taking the lead. See footnotes 148-149 and accompanying text.
  • Deposition rules in Delaware impose more restrictions and duties on lawyers compared to many other states. See page 77.
  • Deadlines in scheduling orders are strictly enforced in Delaware. See page 79.
  • Privilege may be waived if a privilege log is not properly compiled. See pages 79-80.
  • Boilerplate objections to discovery requests are not truly replies at all–especially when the objection does not make clear what exactly is being withheld and what is being produced. See pages 80-82. See also Del. Ct. Ch. R. 34(b) (requiring specific objections and explanations about what is being withheld based on objections.)

Several recent articles by corporate law scholars and a jurist (who also deserves to be called a scholar) are worth highlighting. Professor Stephen Bainbridge, often cited in Delaware court decisions and a friend of this blog, and Vice Chancellor Travis Laster, have authored recent articles that should be of interest to those who follow Delaware corporate law.

Professor Bainbridge penned a law review article entitled: A Course Correction for Controlling Shareholder Transactions, which, as the title suggests, analyzes the duties of controlling shareholders and related issues.

Vice Chancellor Laster also penned an article on the duty of controlling shareholders, that appeared on LinkedIn.

Professor Bainbridge commented on that article on his blog at this link.

Then, Vice Chancellor Laster made observations on LinkedIn about Professor Bainbridge’s blog post regarding the Vice Chancellor’s article.

Lastly, on a somewhat different aspect of corporate law, more recently the good professor addresses on his eponymous blog an article by another law professor, and incorporates responses to that article by a Delaware practitioner, that together address the perennial question of whether other states are seriously challenging Delaware’s prominence in the corporate law universe–especially in light of recent Delaware court decisions that, in the view of some, are perceived as anti-business.

Lawrence Cunningham is the new Director of the Weinberg Center for Corporate Governance at the University of Delaware. He is a prolific corporate law scholar and provides thought leadership on the perennial issue of Delaware’s role in the nation’s corporate law in a new article entitled: Delaware Corporate Law Still Gold Standard Amid ESG Blowback.

In a masterpiece of contract interpretation and statutory analysis, the Delaware Court of Chancery recently reconciled juxtaposed provisions in the Delaware General Corporation Law and a Certificate of Incorporation to allow a reincorporation of a Delaware company in Nevada with a majority vote—as compared to requiring a supermajority vote. Gunderson v. The Trade Desk, Inc., C.A. No. 2024-1029-PAF (Del. Ch., Nov. 6, 2024).

Brief Overview

Naturally, the detailed facts of this case are important but, in essence, the company involved proposed to effect its reincorporation pursuant to a conversion under Section 266 of the Delaware General Corporation Law. Section 266 allows a conversion by a majority of the outstanding shares of stock of the corporation entitled to vote upon the proposal. Article X of the corporation’s Certificate of Incorporation, however, requires the approval of 66 2/3rds of the outstanding voting power of the corporation’s stock, voting as a single class, to “amend or repeal, or adopt any provision” of the certificate inconsistent with certain enumerated articles of the certificate.

A stockholder alleged that the conversion resulted in an amendment of the Certificate of Incorporation and, therefore, triggered the supermajority requirement. The court disagreed.

Key Holding

Relying on the doctrine of independent legal significance, and a long line of cases upholding that doctrine, the court reasoned that the conversion was not subject to the supermajority vote requirement in the charter or certificate of incorporation.

In order for that supermajority provision to have applied, among other reasons, the charter would have needed to include additional language required to specify that the provisions of the charter applied outside of Section 242 of the DGCL, which governs amendments to a charter.

Highlights of the Court’s Analysis and Decision

  • A key principle that is a bedrock of Delaware corporate jurisprudence is that actions of a director are “twice-tested”: first for legal authorization, and second by equity. See footnote 23.
  • A keystone of the court’s analysis was the well-established doctrine of independent legal significance which holds that “legal action authorized under one section of the corporation law is not invalid because it causes a result that would not be achievable if pursued through other action under other provisions of the statute.” Slip op. at 16.
  • The court discussed at length a multitude of cases discussing the doctrine of independent legal significance, beginning with a case that was decided about 90 years ago. Slip op. at 16-26.
  • A few eminently quotable statements of law buttress the court’s reasoning, including the following:

“General language alone granting preferred stockholders a class vote on certain changes to the corporate charter (such as authorization of a senior series of stock) will not be read to require a class vote on a merger and its integral and accompanying modifications to the corporate charter and the corporation’s capital structure.”

Slip op. at 24 -25 (citations omitted).

  • Delaware has long adhered to: “application of the doctrine of independent legal significance and refused to extend charter-based voting requirements to mergers and consolidations absent clear language . . ..” Slip op. at 25 (citations omitted).
  • The court underscored that: “. . . it is well-established that, like the preferences of preferred stock, ‘high vote requirements’ ‘must be clear and unambiguous,’ leaving ‘no doubt that the shareholders intended that a supermajority would be required.”’ (citations omitted). Slip op. at 27.
  • “Delaware decisions have made clear that: if a party wants a consent right that applies to mergers generally, or which applies to mergers that have the effect of altering, amending or eliminating the special right that the party possesses, then the consent right must refer specifically to a merger.” Footnote 31.
  • In addition to the basic contract interpretation principles that apply to interpretation of a certificate of incorporation, the court emphasized a consequential principle of interpreting a charter that is an essential tool for the toolbox of corporate litigators: “When it comes to the construction and interpretation of a certificate of incorporation, ‘the agreement as a whole’ includes the DGCL and all of its amendments, which the Delaware legislature has determined ‘shall be a part of the charter, or certificate of incorporation of every corporation except so far as the same are inapplicable and inappropriate to the objects of the corporation….’” Slip op. at 28-29. See 8 Del. C. § 394. Also included are cases interpreting the DGCL.
  • The court noted that the doctrine of contra proferentem was not applicable when a contract was not ambiguous. Slip op. at 42.
  • In closing, the court explained that it would enter a partial final judgment pursuant to Rule 54(b) to allow an expedited appeal if any of the parties so chose.

The current issue of Delaware Today magazine published this month a list of “Top Lawyers” in Delaware for various areas of the law. Yours truly was included in the list under the category of “corporate law”. (There was no separate category for corporate litigation.) Congrats to my fellow Delaware lawyers who were included in the list, including my Delaware partners, Scott Cousins for business bankruptcy and Ciro Poppiti for hospitality law.

A recent Delaware Court of Chancery opinion addressed the not infrequent situation where a distressed company is sold or merged but only the preferred stockholders receive consideration—and the common stockholders receive nothing. In Jacobs v. Akademos, Inc., Del. Ch., C.A. No. 2021-0346-JTL (Del. Ch. Oct. 30, 2024), a scholarly work of art, the court conducts an analysis of the fiduciary duties of the directors who approved the deal.

Brief Factual Background

The first 3-pages of the decision provide a pithy overview of the key factual circumstances including that the challenged transaction was not conditioned on the twin MFW requirements—approval from both an independent special committee and a majority of the unaffiliated stockholders—because the company was in such a distressed financial situation that it lacked the funds to support a full-blown MFW process.

A group of common stockholders led by the company’s founder sought appraisal rights and also asserted plenary claims for breach of fiduciary duty against the directors, challenging the deal on the basis that the common stockholders did not receive any consideration. The first 33-pages or so of the decision provide an exhaustive recitation of the factual details and credibility determinations.

The company involved had not made a profit in its 20-year history. An investor continued to provide necessary working capital and in exchange received preferred stock and other preferential rights upon sale or liquidation.

Summary of Holding

The court determined that the plaintiffs did not present a credible valuation, and the defendants at trial presented a convincing case that the fair value of the common shares at the time of the merger was zero. Regarding the plenary claims, the defendants bore the burden of proving that the challenged transactions were entirely fair, and they carried that burden. The court also noted, as an aside, that the net loss from the transaction to the primary investor with the preferred stock was $18 million.

Highlights

  • The court provides a primer on principles of Delaware appraisal law, as well as a critique of competing reports of valuation experts. The court explained: (i) why the court gave no weight to a Rule 409A valuation, and (ii) why it did not rely on deal price. Slip op. at 35 to 56.
  • The court addressed the analysis of the fair value of the minority interest by assessing the value attributable to the shares as a going-concern. Slip op. at 56 to 66. Notably, the court observed that in appraisal actions in Delaware, there is no minority discount imposed. Slip op. at 58 to 59.
  • The court described the two elements of a breach of fiduciary duty as: first, establishing that a fiduciary duty existed, and then, establishing that the defendant breached that duty. Slip op. at 67. The court observed that establishing the first element was easily satisfied in this matter, but the second element in this case was more complex.
  • The court distinguished between the standard of conduct and the standard of review when determining whether corporate fiduciaries breached their duties when approving a transaction.
  • The standard of conduct describes what those with fiduciary duties are expected to do, and is defined by the content of the duties of loyalty and care. Slip op. at 68.
  • The standard of review arises in the context of litigation when instead of using the standard of conduct, the courts in Delaware use three tiers of review for evaluating director decision-making: (i) the business judgment rule; (ii) enhanced scrutiny; and (iii) entire fairness. Slip op. at 68.
  • The entire fairness standard of review applied in this case and the two dimensions include: (1) substantive fairness (fair price); and (2) procedural fairness (fair dealing). Id.
  • The court underscored the distinction between “fair price” for purposes of appraisal, as compared to satisfying the entire fairness standard in connection with a breach of fiduciary duty claim: (i) the appraisal statute requires that the court determine an estimate for fair value using the special valuation standards in the statute. (ii) by contrast the fair price aspect of the entire fairness test is the standard of review to identify a fiduciary breach, and instead of picking a single number, the task of the court is to determine whether the transaction price falls within a range of fairness. Slip op. at 69 to 70 and 72 to 73.
  • The court elaborated on the fair price and fair dealing components of the entire fairness test. Slip op. at 69 to 72.
  • My favorite quote from the case is the following:
    • “Ultimately, fairness is not a technical concept. ‘No litmus paper can be found or Geiger-counter invented that will make determinations of fairness objective.’ A judgment concerning fairness ‘will inevitably constitute a judicial judgment that in some respects is reflective of subjective reactions to the facts of a case.’” Slip op. at 72.
  • The court also observed that in an appraisal proceeding the going-concern standard looks to the value of the corporation without considering issues of control, by contrast a claim for breach of fiduciary duty that challenges the fairness of a squeeze-out transaction must account for the implications of control. Slip op. at 72-73.
  • The court provided a detailed analysis to apply the standards of fair price and fair dealing to the facts of this case. Slip op. at 72-85.
  • The court concluded that the preferred stockholders proved that the fair value of the common stock for purposes of appraisal was zero, and they proved that the other challenges to the transaction satisfy the entire fairness test, and therefore, did not breach any fiduciary duty.

In a recent decision, the Delaware Court of Chancery determined that an agreement that required a release to be signed as a condition precedent to receiving severance benefits was enforceable, and that the failure to sign the release was a defense to the payment of severance benefits. An important aspect of this decision was that the requirement of a release was an explicit provision in the agreement between the parties, as compared to a situation where a release might be requested but when it was not a condition precedent in any pre-existing agreement.

In Roth v. Sotera Health Company, C.A. No. 2022-1192-LWW (Del.Ch. Sept. 23, 2024), the court also declined to rule before trial on a material issue of fact about whether the vesting conditions for the restricted stock under the same agreement were satisfied.

The following selected highlights of this decision may be useful to those who litigate these types of cases:

Highlights

  • The Court explained why the signing of a release that was a condition precedent in the agreement of the parties, was not satisfied—thereby serving as a defense to payment of the severance benefit. Slip op. at 8, as well as pages 25-26 and footnotes 111 to 113.
  • Recitation of the truism that contract interpretation is appropriate for a motion for summary judgment. Slip op. at 17-18 and footnotes 79-81.
  • Basic contract interpretation principles focus on the four-corners of an agreement to determine if ambiguity exists. Slip op. at 19-20 and footnotes 83-89.
  • The court observed the principle that when one agreement incorporates another agreement, under certain circumstances they will be interpreted together. Slip op. at 22-23 and footnotes 97-98.
  • The validity of restrictions on shares pursuant to Section 202 of the Delaware General Corporation Law was addressed. Slip op. at 24-25.

Frank Reynolds, who has been covering Delaware corporate decisions for various national publications for over 35 years, prepared this article

The Delaware Court of Chancery recently reconsidered most of its earlier dismissal of an investor challenge to IAC/InterActive Corp’s spinoff of its Match.com internet dating subsidiary after the state high court ruled that dual-position Match/IAC fiduciaries may have been too conflicted to get the protection of the business judgment rule in In re Match Group, Inc. Derivative Litigation, No. 2020-0505-MTZ (Del. Ch. Oct, 2, 2024).

Vice Chancellor Morgan Zurn’s September 1, 2022 opinion had dismissed investors’ derivative breach of duty charges over the Match separation for failure to show that the defendant directors lacked the independence to fairly decide whether the suit had enough merit to go forward.  In re Match Gp., Inc. Deriv. Litig. (“Match I”), 2022 WL 3970159 (Del.  Ch. Sept. 1, 2022).

But the Delaware Supreme Court partially reversed, finding that under its seminal MFW decision, no matter what procedure the defendant board used to ensure that the deal was fair in price and method, it would still be questionable if the directors who negotiated and approved it were conflicted. In re Match Gp., Inc. Deriv. Litig. (“Match II”), 315 A.3d 446 (Del. 2024).

Then, the vice chancellor’s Oct 2 opinion deciding that director independence question on remand from the state Supreme Court applied the requirements of the high court’s seminal MFW decision to the actions of the Match/IAC directors and officers and decided the shareholder plaintiffs have grounds to continue their charges against the defendants—except parent company controller Barry Diller.  Kahn v. M & F Worldwide Corp., 88 A.3d 635 (Del. 2014).

That Chancery opinion will be closely examined by corporate law specialists nationwide because it applies the state high court’s September 1 interpretation of MFW to the question of when and why allegedly disloyal inside directors and officers must face derivative charges if they purportedly manipulate transactions for their advantage in a non-freeze-out situation.

 Background

The challenged 2020 transaction involved the creation of two new corporations out of the former IAC and Match.com businesses and a reshuffling of the assets and liabilities of those two entities that was engineered by a “separation committee” composed of IAC directors who also held positions at the Old Match.  Old Match was later dissolved into the new IAC.

Three pension funds that owned that eliminated stock sued, alleging that the separation was a conflicted transaction in which Old IAC, as Old Match’s controlling stockholder, stood on both sides of the transaction. The plaintiffs claimed that Old IAC obtained significant “non-ratable” benefits in the Separation to the detriment of Match and its minority stockholders, and argued that the Separation Committee was conflicted and the proxy disclosures misled the Old Match minority stockholders.

The initial trial court ruling

Although the Court of Chancery initially found that the plaintiffs successfully pleaded facts creating a reasonable inference that one deal approving director was not independent of Old IAC, it ruled that a plaintiff must nonetheless show that “either:

(i) 50% or more of the special committee was not disinterested and independent,” or (ii) the minority of the special committee ‘somehow infect[ed]’ or ‘dominate[ed]’ the special committee’s decision-making process.“

 Finding that plaintiffs failed to do that, the vice chancellor dismissed.

Diller different than directors

But after the state high court’s reversal, on remand, Vice Chancellor Zurn then examined the independence of Diller and each defendant in turn.  First she found, that just because Old IAC held a controlling interest in Old Match and Diller owned a majority of Match through multiple- vote stock, that doesn’t mean he personally controlled Match’s merger decisions directly.  Therefore he should be dismissed for lack of proof that he suffered from a conflict of interest regarding the separation, the court ruled.

The remaining directors argued that they are exculpated from all of the fiduciary charges that the plaintiffs say disables them from deciding whether the suit has enough merit to continue. But the vice chancellor said they all fail the key rule in this area because, “Where a corporate charter contains an exculpatory provision, claims against a director will survive a motion to dismiss if the plaintiff pleads that the director

(1)“harbored self-interest adverse to the stockholders’ interests”;

(2) “acted to advance the self-interest of an interested party from whom they could not be presumed to act independently”; or

(3) “acted in bad faith

The vice chancellor held that the motion to dismiss failed because “The Dual Fiduciary Defendants each face such a conflict, so the claims against them are not exculpated.”

Much has been written regarding Elon Musk’s criticism of the State of Delaware and the decisions of its courts about him and his many successful business enterprises–and by extension the large number of other businesses impacted by Delaware law. In a broader sense, Musk’s criticism, and that of others, has generated discussion about the perennial question of: whether Delaware’s prominence in the corporate law world is at risk. See, e.g., the scholarship of this blog’s favorite corporate law scholar, Professor Stephen Bainbridge, on whether the impact of Musk and others will have an effect on Delaware as the leading choice for formation of corporations and other business entities (“DExit”). Relatedly, there has been an enormous amount of commentary on recent changes to the Delaware General Corporation Law that arose out of a protest of sorts to recent decisions by the Delaware Court of Chancery. See, e.g, one of many articles on those recent changes to Delaware corporate statutes.

Though I have published more than a thousand articles in various publications, which includes the commentaries and highlights about Delaware law on these pages over the last several decades, if I made my living in the halls of academia instead of needing to serve paying clients, I could devote more time to a detailed analysis of the titular topic.

Although some of my articles have been cited by the Delaware Supreme Court, the Delaware Court of Chancery, and the Delaware Superior Court, my purpose in this short blog post is simply to raise the question for discussion about the titular topic. It may be difficult or impossible to measure what impact, if any, on the decisions of Delaware Courts, and Delaware public policy in general, the criticism of Elon Musk, with over 200 million followers on X, formerly Twitter, will have on a long-term basis, even if only in a nuanced manner.

By comparison, many articles have been written, quite a while ago, about the “Greenhouse Effect” on decisions of the U.S. Supreme Court based on criticism of the High Court by a New York Times reporter of that name. But Elon Musk, one of the most influential and productive geniuses of our time, and maybe the most impactful person in history–from building rockets in a quest to colonize Mars, to self-driving cars, and autonomous robots, to advances in artificial intelligence, and brain implants–likely has an effect far greater than a New York Times reporter. Food for thought.

A recent Delaware Court of Chancery decision should be read by every lawyer who issues formal legal opinion letters—and those who litigate issues involving them. In Bandera Master Funds LP v. Boardwalk Pipeline Partners, LP, C.A. No. 2018-0372-JTL (Del. Ch. Sept. 9, 2024), the court amplified its earlier post-trial decision, highlighted on these pages, after remand from the Delaware Supreme Court, whose decision was also highlighted on these pages.

This 116-page opinion deserves careful study for its thoughtful and scholarly analysis of the issues surrounding a formal legal opinion letter that was issued in connection with the exercise of a call right pursuant to a complex set of prerequisites in a limited partnership agreement.

The limited purpose of this short blog post is to highlight selected notable excerpts of the opinion to encourage interested readers to review the whole decision.

Highlights

  • The court discusses the terms of art and the important distinction between a “reasoned” and “non-reasoned” formal opinion letter, as well as a “non-explained” or “clean” opinion letter. Slip op. at 40.
  • The court emphasizes the key differences between the common practice of non-Delaware lawyers opining on “straightforward” issues of Delaware law—but observing also that non-Delaware attorneys do not regularly opine on “complex” or unsettled issues of Delaware law. See Slip op. at 42 and footnote 80.
  • The opinion features copies of handwritten notes and marginalia—imbedded into the court’s decision—of the lawyers who prepared the formal opinion letter at issue. This emphasizes the importance to the court’s analysis of all the backup documents as well as the emails and notes created in connection with drafting the formal opinion letter. Slip op. at 23 and 26.
  • The court emphasized that in its prior decision in this case it did not conduct a de novo review of the formal opinion letter at issue, but it did review objective facts to determine bad faith, and it cited to scholarly articles for examples of how one’s conduct can reveal one’s state of mind in connection with surrounding circumstances. See Slip op. at 59-67 and footnotes 159-160.
  • The court explained that in its prior opinion it only referred to one of the law firms involved as issuing a formal opinion letter in bad faith, and it cited to scholarship and academic studies about observations confirming the truism that: even big-law lawyers are humans and can succumb to pressures to please clients.  See Slip op. at 50-53 and footnotes 109-117.
  • The court underscored that its decision “should not have any negative impact on the practice of rendering opinions.” See Slip op. at 78. In part, this conclusion is buttressed by the reality that lawyers rendering formal opinion letters should expect to support the basis for their opinions if litigation ensues. See generally footnote 212 (referring in a different context to why a board consent must be unanimous).
  • The court provided an always useful restatement of the elements of claims for: (i) tortious interference with contract, see Slip op. at 89-93; (ii) breach of the implied covenant of good faith and fair dealing, see Slip op. at 99-104; as well as (iii) restating the elements of an unjust enrichment claim, see Slip op. at 115.

Takeaway:

This blog post discusses a recent court decision that provides detailed analysis on the issuing of formal legal opinion letters. The court decision emphasizes the differences between various types of opinion letters and highlights the importance of supporting documents in drafting these letters. The decision also restates the elements of certain related claims.

A recent Delaware Court of Chancery decision clarified Delaware law in connection with determining that an alleged violation of a non-disparagement clause could be the basis to trigger the repurchase of LLC interests post-closing, in connection with the sale of a company—notwithstanding the general rule that the absolute litigation privilege generally bars claims of defamation based on pleadings filed with the court. Seva Holdings Inc. v. Octo Platform Equity Holdings, LLC, C.A. No. 2022-0437-PRW (Del. Ch. August 29, 2024).

Brief Factual Overview

The court examined the issues in the factual context of an LLC agreement that gave the seller of a company, as part of the deal, LLC interests in the holding company of the buyer. The seller’s founder also signed a related employment agreement that included confidentiality, non-compete, non-solicit, non-interference and non-disparagement clauses. (Superior Court Judge Paul Wallace was siting by designation of the Chief Justice pursuant to an order assigning selected Superior Court judges to hear Chancery decisions that arise under 8 Del. C. § 111.) 

The founder of the selling company, Sonny Kakar, remained involved in the business after the sale but the relationship with the buyer did not go smoothly. Not long after the closing he was purportedly terminated for cause. Both Kakar and the purchaser believed that they were disparaged in connection with Kakar’s departure post-closing. Several lawsuits and counterclaims were filed by the parties, most of which were consolidated into the Chancery matter.

Shortly after the lawsuits were filed, the purchaser purported to exercise an option to repurchase the LLC interests of Kakar based on a triggering provision which included claims of a violation of non-disparagement obligations. The employment agreement, which includes the non-disparagement clause that was a triggering event in the LLC agreement, defined “disparaging statements” but includes an exception for truthful information. The notice of repurchase cites to “publicly filed complaints” against the purchaser of a defamatory nature as the basis for the trigger.

There were other issues in the case about whether the procedural prerequisites in the LLC agreement for the repurchase were satisfied, such as whether a promissory note sufficed instead of cash, but the court determined there were too many factual issues to make a ruling on summary judgment on those other issues.

Noteworthy Highlights

I am providing selected highlights of the opinion that provide useful insights into how Delaware law treats alleged violations of a non-disparagement clause as a trigger to the right to repurchase LLC membership interests—and whether statements made in connection with court filings in a lawsuit can serve as a defense to the non-disparagement claims based on the absolute litigation privilege.

  • The court rejected the argument that the repurchase was void based on the unsuccessful position that statements made in a complaint filed with the court could not be the basis of a violation of the non-disparagement clause due to the absolute litigation privilege.
  • In order to understand the court’s ruling, we must understand what the absolute litigation privilege (“ALP”) is. The court explained that the ALP “protects from actions for defamation statements of judges, parties, witnesses and attorneys offered in the course of judicial proceedings so long as the party claiming the privilege shows that the statements issued as part of a judicial proceeding and were relevant to a matter at issue in the case.” Slip op. at 12.
  • The court provides citations to cases that explain the public policy behind the ALP. The court referred to two other decisions that it distinguished and a third decision dealing with this issue that formed the foundation for its reasoning. The court distinguished the following two cases: Ritchie CT Opps, LLC v. Huizenga Managers Funds, LLC, a 2019 Chancery decision, as well as Sheehan v. AssuredPartners, a 2020 Chancery decision. 
  • The court also discussed the 2022 Superior Court decision in Feenix Payment Systems LLC v. Blum, and found the facts and reasoning in that case to be applicable. The Feenix decision also distinguished the Ritchie and Sheehan decisions.
  • The competing public policy interests in the three cited cases, and the instant matter, are: (1) the freedom of a person to pursue one’s claims in court; and (2) upholding the freedom of contract. The court described the Feenix case as falling on the “latter end of the spectrum” and Sheehan and Ritchie cases falling on the other.
  • The court rejected what it referred to as the attempt by the seller to expand the scope of the ALP to nullify the repurchase of a member’s interest in a Delaware LLC in part because the court explained that: “[the seller] identifies no Delaware caselaw permitting this.”  Slip op. at 16.
  • The court reasoned that the balancing of the two policy interests at play, based on the circumstances of this case, require freedom of contract to prevail—regardless of the collateral effect that the repurchase of Kakar’s LLC interests will have on Kakar’s decision to litigate claims against the buyer, and defending claims that the non-disparagement clause was violated.  Slip op. at 16.
  • The court emphasized that Delaware law upholds the primacy of contract, especially in the context of agreements governing the internal affairs of an LLC. Id.
  • The court also found support for its reasoning in the Delaware Supreme Court decision of Cantor Fitzgerald, L.P. v. Ainslie, 312 A.3d 674 (Del. 2024). Although that case involved a limited partnership, the reasoning in cases involving the LP Act and the LLC Act are nearly interchangeable. The court focused on the reasoning of the high court in that case which resolved the divergent policy interests of respecting parties’ private agreements and the public interests against restraints of trade—in favor of the former.
  • The Ainslie case involved a forfeiture-for-competition in the non-compete context. The Delaware Supreme Court found that that provision did not prohibit the limited partners from engaging in competitive behavior, and held that the policy interests of disfavoring restraints on trade “significantly weakened.” Id. at 691. Therefore, the high court enforced the contract provisions in that case.
  • The court in this case found that Delaware precedent, including the Ainslie case, supported a similar limitation on the scope of the absolute litigation privilege.
  • The court underscored the important fact that the ALP was not being used as a defense to the non-disparagement claims under the employment agreement—but rather was being used as a means of opposing the right to repurchase under the LLC agreement. Slip op. at 18.
  • The court highlighted the determining factor of the contractual provisions involved controlling the governance of the internal affairs of the LLC, which the court was “strongly inclined” to respect unless, unlike the facts of this case: “dishonoring the contract was required to vindicate a public policy interest even stronger than freedom of contract.” Slip op. at 18 (footnote omitted).
  • The court’s summary of its key holding on this issue deserves to be quoted verbatim:
  • “In sum, Delaware law provides for maximum freedom in allowing parties to order their governance arrangements.  It doesn’t offend the public policy of this state for a Delaware limited liability company’s operating agreement to condition a member’s ownership in the business on whether a member makes disparaging remarks about the business.” Slip op. at 19.

The court also addressed issues relating to whether procedural prerequisites under the LLC agreement for the repurchase were complied with, but the court determined that there were too many factual issues to decide those matters before trial, such as whether a promissory note was sufficient in lieu of cash.

Frank Reynolds, who has been covering Delaware corporate decisions for various national publications for over 35 years, prepared this article

The full Delaware Supreme Court recently ruled that $26.67% fee and expense award to plaintiffs’ attorneys in the $1 billion settlement of a challenge to Dell Technologies Inc.’s redemption of its Class V stock for what shareholders claimed was an unfair price did not exceed the Chancery Court’s discretion in the ma tter styled In re Dell Techs. Inc. Class V S’holders Litig., C.A. No. 2018-0816 (Del.Supr. Aug. 14, 2024).

Chief Justice Collins Seitz Jr., writing for the unanimous en Banc court, affirmed the Chancery’s decision that although the $266.7 million award was near the top of the applicable range for settlements of that type, under the high court’s milestone Sugarland ruling, each of the fee objections and reductions filed by selling Class V shareholders were rightly rejected. In re Dell Techs. Inc. Class V S’holders Litig., 300 A.3d 679 (Del. Ch. 2023), as revised (Aug. 21, 2023).  

The decision is a fresh application of the high court’s Sugarland yardstick ruling on Chancery fee disputes that is sure to be closely examined by corporate law specialists nationwide, because the justices, among other things:

 *Took a comprehensive look at how the famous five Sugarland factors should be applied in large settlement fee request disputes. Sugarland Indus., Inc. v. Thomas, 420 A.2d 142, 149–50 (Del. 1980).

*Turned down a call to apply a declining fee percentage award to large settlements as judges in federal securities often do and said Chancery awards should be based on the “stage” of the litigation at settlement.

*Rejected the federal lodestar approach — that takes the time counsel expended and multiplies it by an approved hourly rate –because it would require Chancery to engage in “elaborate analyses” when the existing practice was sufficient, and

*Noted that, when applying the Sugarland factors, “Delaware courts have assigned the greatest weight to the benefit achieved in litigation.”

Background

Michael Dell and private equity firm Silver Lake Group LLC, who took Dell, Inc. private through a leveraged buyout in 2013, owned a controlling stake in the successor tech hardware company, and immediately set their sights on EMC Corporation, a publicly traded data-storage firm which held an 81.9% equity stake in VMWare, also a publicly traded data company. 

The court said Mr. Dell would have preferred to acquire those companies in an all-cash buy, but Dell was already over-leveraged, so he  settled for using a newly-issued V class of Dell stock in a part-stock deal.  The price Dell arrived at and the method it used prompted some of the class to sue the Dell directors for breach of duty in the Court of Chancery Court for two and a half years before a $1billion settlement was reached.

Their complaint alleged that the director defendants breached their fiduciary duties by approving the redemption, coercing the Class V stockholders to vote in favor of the redemption, and for making materially false and/or misleading proxy statements.

That complaint resulted in a $1billion settlement after two and a half years of discovery and litigation.

Clients vs. attorneys

But when the law firms that represented the plaintiff investors filed a motion for fees of 26.67% of the settlement that the Dell defendants had agreed to, some of the investors objected that the amount was so disproportionately large that their recovery was unfairly compromised. 

In its decision to dismiss the objectors’ action, Chancery observed that the Supreme Court’s seminal decision in Sugarland governs fee awards in representative actions so, when the court considers a fee application, the court should at the outset, review:

(1) the results achieved;

(2) the time and effort of counsel;

(3) the relative complexities of the litigation;
(4) any contingency factor; and

(5) the standing and ability of counsel

Chancery ruling ratified

The Court of Chancery found that the proposed fee met all five factors and the objectors appealed, arguing that among other things, the court misapplied the first two Sugarland factors — the results achieved and the time and effort of counsel. For the former, they claimed the recovery was a small fraction of what could have been obtained after trial. And for the latter, that the fee is seven times counsel’s customary rate, resulting in an award at the high end of fee awards in the Court of Chancery.

The high court said one of the exceptions to Delaware’s “each pays his own attorney fees” rule is the common fund exception which is “founded on the equitable principle that those who have profited from litigation should share its costs.”

As to the reasonableness of the fee amount, the justices agreed that, in addition to considering the other Sugarland factors, Chancery must weigh “the degree of the ’cause and effect’ between what counsel accomplished through the litigation and the ultimate result.”  Instead of adopting a “formulaic” approach such as the lodestar, to fee requests, we commit the fee award to the discretion of the Court of Chancery.

In summary, the Chief Justice wrote that, “On appeal, this Court will not usually disturb the Court of Chancery’s ruling if the court adequately explains its reasons and properly exercises its discretion when it applies the Sugarland factors”,

What about windfalls?

However, he cautioned that there may be an increasing number of corporate cases on the horizon that could generate so-called “megafund” outcomes with possible fee awards so large that “typical yardsticks, like stage-of the-case percentages, must yield to the greater policy concern of preventing windfalls to counsel.”

Some Delaware corporate law practitioners believe at least one case in the Chancery—involving Elon Musk’s attempt to earn a $56 billion pay package from his Tesla automaker’s investors—could present such a windfall award if objecting shareholders are the final winners.

Andrew A. Ralli, an associate in the Wilmington office of Lewis Brisbois, prepared this blog post.

A recent Delaware Court of Chancery decision determined whether persons seeking advancement satisfied the undefined term “officer” under the Bylaws and the Delaware General Corporation Law (the “DGCL”).  In Gilbert v. Unisys Corp., No. 2023-0513-PAF (Del. Ch. Aug. 13, 2024), the Court was tasked with determining whether Plaintiffs, a former Senior Vice President and Vice President of a Delaware corporation, were “officers” entitled to advancement for fees incurred to defend themselves in a Pennsylvania action.

The Plaintiffs proffered three theories under which they believed they are entitled to advancement under the Bylaws: (i) they were officers of the corporation; (ii) the “Presidents” were officers, and became Presidents, after an acquisition; and (iii) Plaintiffs served an enterprise at the request of the Corporation. The court addresses each theory in turn and found that Plaintiffs were entitled to advancement under each theory.

Highlights:

The Court recognized that advancement is “purely permissive” and, under Section 145(f) of the DGCL, permits a corporation to grant advancement rights in its corporate documents or by separate contract.  As Vice Chancellor Fioravanti explained, Section 145 serves the dual policies of: “(a) allowing corporate officials to resist unjustified lawsuits, secure in the knowledge that, if vindicated, the corporation will bear the expense of litigation; and (b) encouraging capable women and men to serve as corporate directors and officers, secure in the knowledge that the corporation will absorb the costs of defending their honesty and integrity.” 

Many Delaware corporations “provide for mandatory advancement as an enticement to attract qualified individuals to serve as directors and officers.” This is because the corporation maintains the right to be repaid all sums advanced, if the individual is ultimately shown not to be entitled to indemnification. Thus, the advancement decision is, effectively, a contingent loan. 

In this case, neither the Certificate nor the Bylaws explicitly define “officer.” However, the Bylaws do identify two categories of officers, which were “at a minimum”  ambiguous.  First, there are officers who are expressly identified by title. These are “a Chief Executive Officer, a President, one or more Vice Presidents, a Secretary, a Treasurer, [and] a Controller.” Section 1 states that these “shall” be officers. The court labeled these as “mandatory officers.” The second category comprises of “other officers as may be elected … at the Board’s discretion.” The Court labeled these as “discretionary officers.” 

Due to the Bylaws’ ambiguity in “mandatory” and “discretionary” officers, Plaintiffs, unsurprisingly, contend that the ambiguity must be construed in their favor under the doctrine of contra proferentem.  Seeking guidance from Delaware precedent, the Court found that “[t]here is a tension between the transcript rulings in Pulier[1] and Centrella I,[2] which held that an election was a pre-requisite for officer status, and Aleynikov[3] and Kale,[4] which took a broader view and relied on contra proferentem.”  In resolving this tension, the Court stated:

Admittedly, some of the discussion in Aleynikov, despite its careful and detailed analysis, is dicta. But so are Pulier and Centrella I on the issue of whether a bylaw that denominates Vice Presidents as mandatory officers precludes persons with that title from receiving mandatory advancement unless the board of directors formally chooses them as officers or expressly designates another officer to do so, as both resolved whether discretionary officers were entitled to advancement.

…

One can easily imagine a prospective officer reading the Bylaws, seeing that vice presidents “shall” be officers, and concluding that they would be an officer entitled to advancement. . . . [C]onsistent with the persuasive reasoning in Aleynikov, the court finds that reasonable individuals who are hired as [] Vice Presidents by persons with authority to bestow the title can reasonably conclude under the Bylaws that they are officers of the Company.

In other words, the Court agreed with Plaintiffs that the president Plaintiffs are officers under the Bylaws’ advancement provision and, thereby, entitled to advancement of fees and expenses for the Pennsylvania action, further explaining that: “Delaware policy ‘supports the approach of resolving ambiguity in favor of indemnification and advancement.’”

Notable Takeaway:

When a corporation decides to utilize Section 145(f) of the DGCL, it should do so with specificity. In failing to do so, corporations, being the “drafters” or otherwise, potentially face the unwanted consequence of advancing fees and expenses to more persons than intended. The Court’s decision in Gilbert serves as a “caution” for others:

A reasonable person standing in the shoes of a prospective indemnitee … ought to be able to look at the advancement provisions in the … [corporate documents] and clearly determine whether they are entitled to advancement … rely[ing] on a reasonable interpretation thereof. … Plaintiffs are correct. That [the Corporation] doled out Vice President titles to dozens of employees is of its own doing. [The Corporation] “easily could have clarified whether or not the title of ‘Vice President’ was an officer title for purposes of advancement and indemnification.” [They] did not. Therefore, the ambiguity must be resolved in Plaintiffs’ favor.

With Delaware’s bedrock freedom of contract principle, parties have a right to enter into good and bad contracts. The law enforces both.

Footnotes

[1] Pulier v. Computer Scis. Corp., C.A. No. 12005-CB (Del. Ch. May 12, 2016) (TRANSCRIPT).

[2] Centrella v. Avantor, Inc. (Centrella I), C.A. No. 2022-0876-NAC (Del. Ch. Dec. 14, 2022) (TRANSCRIPT).

[3] Aleynikov v. Goldman Sachs Gp., Inc., C.A. No. 10636-VCL (Del. Ch. July 13, 2016) (ORDER).

[4] Kale v. Wellcare Health Plans, Inc., C.A. No. 6393-VCS (Del. Ch. June 13, 2011) (TRANSCRIPT).

The Delaware Supreme Court recently affirmed a Chancery decision that was highlighted on these pages, which described the limited scope of a summary proceeding under DGCL Section 225 to determine who properly holds a corporate office.

In Barby v. Young, No. 391-2023 Order (Del. June 11, 2024), the high court described that among the limited related topics that can be addressed in connection with determining who properly holds a corporate office, are: the validity of stock issuances, stock transfers, and stock acquisitions to determine which vote should be counted in ascertaining proper board composition. See footnote 2.

The court emphasized that the limited scope of a 225 proceeding cannot include the rescission of a transaction procured through unlawful behavior, which is the type of relief that can only be obtained in a plenary action in a court that has in personam jurisdiction over necessary parties as opposed to an in rem Section 225 proceeding. 

A recent Delaware Court of Chancery decision addressed issues with the receivership of a defunct corporation and the report of a Special Magistrate appointed to investigate claims against the court-appointed Receiver. In B.E. Capital Management Fund LP v. Fund.com Inc., C.A. No. 12843-VCL (Del. Ch. July 18, 2024), the court reviewed the report de novo of a Special Magistrate who chronicled the misdeeds of a Receiver appointed by the court for a defunct corporation.

Highlights

  • The court noted that DGCL Section 226(a)(3) limits the appointment of receivers for a defunct corporation in a manner that is an analogous to Chapter 7 in bankruptcy–not a Chapter 11 bankruptcy. See footnote 1. The court also observed that DGCL Section 226(a)(3) does not authorize a receiver to revive the defunct corporation, but rather a receiver can be appointed when the corporation “has abandoned its business and had failed within a reasonable time to take steps to dissolve, liquidate or distribute its assets.”  See DGCL Section 226(a)(3). The court also doubted that it would make the same appointment of a receiver today in this case if it knew then what it knows now about the undisclosed details.
  • A notable aspect of this decision, due to the paucity of case law addressing the standard of review of a Special Magistrate’s report regarding the determination of damages, is the court’s use of the summary judgment standard for reviewing the damages determination by the Special Magistrate. See Slip op. at 39-40.
  • More specifically, the court applied the Third Restatement of Restitution and Unjust Enrichment to analyze the damages recommended by the Special Magistrate, for example, in connection with deposits and withdrawals over a period of time, and profits received from embezzled funds.  See Slip op. at 41-47 and footnotes 11 and 13.
  • The court also explained the limits to the right to invoke the Fifth Amendment in a civil proceeding. See Slip op. 35-36.

Frank Reynolds, who has been covering Delaware corporate decisions for various national publications for over 35 years, prepared this article     

The Delaware Court of Chancery recently ordered biotech firm InterMune Inc.’s former CEO to repay nearly $6 million in director and officer insurance funds he spent trying to overturn his felony wire fraud conviction for misleading investors about the effectiveness of a lung disease treatment in InterMune Inc. et al. v. Harkonen, No. 2021-0694-NAC (Del.Ch. Aug. 1, 2024)

Vice Chancellor Nathan Cook found that in nearly two decades of investigation, negotiation and litigation stemming from a false 2002 press release about the commercial prospects for his interferon gamma-1b treatment Harkonen never successfully appealed his convictions or proved that he should not be liable for all the defense funds advanced to him from various D&O insurers and InterMune’s coffers. 

He ruled that two D&O insurers that had advanced funds had been paid by InterMune in a settlement after Harkonen was convicted and that under Section 145 of the Delaware General Corporation Law the company had a right to sue its ex-officer to repayment since the litigation was found to be non-indemnifiable.  

In addition, the vice chancellor rejected Harkonen’s counterclaims seeking a declaration that the Company must reimburse him for various legal expenses he accrued in a related California Medical Board disciplinary proceeding, two insurance arbitrations, advancement negotiations with InterMune, and a presidential pardon. 

He found that then-President Donald Trump’s pardon of the wire fraud conviction came long after a final adjudication of the case and could not qualify as a “successful defense of the charges.”  And “In addition to being procedurally improper, each of Dr. Harkonnen’s claims is either untimely or fails to satisfy the requirements for indemnification under Section 145.” 

Background

Harkonen founded InterMune in 2000 and issued a press release two years later extolling his new product, Actimmune which he claimed was “a major breakthrough” with “results [that] will support the use of Actimmune and lead to peak sales in the range of $400–$500 million per year[.]” – even though the study’s results indicated a failure.  One year later, Harkonen and InterMune negotiated a mutual release of claims against each other, and he resigned, only to face a 2004 justice department investigation that led to a 2008 indictment and a 2009 conviction.

That conviction carried an up to 20-year prison sentence; meanwhile InterMune’s D&O insurers began to seek repayment after learning that the charges and advancement would not qualify for indemnification and Harkonen began a decade of appeals.

At the same time, InterMune and its insurers pressed objections to what they insisted was Harkonen’s continuing “profligate” spending on attorney fees in many appeals and other legal proceedings.

The indemnification ruling

The vice chancellor laid out the ground rules for this type of indemnification case, noting that:

*”The corporation, rather than the employee, bears the burden of proof in an advancement claw-back action.”

*“In the case of a mandatory indemnification provision, the burden rests on the party from whom indemnification is sought to prove that indemnification is not required.”

*The applicable evidentiary burden in this post-trial context is proof by a preponderance of the evidence. [P]roof by a preponderance of the evidence means proof that something is more likely than not.”

*”Bylaw[s] not only mandate indemnification; [they] also effectively place the burden on [the Company] to demonstrate that the indemnification mandated is not required.”

Fraud = bad faith conviction

“Dr. “Harkonen is precluded from establishing good faith under Section 145(a) because his [wire fraud] conviction is conclusive evidence that he acted in bad faith,” Vice   Chancellor Cook wrote. “Dr. Harkonen is therefore ineligible to be indemnified for the advanced amounts he spent defending his wire fraud charge and appealing his conviction.”

Therefore Dr. Harkonen must repay the Company for the $5,906,927.02 it paid to settle the insurance disputes and six defenses Harkonen presented fail to prevent that, the court ruled, noting why each argument fails:     .

  • The Company waived and released all claims under the Mutual Release. The Court said: “Nowhere in Dr. Harkonen’s affirmative defenses did he assert the Mutual Release as a defense to InterMune’s claims. “
  •  The Company is barred by hold harmless provisions in the Indemnity Agreement and the Mutual Release. The Court said, “This defense, like the Mutual Release defense, was raised for the first time in the pre-trial briefings, which was too late for InterMune to focus its discovery on the hold harmless provisions of the two agreements.”
  •  The settlement payment was voluntary. The Court said: “InterMune devoted not insignificant portions of its briefing to rebutting this defense. And Dr. Harkonen ultimately withdrew the defense of voluntary payment at trial. “
  •  The Company’s claims are time-barred, The Court said: “InterMune filed its Complaint on August 11, 2021, well within the 3-year window under either alternative.  Harkonen’s time-bar defense therefore fails.” 
  •  The Company is barred by the unclean hands doctrine. The Court said: “The Company’s efforts to win the insurance arbitrations, or at least minimize any award, are not unclean hands. If they were, companies would be confronted with conflicting and strange incentives.” 
  •  The settlements themselves are not advancement fees. The Court said, “By mentioning the defense for the first time in passing at the trial on a paper record, the defense is waived. The analysis ends there.” 

Additional indemnification requests

The vice chancellor said Dr. Harkonen now requests indemnification “under 8 Del. C. § 145(c) for expenses incurred in (1) litigating the MBC action, (2) seeking advancements from the Company, (3) litigating the D&O insurance arbitrations, and (4) seeking the Pardon.” 

No fees or fees-on-fees

The Court held that Dr. Harkonen is not entitled to indemnification for the costs incurred in the medical board proceeding either, because the claim is both untimely and he was unsuccessful in the respective proceeding. This advancement claim regarding any of the legal actions is brought too late for the three-year time limit, the court said.  Finally, Dr. Harkonen also requests an award of fees on fees for this action, but given that he did not prevail on any claim, Dr. Harkonen is not entitled to fees on fees, Vice Chancellor Cook concluded

The Delaware Court of Chancery recently explained that a charging lien is the exclusive remedy of a judgment creditor against a member’s interest in an LLC, in XRI Investment Holdings LLC v. Holifield, C.A. No. 2021-0619-JTL (Del. Ch. July 24, 2024). See Slip op. at 7-8 and footnote 6 (citing Section 18-703(d) and other sources).

A Delaware Supreme Court opinion and a Chancery decision in this matter were previously highlighted on these pages.

Short Factual Overview

The abbreviated factual background of this case involved the parties structuring several special purpose vehicles in an effort to circumvent an existing lien on LLC membership units by designing the right of a subordinate creditor to receive proceeds from the sale of the membership units already encumbered—as opposed to a security interest in the membership units themselves. See Slip op. 9-14.

Highlights

A recent Delaware Court of Chancery decision is required reading for anyone who wants to know the requirements for validly transferring a member’s interest in an LLC, for example, upon death or bankruptcy of a member. 

In Gurney-Goldman v. Goldman, C.A. No. 2023-1124-JTL (Del. Ch. July 12, 2024), the court explained some aspects of the Delaware LLC Act in connection with the transfer of membership interests that, in the court’s words: “To put it mildly, [. . .] is not a well developed area of Delaware law.” Slip op. at 31. See Section 18-705.

As a bonus of sorts, the decision also features an exemplary overview of the dissolution process for both LLCs and corporations. See footnote 69.

Factual Background

The essential factual background involves four siblings who inherited a real estate empire in New York City involving “literally hundreds of entities.” Although the siblings hired one of the largest New York law firms to create the legal structure for their business, the court observed that entity formalities were not always observed and that some of the LLCs did not have any written operating agreements.

Moreover, there were no documents establishing the transfer of interest in key entities from the widow of the patriarch to the siblings. The management structure was not formalized. The 2 siblings who were the primary decision-makers did not have clear documentation to establish the basis of their authority.

After one of the two siblings who had historically been the decision-makers for the operation of the business passed away, his son sought to take over the role of his father in managing the business but the remaining sibling who historically managed the business did not agree that the son had a right to take over his father’s managerial role.

The LLC at the heart of this case, SG Windsor, did not have a written LLC agreement.

Issues Addressed

The litigation sought: (1) a declaration that SG Windsor is a member-managed entity; (2) that the estate of the sibling who historically was a co-manager of the LLC became a member of SG Windsor or, to the extent the estate is only an assignee, that the son is able to exercise governance rights in his capacity as an executor to the estate.

Key Takeaways

There are many principles in this epic decision of both well-settled and not well-traveled aspects of the Delaware LLC Act that should be of interest to anyone who either forms or litigates Delaware LLCs.

  • Under the LLC Act, the default rule is that an LLC is member-managed.  See 6 Del. C. § 18-402.

LLC Agreement Terms/Formation

  • Although SG Windsor did not have a written LLC agreement, the statute allows for an LLC agreement to be “oral or implied.”  See § 18-101(9).
  • The court explained that an implied agreement is one inferred from the conduct of the parties “though not expressed in words.”  See cases cited at footnote 16.
  • The court explained that to prove an implied agreement, the court must be able to infer “as a fact, from conduct of the parties showing, in light of the surrounding circumstances, their tacit understanding. The failure to object may be treated as acceptance.”  See Slip op. at 13-14 and footnotes 19-20.

Appointment of Manager

  • The court referred to “manager” as a term of art under the LLC Act, which defines it as a person who is either named as a manager in the LLC agreement or designated pursuant to a similar instrument.  This term of art should be distinguished from the colloquial use of the word manager where, as here, a person manages the company without the formal title or documentation giving him that title. See § 18-101(12).  See Slip op. at 16.

Transfer of Membership Interests in LLC

  • The default rule under the LLC Act when a member transfers its member interest is that the recipient of the interest does not automatically become a member.  See § 18-702. Rather, the recipient only holds the right of an assignee. Slip op. at 20-21.
  • The assignee does not receive any of the governance rights associated with the interest, nor does an assignee have the right to seek books and records or seek statutory dissolution.  Slip op. at 21 and footnotes 40-42.
  • The court explained the reasons for the default rules include the “pick-your partner principle” which underlies § 18-702(b)(3), and which essentially tries to avoid a situation where a new co-manager is imposed on a member as opposed to a new “passive co-investor.”  Slip at. 21-26.

How to Become a Member

  • To implement that principle, the LLC Act addresses: “(i) what a member is, and (ii) how an assignee becomes a member.  Slip op. at 23.
  • § 18-301 describes how an assignee becomes a member. After the formation of an LLC, the requirements for becoming a member are described in § 18-704(a). Those two ways include: (1) pursuant to provisions in the LLC Agreement; or (2) upon the affirmative vote or written consent of all the members of the LLC.

Death of Member

  • The court instructed that the death of a member who was a natural person terminates that person’s membership. See footnote 52 and accompanying text.
  • A member’s interest in an LLC, like other personal property, transfers by operation of law to the estate of the deceased member.

§ 18-705 – Rights of Personal Representative

  • § 18-705 authorizes the personal representative of a deceased or disabled member to exercise all the member’s rights only as provided in § 18-705, and those rights are limited as an assignee as compared to plenary rights.
  • The court was not persuaded by the Schedule K-1 forms that the parties used because those forms offer two options: (i) general partner or LLC member-manager, or (ii) limited partner or other LLC member. The second box was checked for the three living siblings and the estate, which is inconsistent with the positions taken by the parties in the lawsuit.

Can an Executor Exercise Member-Manager Powers under § 18-705

  • The court explained that this is not a well-developed area of Delaware law, but the court did a deep dive with extensive citations to treatises, case law and other learned commentary.
  • In the course of a short law review article  on § 18-705, the court elucidated several key points.
  • A consequential point for single-member LLCs is the court’s instruction that pursuant to § 18-801(a)(4), the general rule is that when the member of a single-member LLC who is a natural person dies, the default rule is that the LLC is dissolved.
  • Regarding dissolution, in connection with the deep dive into § 18-705, the court provided an illuminating footnote that spans over 4 pages and that provides a paradigmatic encapsulation of the stages of dissolution for both a corporation and an LLC. The court explained that the shuttering of an entity involves: “ … two distinct events that bracket an intermediate period of activity. The first event is dissolution, marking the point at which the entity enters the intermediate period called winding up.  The second event is termination, which takes place after the entity completes winding up.”  See footnote 69.

Stages of Dissolution for LLC and Corporation

  • The court went into further detail by comparing the stages for dissolution of a corporation and an LLC. Referring to DGCL § 278, the court described the Certificate of Dissolution as marking the start of the 3-year winding-up period that includes things such as marshalling assets and distributing any remaining assets after payment of liabilities. At the end of the winding-up period, the corporation’s existence terminates.
  • As for an LLC, dissolution marks the start of the winding-up period.  See § 18-801(a). The winding-up period is similar to that of a corporation. See § 18-803, § 18-804. At the end of the winding-up process an authorized person files a Certificate of Cancellation. See § 18-203.

§ 18-705 Needs Fixing

  • The court suggested that the language in § 18-705 referring to termination makes little sense based on the foregoing overview of termination ending the existence of an LLC, and that the legislature should consider a clarification and refinement of the language in the statute. See footnote 69.

History of § 18-705

  • The court provides an extensive historical overview of the origin of § 18-705 and the limits of the power of a personal representative of a deceased member.  See Slip op. 31-69.

A recent Delaware Court of Chancery decision provides a concise summary of the fiduciary duty of disclosure in the context of a proxy statement. In Stansell v. Rosensweig, C.A. No. 2023-0180-PAF (Del. Ch., June 12, 2024), the court rejected the claim that the proxy statement should have included a reference to reports that students are using the company’s online services to help them cheat on homework.

Highlights

  • The court restated established Delaware law that directors are not required to accept factual allegations prior to a formal adjudication.  This is sometimes referred to as directors having no duty to engage in self-flagellation. See Slip op. at 13.
  • The court reiterated that Delaware has adopted the federal standard for materiality in this context. Slip op. at 12.
  • The court provided a cogent analysis of the logical fallacies in the factual allegations for the claims that the proxy statement omitted material information. See Slip op. at 14 – 20.
  • The court noted the procedural issues involved with the decision by the plaintiff not to seek relief until after the annual meeting which the proxy statement related to.

A recent Court of Chancery decision allowed claims to proceed for the refusal to enable the seller of a business to exercise options in the new company.  In Osios LLC v. Tiptree, Inc., C.A. No. 2023-0589-NAC (Del. Ch. June 12, 2024), the court described a factual background in which the buyers of a business, to use a colloquial phrase, stiff-armed the buyer and did not provide, at least according to the allegations, a good-faith basis to refuse to allow the exercise of the options described in the LLC agreement.

Highlights

  • Form of Notice: The most noteworthy aspect of this decision is the court’s reasoning to support its rejection of the argument that the form of notice expressing an intent to exercise the options did not comply with the form of notice required under the agreement. The court determined that it need not decide whether “substantial compliance” with the notice provisions was satisfied due to the likelihood that the requirement was waived.  See footnote 54 and accompanying text (also collecting cases on substantial compliance with notice.)
  • This should be compared with the factually distinguishable notice issues in another recent Chancery decision, decided two days earlier, involving notice for an indemnification clause in an agreement that did not include a required form of notice.  See recent Chancery decision in Trifecta case, highlighted on these pages, that addressed adequate notice when no requirement for the form of notice was provided in the agreement.
  • Another noteworthy part of this decision involved a reference to the implied covenant of good faith and fair dealing as falling into two categories: (1) gap filling; and (2) protecting against arbitrary and bad faith exercise of discretion.  See Slip op. at 13 and footnote 61.
  • Lastly, always useful is a recitation of basic contract interpretation principles. See Slip op. at 8 – 9.

In a common fact pattern involving allegations that the buyer of a company intentionally derailed the attainment of milestones that would trigger additional payments, the Court of Chancery allowed several claims to survive a motion to dismiss. Trifecta Multi-Media Holdings, Inc. v. WCG Clinical Services LLC, C.A. No. 2023-0699-JTL (Del. Ch. June 10, 2024). The claims included fraud, breach of the implied covenant of good faith and fair dealing, breach of contract, and indemnification. 

As part of the factual background, the court provided detailed examples of the unabashedly disrespectful approach of the buyer when challenged regarding the multiple actions it took to allegedly prevent the milestone payments from being made.

Although the claims are not novel, it remains helpful to highlight some of the fundamentals of basic legal principles often involved in corporate and commercial litigation about post-closing disputes.

Highlights

  • The court recited the elements of fraud that must be pled to prevail on that claim, but also explained that in Delaware there is no difference between fraud and fraudulent inducement.  See page 20 and footnote 34.
  • Unlike fraud, the court also explained why some statements are mere puffery.  See Slip op. at 21 and 22.
  • The court described the scienter element of a fraud claim as requiring allegations with enough factual detail to support an inference that the speaker had no intent to perform when a promise was made.  Slip op. at 22 – 23.
  • Regarding the requirement of reliance, the court explained that this element is typically not suitable for a motion to dismiss unless a fully integrated contract has as an anti-reliance clause.  See Slip op. at 24 – 25 and footnote 47.

Required Reading

  • The court instructs on the interfacing between an integration clause and the requirements of an anti-reliance clause if someone seeks to prevent the use of statements outside the four corners of an agreement. See Slip op. at 24 – 28.

Indemnification

  • The court rejected the argument of ripeness as a basis to dismiss this claim because of the potential recovery for attorneys’ fees. Slip op. at 37-39.
  • Notice Requirement
    • Also noteworthy is the court’s observation that the agreement at issue did not require any specific form of notice and therefore the court found that filing the complaint sufficed for the notice requirement in the indemnification provisions.  See Slip op. at 37 -39 and footnote 93. 
  • Even though the elements for a breach of contract claims are well-known, this decision addressed two key points: (i) damages need not be alleged in a quantifiable amount because the court can award nominal damages; and (ii) liberal notice pleading rules do not require explicit allegations.  See Slip op. at 35 – 37. AS A SIDE NOTE, in my experience it may be dangerous to rely too much on liberal notice pleading rules when in Delaware, depending on the context and the claims, some members of the court can be quite willing to dismiss cases absent copious factual details.
  • The court provided an elucidation that although a claim for the breach of the implied covenant of good faith and fair dealing can be a gap filler—it does not fill all gaps, for example, where, as here, a term was expressly rejected during the drafting of the agreement.  See Slip op. at 28 – 32.

Frank Reynolds, who has been covering Delaware corporate decisions for various national publications for over 35 years, prepared this article.  

The Delaware Court of Chancery, citing the milestone Corwin decision, recently dismissed a suit by Anaplan Inc. shareholders who claimed post-merger pact equity grants for some officers and directors cheated them out of $400 million of the original $10.7 billion price pursuant to a merger agreement requiring Thoma Bravo (not a typo) to pay for the business planning software company in In re Anaplan Inc. Stockholders Litigation, C.A. No. 2022-1073-NAC (June 21, 2024).

Vice Chancellor Nathan Cook ruled that whether defendants breached fiduciary duties, giving rise to a derivative suit, or whether they violated direct contract duties by mismanaging the deal–justifying a direct action–the suit fails the Corwin test because there was no proof that the Anaplan deal was inadequately disclosed or that the shareholders were coerced. See Corwin v. KKR Fin. Holdings LLC (Del. 2015).

Under Corwin, the Delaware Supreme Court held that the business judgment rule is invoked as the appropriate standard of review for a post-closing damages action when a merger that is not subject to the entire fairness standard of review has been approved by a fully-informed, uncoerced majority of the disinterested stockholders. 

The opinion’s comprehensive examination of Corwin’s requirements to prove structural or situational coercion and what disclosures fully inform investors, is worthwhile reading for corporate law specialists. 

The court ruled that although the final price the Anaplan investors got took a big cut when their officer and director grants gave the original offer a $400 million “haircut,” the investors were not forced to accept a deal that gave them “nothing” because even the reduced offer provided a substantial premium over market value for their shares.

Background

The dispute began shortly after Anaplan accepted private equity firm Thoma Bravo’s March 2022 acquisition offer, when a handful of Anaplan officers and directors gave themselves $400 million in equity grants—an amount that, Bravo charged, violated the merger agreement.  Anaplan and Bravo later negotiated an amended merger agreement that provided $63.78 rather than the original $68.00 a share.  That pact still provided Anaplan investors with a premium but Pentwater Capital Management LP and other Anaplan shareholders filed suit to recover the $400 million, charging that three ex-officers and three former directors breached the merger pact’s $105 million limit on grants to employees and reduced the worth of plaintiffs’ shares.

Defendants’ motion to dismiss the claims argued that the charges are derivative, not direct, as plaintiff contended, because the alleged conduct only affected Anaplan’s stock price, but plaintiffs responded that it was only their stock value that was directly affected.

Plaintiffs also argued that the officer defendants violated their continuing Revlon duty to get the best price for the company, but defendants countered that a majority of the directors were not implicated as Revlon requires. 

No need to resolve

The court noted that, “To put it mildly, the parties have raised very interesting questions. They are not, however, questions I need to answer to resolve the Motion.”  But under Corwin, the Vice Chancellor said, “Plaintiff’s claims must be dismissed because they do not survive the informed and uncoerced vote of Anaplan’s stockholders approving the Merger.”

 He said Corwin enables parties to “avoid the uncertainties and costs of judicial second-guessing when the disinterested stockholders have had the free and informed chance to decide on the economic merits of a transaction for themselves. And I do not read our Court’s Corwin decisions, or the policy rationale underlying Corwin, as intended to apply Corwin narrowly.”

A fully informed vote?

Under Delaware law, when directors solicit stockholder action, they must “disclose fully and fairly all material information within the board’s control,’ the vice chancellor said, but he noted that “An omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote.” However, that doesn’t mean the standard requires “proof of a substantial likelihood that disclosure of the omitted fact would have caused the reasonable investor to change his vote,” he added.

In this case, the shareholders got a proxy that acknowledged a dispute between Anaplan and Thoma Bravo over the grants, but the disclosure stated that the company believed no wrongs were committed, so investors could make up their own minds whether to take the offer or take the risk of losing it, the court said in ruling that disclosure was adequate.

Was there coercion?

Plaintiffs asserted that the approval vote was coerced because “stockholders had a metaphorical gun to their head” when asked to approve a merger that was ”either situationally or structurally coercive.”  

However, the court defined an uncoerced vote as one that simply gives stockholders a “free choice between maintaining their current status and taking advantage of the new status offered by” the proposed transaction,” adding that, “The status quo may be undesirable or unpleasant, but that fact does not render the transaction coercive.”

Situational coercion—”arises when the status quo is so unattractive that it prevents a stockholder vote from operating as a clear endorsement of a transaction. ”It is “[t]he situational backdrop of an unacceptable status quo [that] calls into question the meaning of a stockholder vote such that it should not be given cleansing effect.”

The vice chancellor ruled that there was no situational coercion because, ‘”Although at a discount to the Original Merger Agreement, the Revised Merger Agreement still reflected a substantial premium both to Anaplan’s unaffected share price and to its expected share price if stockholders voted not to approve the Merger.”

Structural coercion— is simply “a vote structured so that considerations extraneous to the transaction likely influenced the stockholder-voters, so that [the Court] cannot determine that the vote represents a stockholder decision that the challenged transaction is in the corporate interest.”

Vice Chancellor Cook ruled that ”Plaintiff does not allege self-dealing or other extraneous factors that might warrant calling upon the principle of structural coercion.”

Was there waste?

Corwin includes no cleansing provision for waste, the court said, but it noted that, in addition to numerous other benefits and concessions, the final merger offer provides 10.4 billion in cash.

No new D&O route

Perhaps with a different set of facts, plaintiffs’ claims might have survived a motion to dismiss, but “acquiree fiduciaries are already disincentivized from acting in ways that jeopardize a merger’s closing,” the Vice Chancellor concluded. “Although this case presents what some might view as hard facts, it is not at all clear to me that the correct response is to open a new route for director and officer liability. “

A recent Delaware Court of Chancery ruling is a gem, notwithstanding—or maybe because of—its brevity, that addresses the minimum allegations required to seek dissolution of a business entity, and deserves a place in the pantheon of Delaware decisions.  It presents itself to the world in the form of a short and humble Order that simply recites core principles while denying a motion to dismiss a petition for the dissolution of an LLC. It is a big win for acknowledging the nuanced dynamics of business relationships in a closely-held entity. 

In Walter v. McManus, C.A. No. 2024-0412-NAC, Order (Del. Ch. June 7, 2024), the Court restated several key principles of law regarding the dissolution of LLCs or corporations that I highlight below in bullet points.

[Initially, I note that among the most exemplary discussions of the minimum requirements for surviving a motion to dismiss a petition for dissolution of a business entity are those in the Chancery decision of T&S Hardwoods, highlighted on these pages.]

Highlights of other dissolution decisions on these pages over the last 20 years are available at this link.

Highlights of Walter v. McManus:

  • The first paragraph of the Order describes several “convincing” factors that support a judicial dissolution such as an operating agreement that gives no means of navigating around a deadlock, or the existence of a board level voting deadlock—but the Order wisely at least implies that there is no express per se requirement for a deadlock.
  • The Court astutely observed that: it is not necessary to suggest that the business must be “metaphorically ablaze to state a reasonably conceivable claim to dissolve.”
  • Importantly, the Court instructed that the counterpart corporate statute, DGCL Section 273, is often used by analogy to apply to dissolution cases under the LLC Act. The court sagely reasons that the corporate dissolution statute: “does not mandate that the parties struggle until they have destroyed their relationship entirely and jeopardized their business.”
  • Although it is not required to be so pled, the Court found it relevant that there was “grave risk to the business, even if it is entirely profitable, via a residual inertial status quo.”
  • Delaware law does not require a member to plead she made a performative proposal she knew would be dead-on-arrival as a predicate to seeking judicial resolution.” (citing Seokoh, 2021 WL 1197593, at * 11.) (also distinguishing Arrow, 2009 WL 1101682, as not based on deadlock.)
  • Both the T&S Hardwoods Chancery opinion described on these pages, and this decision demonstrate a sensitivity to the exigencies of the nuanced business dynamics in closely-held entities, and that recognition supports a standard that is more closely aligned to no-fault divorces, as opposed to some opinions at the trial-court level that have attempted to impose additional requirements that are not in the statute, but instead are akin to requiring a purity test in order to establish a deadlock.
  • Lastly, but perhaps of at least equal importance to other principles stated in this Order, is that it remains an insufficient basis to oppose dissolution if a party has an option to sell his interest to a third party, because it would be inequitable to force a party to exercise an option to sell, when that option to sell is entirely voluntary, as an alternative to dissolution.

It would exalt artifice over pragmatism to require talismanic or magic words to be used in pleadings, or to require pleadings that, figuratively speaking, must describe “someone’s hair on fire” in order for one’s investment to be freed from the bondage of a dysfunctional group of a few business owners

The U.S. Court of Appeals for the Eleventh Circuit recently published a concurring opinion in which the judge explained how he used different AI-powered large language models like OpenAI’s ChatGPT to interpret words and phrases at issue in the case decided. Snell v. United Specialty Insurance Company, No. 22-12581 (11th Cir. May 28, 2024)(Newsom, J., concurring).

AI in the law is now mainstream when an appellate court includes references to how it was used as part of an analysis in connection with a published opinion.

A recent Delaware Court of Chancery opinion explains several principles of Delaware law useful for corporate and commercial litigators alike. In ETC Northeast Field Services, LLC v. Muse, C.A. No. 2023-0249-MTZ (Del. Ch. May 31, 2024), the Vice Chancellor determined that laches prevented breach of fiduciary duty claims because to allow the claims would be an impermissible collateral attack on a final arbitration award, which also eliminated the tolling arguments.

The following highlights should be of interest and widely applicable to corporate and commercial litigators, as well as fans of Delaware corporate and commercial law.

Highlights

●    The statute of limitations for breach of fiduciary duty claims is typically three years, and that timeline begins to accrue when the alleged wrongful act occurs, even if the plaintiff is ignorant of the cause of action. See Slip op. at 11-12 and footnote 44.

●    There are three ways to toll the applicable statute of limitations in order to enable a plaintiff to recover over a longer period of time: (i) an inherently unknowable injury; (ii) fraudulent concealment; and (iii) equitable tolling.  See Slip op. at 13-14.

●    The court explained that notice universally limits the tolling doctrines, and a plaintiff cannot invoke tolling doctrines when a plaintiff was objectively aware of—or should have been aware of the facts giving rise to the wrong.  See Slip op. at 14.

●     A basic principle of contract law applicable here is that when a party has assented to clear contractual terms, the parties are on notice of those terms. See footnote 57 and accompanying text (citing Restatement (Second) of Contracts § 157, cmt. (b) (1981)).

Compared to what might be described as an epistemological analysis of some aspects of Delaware corporate law, this short post is a more practical tool for the toolbox of litigators who can benefit, on a substantive level, from enforcing strict compliance with procedural discovery rules. In the case styled: In re Delaware Public Schools Litigation, C.A. No. 2018-0029-JTL (Del. Ch. May 30, 2024), the Delaware Court of Chancery provides a deep dive into the requirements for fee-shifting if a party denies a request for admission–and the requesting party proves at trial that the fact that was denied should have been admitted.  See Rule 37(c) and Rule 36. [As an aside, a few days ago the Court of Chancery published a recent tranche of revisions to its rules that practitioners should carefully review.]

This extensively footnoted 52-page decision deserves a comprehensive review but for purposes of this short blog post I will provide highlights via bullet points.

Highlights

●          Although rarely enforced in practice, and often observed in the breach, the court elucidates the proper way to object to discovery, with citations to extensive support to explain why commonly used boilerplate objections to discovery requests may result in waiver. Valid discovery objections must satisfy three requirements: (1) the objections must specifically apply to the facts of the case; (2) if information is being provided subject to an objection, the objection must clarify how the objection is applied; and (3) the responding party must explain what information is being provided notwithstanding the objection. See Slip op. at 18 and accompanying footnotes.

●          This scholarly opinion explains why Rule 36 allows requests for admissions of “ultimate facts”—but not requests for admissions of “legal conclusions.” The decision cites to and discusses applicable case law that helps to determine the boundaries of those two ends of the spectrum.  See Slip op. at 25-39.

●          In connection with awarding fees, the court reviews the standard to determine what reasonable hourly rate the court will allow, as well as the reasoning to buttress the unwillingness of the court to review bills “line by line.” See Slip op. at 43-50.

Prior blog posts over the last 19-plus years on these pages have addressed the difficulty of succeeding on a motion to disqualify counsel. The recent Delaware Court of Chancery decision in Brex Inc. v. Su, C.A. No. 2022-0758-MTZ (Del. Ch. May 22, 2024), is no exception.

This ruling explains why disqualification of counsel was denied based on an alleged violation of Rule of Professional Conduct 3.7(a), which provides the general prohibition of an attorney acting as a necessary witness and an advocate in the same trial. See prior blogs posts on these pages with highlights of court decisions addressing this rule.

Rule of Professional Conduct 1.9 may bar current representation of a client that is adverse to a prior representation of a former client. But in this case, delay in seeking disqualification on this basis, was the reason why the court determined that the argument was waived. See prior blog posts on these pages with highlights of court decisions addressing this rule.

I often defer to the professoriate for scholarly reviews of lengthy Chancery decisions.  Professor Ann Lipton provides a review of the Caremark analysis in a recent 100-plus page Chancery decision that discussed a conflicted controller transaction with a problematic special committee.  The case is Firefighters’ Pension System v. Foundation Building Materials, C.A. No. 2022-0466-JTL (Del. Ch., May 31, 2024). See professorial commentary here and here.

Of course, there is much more that can be, and will be, said about this important decision.

Frank Reynolds, who has been covering Delaware corporate decisions for various national publications for over 35 years, prepared this article.              

The full Delaware Supreme Court recently reversed the dismissal of a shareholder challenge to a private equity consortium’s acquisition of Inovalon HoldingsInc. after finding the cloud-based healthcare industry support provider’s directors did not fully reveal to investors the conflicted roles of the deal’s financial advisors, as the high court’s seminal MFW ruling requires, in City of Sarasota Firefighters Pension Fund et al. v. Inovalon Holdings Inc., Del. Supr., No. 305, 2023 (May 1, 2024).

The justices unanimously reversed the Court of Chancery’s decision that the transaction met the standard Khan v. M & F Worldwide Corp. 88 A.3d 635 (Del. 2014) demands of controller-dominated deals to qualify for review under the defendant-friendly business judgment standard. The high court said MFW required Inovalon’s special committee of directors that negotiated the merger terms to reveal the full extent of their financial advisors’ involvement with counterparties in this transaction.  Without that information, the Inovalon minority shareholders could not cast the informed merger vote that would justify business judgment review and dismissal of the suit, Justice Karen Valihura wrote.

The decision marked the second time in as many months that the high court overturned a Chancery Court merger ruling on grounds that, the justices found, too little was required of the challenged deal’s proponents under MFW.  In the case styled In re Match Group Inc. Derivative Litigation, Del. Supr., No. 368, 2022 (April 4, 2024), Chancery had allowed an asset reshuffle that allegedly dealt less value and more debt to pension fund investors compared to IAC insiders. The high court said, in a controller-dominated deal, all the directors of the negotiating committee—not just a majority—had to be independent to avoid review under the exacting entire fairness standard.

Background

Three pension funds challenged the Nordic-led acquisition of Inovalon claiming it was a controller transaction that failed to qualify for protection under MFW because the deal did not have the benefit of a fully independent review committee from the outset and did not get a completely informed approval vote from a majority of the minority shareholders.

The suit claimed that Inovalon CEO Kieth Dunleavy and director Andre Hoffmann controlled a majority of Inovalon’s stock through multiple vote shares but did not establish a functioning, fully-independent negotiating committee from the outset of bidding. And it charged that the minority knew only part of the conflicts involving Inovalon’s investment banker financial advisors.

The trial court ruling

In a bench ruling, the Chancery Court dismissed, finding that the deal and disclosures about it to investors met MFW’s requirements. Concerning the ab initio requirement for the special committee, it found that the alleged conflicts did not arise until Nordic “formally requested that Dunleavy participate in an equity rollover as part of its written offer on July 21, 2021,” which marked the official beginning of the negotiations.   The trial court found that the conflicted roles of the advisors was adequately revealed.

The appeal ruling

On appeal, the high court focused on the plaintiffs’ contention that “judicial cleansing under the MFW framework is unavailable because the Proxy omitted material information that rendered the minority stockholders’ vote to approve the Transaction uninformed.”  The full court agreed.

The justices noted that MFW requires of controller buyouts that the business judgment standard of review will be applied “if and only if:”

(i)     the controller conditions the procession of the transaction on the approval of both a Special Committee and a majority of the minority stockholders;

(ii)    the Special Committee is independent;

(iii)   the Special Committee is empowered to freely select its own advisors and to say no definitively;

(iv)    the Special Committee meets its duty of care in negotiating a fair price;

(v)     the vote of the minority is informed; and

(vi)    there is no coercion of the minority.

Full disclosure required

The high court said, “the trial court’s due care analysis concerning the retention and management of the advisors did not sufficiently address all of the disclosure issues and “Delaware courts have required full disclosure of investment banker compensation and potential conflicts.”

Conclusion

It was not enough to simply disclose to investors that the advisors might have received fees from counterparties to the transaction, the high court  said, because, “when a board chooses to disclose a course of events or to discuss a specific subject, it has long been understood that it cannot do so in a materially misleading way, by disclosing only part of the story, and leaving the reader with a distorted impression.” Rather, “[d]isclosures must provide a balanced, truthful account of all matters they disclose.”

The recent Delaware Court of Chancery decision styled In re Columbia Pipeline Group, Inc. Merger Litigation, Cons. C.A. No. 2018-0484-JTL (Del. Ch. May 15, 2024), provides a mini-treatise on the titular topic, and a scholarly deep dive that includes a tour of nearly 40 years of Delaware corporate law on the tension between the contractual obligations of directors—as compared to the fiduciary duties of board members, and the general primacy of contract law.  The court also addresses how those competing principles interface with the theory of efficient breach. See Slip op. at 37-64 and footnote 124.

This 86-page opinion could qualify as a law review article in its own right. A law review article could also be written with commentary on the cornucopia of case law, scholarship and statutory authority cited in the footnotes, as well as insightful analysis of the most important Delaware decisions on the titular topic over the last four decades.

It may be audacious, and it risks treating a serious topic too casually, but for purposes of busy readers who might be interested primarily in the highlights, I provide a few bullet points.

Takeaways and Gems of Delaware Law

  • The court observes that “Delaware law does not regard a contractual breach as less culpable than a fiduciary breach.”  See Slip at 39. The court begins the opinion with a quote from the Shakespeare play Measure for Measure:  “The tempter, or the tempted, who sins most?”  The court in the first sentence of the opinion describes that quote as a summary of the primary dispute addressed in the opinion, which is the final chapter of a case which includes the liability decision styled In re Columbia Pipeline Gp., Inc. Merger Litig., 299 A.3d 393 (Del. Ch. 2023). 
  • The court’s thorough discussion of the issue of whether a breach of contract or a breach of fiduciary duty is a greater sin, and whether one warrants graver consequences, reminds me of the iconic description of the many circles of hell in Dante’s Inferno, which assigns descending levels (or concentric circles) of eternal torment in the afterlife depending on the types of transgressions for which people were condemned to hell. [Applying the reasoning in this opinion to the circles of hell in Dante’s Inferno, if someone suffered damnation for breach of fiduciary duty or breach of contract, they would find themselves in the same circle of hell forever.]
  • The court describes why, under Delaware law, fiduciary duties do not trump contracts—but rather, the opposite is true. The court discussed the rationale of the key Delaware cases on this topic over nearly 40 years:  Van Gorkom; QVC; Omnicare; post-Omincare cases such as, e.g., C&J Energy Servs., Inc. v. Miami Gen. Empls.’, 107 A.3d 1049, 1072 (Del. 2014). Slip op. at 39 to 64.
  • The court emphasized that Delaware law does not regard the fiduciary duties imposed by equity as more important than voluntarily assumed contractual commitments.  Slip Op. at 61.  Rather, the court instructed that:

The cases overwhelmingly demonstrate that a court cannot invoke the fiduciary duties of directors to override a counterparty’s contract rights.  That is true even when a heightened standard of review applies. To argue that case law empowers a court to set aside a contract when reviewing director actions under an enhanced form of judicial scrutiny, embraces the much-ridiculed position that the Omnicare majority was perceived to take.  As consistently interpreted by courts and commentators, QVC does not support that assertion, and post-Omnicare case law soundly rejects it.

See footnote 122 and accompanying text.

  • The court noted that in some situations both claims for breach of fiduciary duty and breach of contract can proceed in the same case. In the present case, however, contractual pre-emption “has the upper hand.”  See footnote 122 at page 63.
  • In connection with explaining that the fiduciary duties of directors did not enable the corporation to escape a contract, the court recognized the concept of “efficient breach,” and that a corporation can engage in efficient breach just like any other contracting party.  See footnote 124.
  • For students and fans of philosophy, it is always enlightening to see a quote about metaphysical insights in a judicial opinion from a famous philosopher.  See footnote 140 quoting from Jean-Paul Sartre, Existentialism Is a Humanism 44 (Carol Macomber Trans., Yale Univ. Press 2007) (“[W]hat is impossible is not to choose.  I can always choose, but I must also realize that, if I decide not to choose, that still constitutes a choice.”)  This quote was in connection with the reference to several Delaware decisions in which the court referred to a conscious decision to refrain from acting as being nonetheless a valid exercise of business judgment.  See Aronson v. Lewis, 473 A.2d 805, 813 (Del. 1984) (subsequent history omitted).
  • The court also engaged in an extensive discussion of the Delaware Uniform Contribution Among Tortfeasors Act (DUCATA), and how to allocate damages when a plaintiff releases some, but not all tortfeasors, and later recovers damages in a higher amount.  See Slip op. at 31-32. The court also discussed the interfacing of the unclean hands doctrine with DUCATA.  See Slip op. at 33.

A recent Delaware Court of Chancery decision addressed many Delaware legal precepts of importance in connection with claims by members in a web of related alternative entities, that have broad application for those involved in commercial and business litigation.

In the case styled Kuramo Capital Management, LLC v. Seruma, C.A. No.  2021-0323-KSJM (Del. Ch. April 30, 2024), the court issued a 94-page decision, with the first 51-pages or so providing a detailed factual background that describes the multiple layers of interrelated entities and the shifting relationships among the parties as well as the multiple changes of ownership which impacted the duties and liabilities that gave rise to a panoply of claims. The court provides two charts to diagram the evolving relationships among the many entities involved and how their interrelated ownership changed over time.  Those charts filled the better part of two pages.  See Slip op. at 13 and 17.

With that backdrop, it may seem bold and unrealistic to provide a short overview of such a lengthy decision with so many complicated factual details and intricate legal issues and analyses.

Nonetheless, for the benefit of those readers who are primarily interested in the essential takeaways from the decision, and the irreducible kernels of wisdom that might be generally applicable, as well as insights that might lead one to decide that it would be helpful to read the whole opinion, I provide the following bullet points:

Highlights

  • The fiduciary duties of LLC managers, and the prerequisites for limiting or eliminating those duties is a perennial issue that the court addresses at page 53. See also footnotes 282 and 283.
  • The court also describes the contractual standard requiring actions to be “fair and reasonable,” to be akin to, “if not equivalent to, entire fairness review.”  See cases cited at footnote 283.
  • The always important recitation of the well-known three standards of review when analyzing claims for breach of fiduciary duty, is addressed at page 55.
  • The well-worn entire fairness standard is discussed and applied at pages 57 through 62.
  • The court also noted that the plaintiff repackaged its claim for breach of fiduciary duty as a claim for fraud, but the fraud claims appeared largely duplicative.
  • However familiar and pedestrian the elements for a breach of contract claim are, it’s always useful to be reminded of them.  See Slip op. at 63.
  • A helpful discussion explains why, based on the facts of this case, the court granted a D.J. that there was no right to indemnification due to the findings of a lack of good faith and breach of fiduciary duty, resulting in a claw back of funds previously advanced.
  • A comparison of the elements for a tortious interference with contractual relations claim, with a claim for tortious interference with prospective business relations, was discussed at page 68 through 71.  This analysis included the seven factors to determine if interference with the contract is justified, and the tension between some unavoidable interference as an allowable consequence of fair competition in the marketplace.  Also discussed was the distinction between interference and free speech as described in Section 768 of the Restatement, Second, of Torts.
  • The court noted the truism that a party to a contract cannot be liable for interfering with its own contract.

The Court of Chancery recently explained in the case styled In Re Harris FRC Corporation Merger and Appraisal Litigation, No. 2019-0736-JTL (Del. Ch. Feb. 19, 2024), the difference between the attorney/client privilege and a lawyer’s duty of confidentiality under Rule of Professional Conduct 1.6.

The titular topic was the subject of my latest ethics column for The Bencher, the publication of the American Inns of Court. I have been writing the ethics column for 25 years.

The titular topic is addressed in the recent Chancery decision of McRitchie v. Zuckerberg, and corporate law scholar Professor Bainbridge provides scholarly insights about the topic and the decision on his blog, which includes the following money quote from the opinion:

Under the standard Delaware formulation, directors owe fiduciary duties to the corporation and its stockholders. Implicitly, the “stockholders” are the stockholders of the specific corporation that the directors serve, i.e., “its” stockholders. The standard Delaware formulation thus contemplates a single-firm model (or firm-specific model) in which directors of a corporation owe duties to the stockholders as investors in that corporation. That point is so basic that no Delaware decisions have felt the need to say it. Fish don’t talk about water.

Frank Reynolds, who has been covering Delaware corporate decisions for various national publications for over 35 years, prepared this article.

The full Delaware Supreme Court recently revived part of an investor challenge to IAC/InterActive Corp’s spinoff of its internet dating subsidiary after finding that the deal that controller IAC imposed on minority shareholders did not meet the exacting standards of the high court’s seminal MFW ruling, in In re Match Group Inc. Derivative Litigation, Del. Supr., No. 368, 2022 (April 4, 2024).

The en banc high court partially reversed a Court of Chancery decision that the derivative suit must be dismissed because IAC met the requirements of independence set by the milestone opinion in Kahn v. M & F Worldwide Corp., 88 A.3d 635 (Del. 2014).  The asset reshuffle allegedly dealt less value and more debt to pension fund investors compared to IAC insiders.  MFW famously said a controller-engineered deal could get business judgment protection if the negotiating committee was independent and disinterested–and the properly-disclosed transaction was endorsed by a majority of the minority shareholders.

The ruling’s importance

But the pivotal issue in this high court appeal concerned the proper standard to determine whether this unique corporate transaction was the product of fully independent, disinterested fiduciaries.  At one extreme, in the case of a freeze-out merger–where the corporate machinery is allegedly used to deprive investors of their shares and/or voting rights–all deal negotiators must be completely independent and disinterested. The high court said the key question in the appeal was: since the Match spinoff did not involve a freeze-out, could the IAC defendants qualify for the protection of the deferential business judgement standard even though one of three deal negotiators was not independent? 

The Court of Chancery said “yes”, agreeing with defendants that a majority of independent directors was enough to trigger the business judgment standard.  The high court said, ‘no“  and reversed. “If the controlling stockholder wants to secure the benefits of business judgment review, it must follow all MFW’s requirements,” the justices said.  In the MFW setting, to replicate arm’s length bargaining, all separation committee members must be independent of the controlling stockholder.

 Background

 The challenged 2020 transaction involved the creation of two new corporations out of the former IAC and Match.com businesses and a reshuffling of the assets and liabilities of those two entities that was engineered by a “separation committee” composed of three IAC directors.  The old Match was later dissolved into the new ICA.

Three pension funds that owned that eliminated stock sued alleging that the separation was a conflicted transaction in which Old IAC, as Old Match’s controlling stockholder, stood on both sides of the transaction. The plaintiffs claimed that Old IAC obtained significant “non-ratable” benefits in the Separation to the detriment of Match and its minority stockholders, and argued that the Separation Committee was conflicted and the proxy disclosures misled the Old Match minority stockholders.

The trial court ruling

Although the Court of Chancery found that the plaintiffs successfully pleaded facts creating a reasonable inference that one director was not independent of Old IAC, it ruled that a plaintiff must nonetheless show that “either (i) 50% or more of the special committee was not disinterested and independent,” or “(ii) the minority of the special committee ‘somehow infect[ed]’ or ‘dominate[ed]’ the special committee’s decision-making process.“  Finding that plaintiffs failed to do that, the vice chancellor dismissed.

The appellate ruling

Defendants argued that the vice chancellor correctly applied a less exacting standard than the one used in MFW and other freeze-out merger cases.  But the Supreme Court  said, in those key cases, “the common thread running through our decisions: a heightened concern for self- dealing when a controlling stockholder stands on both sides of a transaction.’”

In addition, the high court noted that, longstanding business affiliations, particularly those based on mutual respect, are of the sort that can undermine a director’s independence. Directors who owe their success to another will conceivably feel as though they owe a “debt of gratitude” to the individual. The plaintiffs have adequately pleaded that Director Thomas McInerney may have such a relationship with IAC.

The justices said, a controlling stockholder’s influence is not “disabled” when the special committee is staffed with members loyal to the controlling stockholder. “We stated in MFW that the special committee must be independent, not that only a majority of the committee must be independent,” the high court said’,  “A special committee created to secure the protections of MFW should function “in a manner which indicates that the controlling stockholder did not dictate the terms of the transaction and that the committee exercised real bargaining power at an arm’s length.

The unanimous Supreme Court reversed the dismissal, finding the plaintiffs’ claims of an unfair deal by non-independent directors are supported by the facts that:

1) the minority stockholders received a slightly higher percentage of ownership of New Match;

(2) Old Match was capitalized in a vastly different way, with limited cash, much higher debt, and restrictive governance provisions; and

(3) the boards were different

Supplement: One of Delaware’s favorite corporate law scholars, Professor Stephen Bainbridge, provides additional insights about this case on his eponymous blog here and here.

One of the nation’s leading corporate law professors, Stephen Bainbridge, addresses on his eponymous blog, whether a board meeting may be conducted by text messaging alone, and concludes that DGCL section 141(i) requires that board members participating in a meeting must be able to hear each other. The good professor cites to his own law review articles on the topic to support his reasoning.


Frank Reynolds, who has been covering Delaware corporate decisions for various national publications for over 35 years, prepared this article.

Vice Chancellor Travis Laster recently denied the TripAdvisor Inc. directors’ request for a quick appeal of his decision one month earlier to let shareholders press their charge that the board’s charter change move to Nevada robs them of litigation rights in a self-interested transaction that fails the exacting entire fairness standard. Palkon et. al. v. Maffei  et. al., No. 2023-0449-JTL  opinion issued (Del. Ch. Mar. 21, 2024).

The Chancery Court’s interlocutory appeal decision found no motive for the reincorporation move other than insulation of directors and officers and no attempt at bargaining or investor compensation for Nevada’s increased litigation shielding.  He said trial could reveal whether post-move changes in stock price support the plaintiffs’ claim that their shares would lose value while insiders benefited.

The appeal opinion is recommended reading for corporate law specialists in that it applies the Supreme Court Rule 42 interlocutory appeal certification requirements to the novel issue of fiduciary duties in a reincorporation into any entity with different shareholder rights.  Vice Chancellor Laster explained in detail why he rebuffed each of the grounds the defendants submitted as justifications for immediate review.

Background

Gregory B. Maffei, the CEO, Chairman and controlling shareholder of TripAdvisor which operates the world’s largest travel guidance platform, consulted his directors and lawyers  to produce a plan to reincorporate in Nevada to better protect the officers and directors under that state’s corporate law.  Shareholders sued, charging breach of fiduciary duty and defendants moved to dismiss.


The Feb.20 dismissal denial

Vice Chancellor Laster found that the unaffiliated stockholders’ voting pattern “supports an inference of unfairness”. Just as an informed vote by unaffiliated stockholders in favor of a conflicted transaction is evidence of fairness, an informed vote by unaffiliated stockholders against a conflicted transaction suggests unfairness, he said, noting that, “Here, the unaffiliated stockholders resoundingly rejected the conversions.” Palkon et. al. v. Maffei  et. al., No. 2023-0449-JTL  opinion issued (Del. Ch. Feb. 20, 2024).

The appeal

Vice Chancellor Laster examined the defendant’s grounds and found none sufficient.

Does the opinion involve an issue of first impression?

Defendants assert that “no other Delaware court has addressed whether and under what circumstances a company’s move to a state affording some greater litigation protection for potential future cases based on hypothetical future facts constitutes a non-ratable benefit material enough to trigger entire fairness review.”

But the vice chancellor said, “The application of entire fairness to an interested merger is not a novel issue. Nor is the application of entire fairness to a merger that confers litigation protections on the fiduciary defendants who approved it.”  He added that, “The Opinion also did not address a new issue by focusing on the materiality of a reduction in the litigation risk. Using a materiality standard to evaluate interestedness is not novel.”

Would a high court review resolve a conflict among the courts?

Defendants argued that “[t]he decisions of the trial courts are conflicting upon the question of law.” But the vice chancellor said, “Whether the  cases conflict depends how one interprets prior cases. On balance, this factor does not support interlocutory review.

Would review end the case and serve justice?

As their final basis for interlocutory appeal, the defendants invoke two factors

together: factor (G), which asks whether “[r]eview of the interlocutory order may

terminate the litigation,” and factor (H), which asks whether “[r]eview of the

interlocutory order may serve considerations of justice.” That combination does not

support interlocutory review.

The possibility that a reversal could save litigation costs “is not unique to [this] application and would otherwise warrant certification after nearly every trial court decision even in cases lacking ‘exceptional’ circumstance,”  the Vice Chancellor ruled, “Moreover, for reasons discussed previously, this matter is likely to require relatively less extensive litigation efforts than other entire fairness cases.”

“Not invited” to weigh Musk influence?

However, as to the appellants’ assertion that the Opinion decided a substantial issue thereby subtly alluding to the disproportionate media attention given to the Opinion because  “thousands of other Delaware corporations . . . need certainty as to the rules that apply to a decision to reincorporate in another jurisdiction,” the vice chancellor said that alluded to the attention the Feb. 20 opinion received after Elon Musk’s high-profile comments about “forsaking Delaware” following his loss in an unrelated decision in the Chancery Court.

“Rule 42 does not invite a trial court to consider the level of media attention that a decision has received. That does not mean that the Delaware Supreme Court could not consider it.” he said.

Not about Nevada
Finally, the vice chancellor noted that “ nothing about the ruling turns on anything about Nevada as a state. ” If the Company was converting into a Delaware LLC and paralleled Nevada law, then the outcome would be the same, he said. “The allegations about the substance of the post-conversion legal framework generate the result, not whether it was created by Nevada legislators or Delaware lawyers.”

“This is not a case where the interests of justice require early stage intervention

by the Delaware Supreme Court,” the vice chancellor concluded. It is a case where the differences between Delaware law and Nevada law have been explored. However, he noted that this certification review ruling is only a recommendation to the Delaware Supreme Court—which makes up its own mind about whether to grant an appeal.

This year’s Lecturer is Professor Lisa Fairfax from the University of Pennsylvania Law School. Details of the event on April 19 at the Hotel duPont in Wilmington, Delaware, are available at this link.

Hard to believe that when I started this idea while on the law review, it would still be going strong almost four decades later. Named after my father, the Delaware Journal of Corporate Law at the Delaware Law School of Widener University continues to host and organize the event that brings leading corporate law scholars from around the country to share their insights. Prior Annual Lectures have been highlighted on these pages.

Key Delaware decisions on advancement under DGCL Section 145 for directors and officers were highlighted in a just-published book chapter in an ABA publication that I co-authored with 5 of my colleagues in the Delaware office of Lewis Brisbois. This is the 8th year that I have highlighted key advancement cases for a book chapter for the ABA.

Links to other advancement decisions highlighted over the last 19 years on this blog, as well as prior ABA book chapters on this topic are available on these pages.

A recent gem of a short letter ruling from the Delaware Court of Chancery in Goldman v. LBG Real Estate Company LLC, C.A. No. 2023-0426-KSJM (Del. Ch., Feb. 26, 2024), provides important insights, with citations to authority, on three noteworthy topics of widespread relevance to corporate litigators:

  • California courts find “Delaware law on advancement particularly persuasive because of the depth of its experience with corporate governance issues.”  Slip op. at 2 and footnote 6 which cites to several cases (other citations omitted).
  • Like Delaware, California allows fees on fees proportionate to the degree of success of a claimant.  See Slip op. at 2 and footnote 7 (citing cases).
  • This letter ruling was in the context of a motion for reargument under Rule 59(f), and the fact that the court made quick work of the motion in a 3-page decision is an indication of how much of an uphill battle such motions usually are.

A recent Delaware Court of Chancery transcript ruling provides guidance on best practices for how to craft answers to a complaint, in the matter styled: 26 Capital Acquisition Corp. v. Tiger Resort Asia Ltd., C.A. No. 2023-0128-JTL, Transcript (Del. Ch. Feb. 9, 2023). (N.B. In Delaware, transcript rulings can be cited in briefs.)

The court disapproved of the common tactic of denying most allegations in the complaint with a lack of careful attention to detail.  [The Delaware rules require that the allegations of the complaint be restated before the actual response.]  The applicable rule also requires an answer that fairly meets the allegations of the complaint.  The court expressed displeasure about “rampant denials.”

The court did not approve of those who may “have some epistemic doubt about the truth of an allegation that crosses multiple states of the universe . . . notwithstanding their confidence level about what the real state of the world is.”  Transcript at 46.

My additional comment is that an answer is not the correct forum for nuanced or pedantic ruminations about ontology or one’s own Weltanschauung.

The court discouraged denials of things that should be “really difficult to dispute” and instead expected parties to prepare answers that “fairly meet the allegations of the complaint . . . [in a way that] will help frame the issues in dispute.” The court further explained that denials should not be used “. . . even if they didn’t say it precisely like you would have if you had made the allegation.”  Id.

Supplement: Delaware’s favorite corporate law scholar (in my view), Prof. Bainbridge, kindly linked to this post on his eponymous blog.

In a recent magnum opus, the Delaware Court of Chancery in the matter of West Palm Beach Firefighters Pension Fund v. Moelis & Co., C.A. No. 2023-0339-JTL (Del. Ch. Feb. 23. 2024), addressed the tension between DGCL Section 141(a), which provides that directors manage the business and affairs of the corporation unless otherwise provided in the certificate of incorporation–and a stockholders’ agreement.

The court provided extensive scholarly analysis and citations to extensive authorities to buttress its reasoning that the stockholders’ agreement involved in this particular case improperly restricted directors’ powers, contrary to Section 141(a), because those restrictions were not contained in the certificate of incorporation.

Fortunately, Professor Stephen Bainbridge provided his typically erudite insights and learned commentary about this opinion on his eponymous blog. At least for now, I won’t add to the good professor’s insights.

My anecdotal observation is that Professor Bainbridge is one of Delaware’s favorite corporate law scholars to the extent that his prolific scholarship is often cited in Delaware court opinions, including in this opinion at footnotes 15, 296, 297, 298, and 299. 

A prior decision in this same case two weeks earlier was highlighted on these pages.

In his commentary on this most recent decision linked above, Professor Bainbridge was kind enough to give me a “shout out” as he referred to my above-linked highlights of the earlier decision in this case on my blog, writing that:

“My good friend and leading Delaware corporate law litigator Francis Pileggi has a new blog post that digs into an earlier decision in the case. As always, he does a brilliant job.”

  I am grateful to the good professor for his kind words.

Frank Reynolds, who has been covering Delaware corporate decisions for various national publications for over 35 years, prepared this article.

The Delaware Court of Chancery recently refused to dismiss shareholder charges that TripAdvisor Inc.’s CEO/controller and directors robbed them of litigation rights by moving the firm’s charter to Nevada in a self-interested transaction that triggered the exacting entire fairness standard because the changes benefited only the defendants, in Palkon et. al. v. Maffei, et. al., No. 2023-0449-JTL  opinion issued (Del. Ch. Feb. 20, 2024).

Vice Chancellor Travis Laster’s February 20 opinion denied the company’s motion to dismiss the breach-of-duty suit after he found no evidence of a motive for the change other than insulating TripAdvisor officers and directors — and no attempt at bargaining or investor compensation for the increased shielding.

The Opinion’s Importance

The opinion is likely to be closely studied by corporate governance specialists—especially those with clients who would be impacted by a charter change that affects shareholder litigation rights.  Delaware, where two thirds of major Americans are incorporated, prides itself on its efforts to balance the power of public shareholders and corporate management and controllers. 

However, Vice Chancellor Laster’s opinion noted that if the engineers of a transaction control a majority of stock, the minority could go forward with a derivative suit if they can show–as they did here on a motion to dismiss–that the move was self-interested, triggering application of the plaintiff-friendly entire fairness standard.  And although in this case, the defendant CEO owned a full “hard majority” of TripAdvisor through his multi- vote shares, Delaware courts have found defendants with as little as 20 percent interest to be a “controller” if they had an influence over a majority of directors.

The opinion is valuable because it lists the defendants’ failures to craft a transfer plan that would have been fair to the minority and details the steps the defendants could have taken to devise a reincorporation that would not have triggered review under the entire fairness standard.

Background

 Gregory B. Maffei,  the CEO, Chairman and controlling shareholder of TripAdvisor which operates the world’s largest travel guidance platform, consulted his directors and lawyers  to produce a plan to reincorporate in Nevada to better protect the officers and directors under that state’s corporate law.  Shareholders sued, charging breach of duty and defendants moved to dismiss.

What standard applies?

The Vice Chancellor said the outcome of the motion depends first on which of Delaware’s three tiers of review for evaluating director decision-making applies.

Business judgment

This is Delaware’s default standard of review. When applying that standard, a court presumes that the defendant fiduciaries “acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company.”  Unless a plaintiff rebuts one of the elements of the rule, “the court merely looks to see whether the business decision made was rational in the sense of being one logical approach to advancing the corporation’s objective.”

Advanced scrutiny

Under this standard, he said, the directors must establish that they (i) sought to pursue a legitimate end and (ii) selected an appropriate means of achieving it.

Entire fairness

Under that standard, the fiduciary defendants must establish “to the court’s satisfaction that the transaction was the product of both fair dealing and fair price.” “Not even an honest belief that the transaction was entirely fair will be sufficient to establish entire fairness. Rather, the transaction itself must be objectively fair, independent of the board’s beliefs.”

Was there a benefit?

Since Plaintiffs allege—and for purposes of this motion, defendants concede—that Maffei controls TripAdvisor and since no one suggests that the conversion was cleansed in any way, determining the correct standard of review therefore depends on whether the conversion conferred a non-ratable benefit on the fiduciary defendants, the court said.

The next step for the court was to determine whether the reincorporation conferred a “non-ratable benefit” on the controlling fiduciary by reducing the risk of shareholder litigation liability.  The Vice Chancellor said the answer is “yes” because, “Obtaining coverage for future potential liabilities is a benefit, and insureds pay premiums to get it.”

Fair dealing?

The vice chancellor concluded that the way the reincorporation came about was not fair to the public shareholders.  He noted that, “The procedural dimension ‘embraces questions of when the transaction was timed, how it was initiated, structured, negotiated, disclosed to the directors, and how the approvals of the directors and the stockholders were obtained.”

He found that the unaffiliated stockholders’ voting pattern:

“supports an inference of unfairness. Just as an informed vote by unaffiliated stockholders in favor of a conflicted transaction is evidence of fairness, an informed vote by unaffiliated stockholders against a conflicted transaction suggests unfairness.  Here, the unaffiliated stockholders resoundingly rejected the conversions.”

Injunction or Damages?

The court denied the motion to dismiss but declined to approve plaintiffs’ motion to enjoin the reincorporation because money damages could be sufficient, if proven, since they could be based on any decline in stock value after the move.

In the context of explaining why certain challenges to a stockholders’ agreement were not barred by laches and were otherwise timely, the Delaware Court of Chancery recently recited several enduring fundamental principles of Delaware corporate law and corporate governance in the gem of a decision styled: West Palm Beach Firefighters’ Pension Fund v. Moelis & Company, C.A. No. 2023-0309-JTL (Del. Ch. Feb. 12, 2024).

Key Takeaways:

In support of its reasoning for rejecting arguments that challenges to a stockholders’ agreement were barred by laches and ripeness defenses, the Court of Chancery, in a restatement of sorts, recited several basic tenets of Delaware law that have widespread applicability to those who practice or follow Delaware corporate and commercial litigation.

Selected Fundamental Principles and Mandatory Provisions of the Delaware General Corporation Law (DGCL):

The DGCL contains a number of mandatory provisions. The court provided examples of certain mandatory provisions of the DGCL that could be enforced, even after the normal three-years statute of limitations, assuming the corporation managed to avoid suit for that length of time. For example:

  • Section 141(a) should be recognized by readers as providing that:  “The business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors, except as may be otherwise provided in this chapter or in its certificate of incorporation.”  The court observed that over a dozen decisions have invalidated governance arrangements that violated Section 141(a).  See cases cited in footnotes 98 to 105.
  • Section 220. The court described the thought experiment in which a Delaware corporation attempted to include a provision in its chapter or bylaws that purported to bar stockholders from inspecting books and records in the manner provided by Section 220.  The court cited at footnote 32, a decision from almost a century ago that held even a charter provision cannot eliminate Section 220 rights.
  • Notwithstanding Sections 211 and 231, allowing a corporation to evade a challenge to these mandatory provisions by including a hypothetical provision in its charter or bylaws purporting to only require stockholders’ meetings every five years, or to do away with a requirement to appoint inspectors of election—would not be upheld.
  • Section 102(b)(7) authorizes exculpation subject to specified statutory limitations. A corporation should not be able to evade a challenge if no one sued after three years to challenge a charter provision that purported to insulate directors and officers from monetary damages for any breach of fiduciary duty. See Slip op. at 13.
  • The court referred to DGCL Section 327, the contemporaneous ownership requirement, as another example of a mandatory provision that cannot be waived.  Slip op. at 22.  But see footnotes 63 to 67 and related text, where the court discussed the policy reasons why that requirement should be reconsidered.
  • As a final example, the court considered a hypothetical similar to the facts of this case: If a Delaware corporation entered into a stockholders’ agreement stating that the elected board of directors shall have a purely advisory role, the court rejected the logic that a facial challenge would be impossible if no suit were filed to contest the provision within the first three years.

Ineffective Defenses to Challenged Void Acts:

  • Disclosures about legally non-compliant conduct cannot insulate conduct from challenge based on the same reasoning that applies to governing structures and agreements that violate mandatory features of the DGCL.  See footnote 62 and accompanying text.
  • This decision explains why an equitable defense like laches cannot validate a void act.
  • Estoppel is not a defense to challenge a void act.  See Slip op. at 21 and n. 61.
  • Likewise, acquiescence cannot validate a void act.

See generally footnote 11 (cases addressing contracts void as offending public policy).

When Laches or a Statute of Limitations Apply:

The court explained the two conceptual frameworks for analyzing timeliness through an application of the statute of limitations, and the doctrine of laches, and why a court of equity may apply either doctrine.

The court noted that Delaware corporate law relies on the vigilance, of sorts, of private litigants to enforce legal norms and provide fiduciary accountability. See footnotes 27 to 29.

There are Three Methods to Determine When a Claim Accrues:

  • The discrete act method applies when a claim arises at a distinct point;
  • The continuing wrong method; and,
  • The accrual method.

Noteworthy Corporate Law Principle:

A fiduciary does not owe fiduciary duties when exercising contractual rights, even if a counterparty is the fiduciary’s beneficiary.  Slip op. at 39. See also footnote 115 and accompanying text.  See also the 100-plus page Sears opinion of last month authored by Vice Chancellor Laster which discussed the duties of a controlling stockholder in the context of either maintaining the status quo, or challenging the status quo, as well as the applicable standard of review. In Re Sears Hometown & Outlet Stores, Inc. S’holder Litig., 2024 W: 262322 (Del. Ch., Jan. 24, 2024). The Vice Chancellor also provided insights on the topic generally from a seminar in Miami that he participated in and that His Honor highlighted on LinkedIn.

Venerable Twice-Tested Doctrine For Review of Corporate Acts:

In what the decision called “Berle I and Berle II” parts of the two-part test, referring to an iconic article by Professor Adolf Berle cited in footnote 72, Delaware corporate action is twice-tested: 

“First, by the technical rules having to do with the existence and proper exercise of the powers; second, by equitable rules somewhat analogous to those which apply in favor of a cestue que trust for the trustee’s exercise of wide powers granted to him in the instrument making him a fiduciary.”

Slip op. at 26 (citing article). See also footnotes 72, 73 and 75.

For my latest ethics column, now in its 25th year, for the national publication of the American Inns of Court called The Bencher, in the January/February 2024 edition, I highlight a decision of the Delaware Court of Chancery that addressed litigation misconduct in a summary proceeding under Section 220 of the Delaware General Corporation Law. That provision allows stockholders who satisfy certain prerequisites to seek corporate books and records on an expedited trial schedule.

In Myers v. Academy Securities, Inc., C.A. No. 2023-0241-BWD, Order (Del. Ch., Oct. 2, 2023), Magistrate in Chancery Bonnie David explained the circumstances that satisfied the “glaringly egregious” standard which allows the Court to shift fees as an exception to the American Rule, as compared to awarding fees based on contractual or statutory provisions.

The article also cites to other recent Chancery decisions on this topic that support an anecdotal observation: litigation tactics that meet the “glaring egregious” standard are becoming more common of late.

Frank Reynolds, who has been covering Delaware corporate decisions for various national publications for over 35 years, prepared this article.

The Delaware Supreme Court, in a recent guidepost opinion, ruled that officer exculpation amendments to Fox Corp. and Snap Inc.’s charters did not require a separate class vote from those companies’ non-voting common stock classes because they changed no powers, preferences, or special rights of those stock classes in In re Fox Corp./Snap Inc. Section 242 Litig., Nos. 120 &121, 2023 (Del. Supr., Jan. 17, 2024).

The justices’ unanimous en banc ruling upheld the Court of Chancery’s summary judgment decision that the amendments did not deprive the non-voting stock classes of a unique, class-based power to sue their officers for damages for alleged breach of the duty of care. 

It was the high court’s first major clarification in decades regarding the parameters of Section 242(b)(2) to the “powers” in Section 102 of the Delaware General Corporation Law.

The justices upheld Chancery’s view on how two long-standing opinions govern the way the DGCL should operate in this area:

Hartford Accident & Indemnity Co. v. W.S. Dickey Clay Mfg. Co. 24 A.2d 315 (Del. 1942) hereinafter Dickey Clay]; 1993 WL 547187, and

Orban v. Field (Del. Ch. Dec. 30, 1993) [hereinafter Orban].

The high court affirmed Chancery’s reading that had found those decisions stated: “The powers, preferences, or special rights of class shares expressed in the charter include default provisions in the DGCL, which are part of every charter under Section 394. The ability to sue directors or officers for duty of care violations is an attribute of the Companies’ stock, but not a power, preference, or special right of the Class A common stock under Section 242(b)(2 )”

Background

Both news-content generator Fox Corp. and social media content specialist Snap Inc. were multi-stock class companies that in 2022 adopted officer exculpation charter amendments allowed by recent Delaware legislation.   Both were sued by their respective non-voting common stockholder class and those actions were consolidated by the Court of Chancery, which granted the defendants’ joint summary judgment motion.

The Class A Stockholders claimed that the “plain language” of Section 242(b)(2) unambiguously required a class vote before adopting the exculpatory charter provisions. As they argued, stockholders have three fundamental “powers” – to vote, sell, and sue–and that power, according to Black’s Law Dictionary, includes “[t]he ability to act or not act[.]”4

The Companies countered that Sections 242(b)(2), 151(a), and 102(a)(4) – with their overlapping use of the terms “powers,” “preferences,” and “special rights” – must be read together—and when read together, “powers” cannot carry the powerful dictionary definition that the plaintiffs contend it must have. Chancery agreed, finding that the power to sue for breach of duty “is an attribute of the Companies’ stock, but not a power, preference, or special right of the Class A common stock under Section 242(b)(2).”

 The appeal.  

On appeal, the high court agreed that the “the stockholders’ rigid interpretation of “powers” upsets the balance between Sections 242(b)(1) and (2). Section 242(b)(2) is intended as a “safeguard” to protect the powers, preferences and special rights authorized by Section 151 and expressed in the charter. It is not a broad grant of the right to vote on any amendment affecting any attribute of stock ownership.”

Orban and Dickie Clay have final say

The justices noted that:

*In Orban, the Court of Chancery held that Section 242(b)(2) “makes clear that it affords a right to a class vote when the proposed amendment adversely affects the peculiar legal characteristics of that class of stock.”

* For seventy-five years, Dickey Clay has held that “rights incidental to stock ownership are not a peculiar characteristic of the shares of a class of stock” and “Section 242(b)(2) should be read considering other provisions of the DGCL.”

*In the nearly 40 years since 1986 and the adoption of Section 102(b)(7) for directors, no one has taken the position until this case that an exculpation amendment requires a class vote.

Andrew Ralli of the Delaware office of Lewis Brisbois prepared this post.

The Court of Chancery recently granted a motion to strike portions of a complaint derived from privileged or confidential board-level communications in Icahn Partners LP, et al. v. Francis deSouza, et al., C.A. No. 2023-1045-PAF (Del. Ch. Jan. 16, 2024).

Background

Illumina is a biotech company that develops tools and systems for genetic analysis. In April 2023, three Illumina stockholder—collectively owing approximately 1.4% of the Company’s outstanding common stock and under the control of Carl Icahn—proposed a three-candidate slate to challenge the Company’s nominees at the 2023 annual meeting of stockholders. Andrew Teno, one of Plaintiffs’ nominees and an employee of another Icahn-controlled entity, Icahn Capital LP (“Icahn Capital”), was elected to the Company’s Board. Teno subsequently provided privileged and confidential information to Icahn and his affiliates, including information that predated his tenure on the Board.

In October 2023, several months after Teno joined the Board, the same three Illumina stockholders filed a derivative lawsuit claiming Illumina’s Board caused the Company to break the law by voting in favor of the troubled $8 billion reacquisition of Grail, Inc. (“Grail”), which resulted in a $476 million fine by the European Union and barred Illumina from acquiring Grail.

Shortly thereafter, the Company filed a motion to strike paragraphs of the complaint that contain information that Teno obtained and supplied to the Plaintiffs after joining the Company’s Board.

Highlights of the Case

The motion before the court did not involve a dispute over Teno’s entitlement to Illumina information that was protected by the attorney-client privilege. Rather, “[t]he issue is whether Teno is permitted to share that privileged information with the Plaintiffs and whether Plaintiffs may disclose that confidential information in a civil complaint against the Company’s directors.”   

Vice Chancellor Fioravanti acknowledged the Court “has not developed a bright-line rule” regarding directors’ sharing of privileged information with the stockholders who nominated them. After providing a “brief recap of the key precedents . . . to set the stage[,]” the Court recognized that it “has held in a long line of cases dating back to 1992 that a director may share a corporation’s privileged communications with the director’s designating stockholder under certain limited circumstances.”  A director’s sharing information with the designating stockholder, however, “does not give the stockholder freedom to further disseminate the company’s confidential information.”  Under Delaware law, a director may share privileged or confidential company information with a stockholder when the director is either:

(A) designated to the board by the stockholder (known as “designated-director” matters) pursuant to:

(i) a contract; or

(ii) the stockholder’s voting power, i.e., a controlling stockholder. 

(B) serves in a controlling or fiduciary capacity with the stockholder (known as “one-brain” or “dual-fiduciary” matters). 

Vice Chancellor Fioravanti found that “[t]he facts of this case do not fit the paradigm of the cases discussed above.” First, the Plaintiffs did “not have a contractual right to appoint a director and, owning less than two percent of Illumina’s outstanding stock, they did not control the vote during Teno’s election.”  In fact, “as an undisputed factual matter, Plaintiffs did not designate Teno to the Company’s [Board] pursuant to the type of contractual right present in any of the designated-director cases.”  For instance, recently in Hyde Park Venture P’rs Fund III, L.P. v. FairXchange, LLC, 292 A.3d 178 (Del. Ch. 2023), two venture capital funds that owned preferred stock in FairXchange, Inc. had a contractual right to designate a director to the FairX board of directors.

In contrast, Teno, in connection with his joining the Board, agreed to abide by the Company’s Code of Conduct, which provides, inter alia, that, “‘[e]xcept as required for the proper performance of your duties, you may not use or give to others trade secrets or confidential information of the Company.’”

Second, “Plaintiffs’ contention that their relationship with Teno grants them access to Illumina’s privileged information lacks support under either recognized path of acceptable information sharing.”  As the Court noted, for instance, “[i]n the ‘one brain’ cases, the director controlled or served in a fiduciary capacity with the stockholder seeking the information and, therefore, was unable to split their brain between their position as a director and their position controlling or as a fiduciary to the entity seeking information.” Here, Teno’s employment relationship with Plaintiffs is readily distinguishable from the ‘one brain’ cases. Teno did not serve in a fiduciary role for any of the Plaintiffs, nor did Plaintiffs argue that Teno exercises influence over any of them. In fact, Teno is not an employee of any of the Plaintiffs.  Rather, he is an employee of Icahn Capital, which, like the Plaintiffs, is also controlled by Icahn.

Additionally, the Court rejected Plaintiffs’ implicit argument suggesting that Hyde Park expanded the circumstances under which a director could share confidential and privileged information with stockholders:

“Hyde Park did not change the law; it reframed and clarified a ‘framework [that] has been settled law in Delaware for nearly four decades.’ . . . [T]he mere fact that Teno was nominated by the Plaintiffs and is an employee of another Icahn-affiliated entity does not persuade the court that Teno had the right to disclose Illumina’s confidential and privileged information to the Plaintiffs.”

. . .

The Court also rejected Plaintiffs’ argument “that there is no harm” because the complaint was filed confidentially and not available to the public:

“The purpose of the motion to strike is to prevent Plaintiffs from utilizing privileged information to which they are not entitled. The fact that the public is not able to access that information does not remedy Teno’s unauthorized dissemination of Illumina’s privileged and confidential information or Plaintiffs’ unauthorized use of it.”

Conclusion

The Court recognized the  Challenged Information did “not neatly fit into the four categories that permit the court to strike information from a pleading under Rule 12(f).”  Nevertheless, the Court used its broad equitable powers “to protect confidential information and to formulate an appropriate remedy in the event confidential or privileged information is improperly interjected into litigation.” The Court granted the motion and required all references to challenged information be stricken from the complaint.

On January 23, 2024, however, the Plaintiffs filed a motion for reargument, claiming that the Opinion “overlooked or misapprehended facts . . . that met both standards” under which a director may share privileged or confidential company information with a stockholder. The results of that motion–not available as of this writing–should be included in a complete analysis of this case.

This post was prepared by Aimee Czachorowski of the Delaware office of Lewis Brisbois.

The Court of Chancery’s recent Memorandum Opinion in DiDonato v. Campus Eye Management, LLC, C.A. No. 2023-0671-LWW (Del. Ch. Jan. 31, 2024), covers a great deal of ground in addressing a wide variety of defenses raised in connection with a claim under 6 Del. C.  Section 18-110 to confirm whether the plaintiff remained as a manager of the LLC, but of particular interest is the Court’s discussion of whether the defendant should be held in contempt for violating the Court’s status quo order.

The Court explained that Court of Chancery Rule 70(b) provides “broad latitude to remedy violations of its orders” and clearly set forth the requirements for a movant seeking such an order. By a preponderance of the evidence, a movant must show the contemnors violated an order of the Court of which they had notice and by which they were bound and the violation must be a failure to obey the Court in a meaningful way. If that burden is met, the burden then shifts “to the contemnors to show why they were unable to comply with the order.”

After briefing and argument, the Court found the defendant in contempt of its status quo order and, as a remedy, rather than unwinding the transaction at issue, awarded fees incurred by the plaintiff in bringing the motion.    

By: Francis G.X. Pileggi, Sean M. Brennecke, Aimee M. Czachorowski, Rolando A. Diaz, Andrew A. Ralli, Andrew J. Czerkawski, Katherine R. Welch, and Fanta M. Toure

Reprinted courtesy of The Delaware Business Court Insider, ALM Media Properties, LLC, which published this on January 3, 2024.

This is the 19th year that Francis Pileggi has published an annual list of key corporate and commercial decisions of the Delaware Supreme Court and the Delaware Court of Chancery, often with co-authors.  This year’s list does not attempt to include all important decisions of those courts that were rendered in 2023, and eschews some of the cases already extensively discussed by the mainstream press or legal trade publications. This list highlights some of the notable decisions that should be of widespread interest to those involved in corporate and commercial litigation or those who follow the latest developments in this area of Delaware law.

Did Delaware Supreme Court Merge the Blasius and Unocal Standards in Recent Decision of Coster v. UIP Cos., Inc.?

          In Coster v. UIP Companies, Inc., 300 A.3d 656 (Del. 2023), the Delaware Supreme Court approved the Court of Chancery’s combination of Unocal’s nexus test with Blasius’s compelling justification requirement, affirming the holding that:  “To satisfy the compelling justification standard, ‘the directors must show that their actions were reasonable in relation to their legitimate objective, and did not preclude the stockholders from exercising their right to vote or coerce them into voting a particular way.”  The Court of Chancery, noting the case’s “exceptionally unique circumstances,” articulated that “in this context, the shift from ‘reasonable’ to ‘compelling’ requires that the directors establish a close fit between means and ends.”  The Delaware Supreme Court agreed, concluding that courts can apply Unocal “with the sensitivity Blasius review brings to protect the fundamental interests at stake—the free exercise of the stockholder vote as an essential element of corporate democracy.”

Did Delaware Supreme Court Merge the Blasius and Unocal Standards in Recent Decision of Coster v. UIP Cos., Inc. | Delaware Corporate & Commercial Litigation Blog (delawarelitigation.com)

Supreme Court Clarifies Limits of Judicial Equitable Review of LLC Agreements

          In Holifield v. XRI Investment Holdings LLC, 2023 Del. LEXIS 295 (Del. Sept. 7, 2023), the Delaware Supreme Court upheld an LLC agreement’s incurable voidness provision.  The provision at issue rendered void—not just voidable—any transfers of interest that were in violation of the LLC agreement. The Court emphasized that Delaware law affords parties to alternative entity agreements maximum private ordering and contractual freedom.  Though it rejected the notion that parties must use “talismanic magic words,” the Court concluded that the plain, unambiguous language of the LLC agreement indicated that sophisticated LLC members bargained for an enforceable clause voiding non-compliant interest transfers, incapable of being cured—even by a court of equity.

Supreme Court Clarifies Limits of Judicial Equitable Review of LLC Agreements | Delaware Corporate & Commercial Litigation Blog (delawarelitigation.com)

Recent Chancery Decision Clarifies Basis for Judicial Dissolution of LLC

          In In re Dissolution of T&S Hardwoods KD, LLC, 2023 Del. Ch. LEXIS 16 (Del. Ch. Jan. 20, 2023), the Delaware Court of Chancery clarified what kind of allegations seeking the dissolution of an LLC suffice to pass muster under the plaintiff-friendly Rule 12(b)(6) standard.  The allegations reflected a “continuing breakdown” in the relationship of the managers.  Moreover, despite the LLC agreement’s broad, general purpose clause (“engage in any lawful activities”), the Court determined the parties could not carry on their specifically contemplated business.  Also, because the LLC agreement’s buy-sell provision failed to offer the parties an equitable exit mechanism, the action proceeded past the motion to dismiss stage.

Recent Chancery Decision Clarifies Basis for Judicial Dissolution of LLC | Delaware Corporate & Commercial Litigation Blog (delawarelitigation.com)

Caremark Claims Allowed to Proceed Against Corporate Officer

          The Court of Chancery denied a motion to dismiss a McDonald’s shareholders’ derivative complaint against a company officer, which alleged that the officer breached his fiduciary duty of oversight.  The officer contended that Caremark fiduciary obligations do not extend to Delaware corporate officers and thus did not apply to him.  But the Court disagreed.  Mincing no words, the Court in In re McDonald’s Corp. Stockholder Derivative Litigation, 2023 Del. Ch. LEXIS 23 (Del. Ch. Jan. 25, 2023) wrote: “This decision clarifies that corporate officers owe a duty of oversight.”

Caremark Claims Against McDonald’s

Who Can Represent a Cancelled LLC in Response to a Petition Seeking a Receiver?

          In In Re Reinz Wisconsin Gasket, LLC, 2023 Del. Ch. LEXIS 194 (Del. Ch. May 8, 2023), after a company’s counsel filed a notice of dissolution and cancellation, the Court of Chancery prohibited a cancelled LLC from “participat[ing] in the process of appointing its own receiver or retain[ing] counsel to do so.”  The petitioner sought to appoint a receiver and nullify the cancellation.  Opposing the petitioner’s requested relief, Delaware counsel entered appearances on behalf of the company.  Though it granted the request, the Court nevertheless invited the parties “to address the puzzle of a dissolved and cancelled entity appearing to litigate the propriety of its cancellation before they submitted proposed receivers.”

          The Court reflected on the lifespan of an LLC, observing that an LLC’s separate, statutory existence continues until the “cancellation” of its certificate of formation.  Once an authorized person files a certificate of cancellation for the company, “its existence as a jural entity ceases.”  Upon the filing of the certificate of cancellation, “a defunct entity may speak only through a receiver to manage litigation or any other outstanding business: the receiver is appointed because there are no other fiduciaries to make decisions for the entity.”  Finding that a non-existent entity could not retain counsel, and considering it a “metaphysical wonder,” the Court determined: “Counsel’s purported representation of a defunct limited liability company is not only puzzling, but impossible.”

Who Can Represent a Cancelled LLC in Response to a Petition Seeking Receiver? | Delaware Corporate & Commercial Litigation Blog (delawarelitigation.com)

Delaware Court of Chancery Provides Guidance on Standard for Awarding Mootness Fees

          In the runup to a merger, a shareholder plaintiff challenged the “don’t, ask don’t waive” provisions in the company’s confidentiality agreements with the bidders by contending that the proxy statement contained materially deficient descriptions.  In Anderson v. Magellan Health, Inc., 298 A.3d 734 (Del. Ch. July 6, 2023), following the suit’s commencement, the company (i) waived some of its confidentiality rights and (ii) supplemented its proxy statement, further detailing the “don’t ask, don’t waive” provisions.  The supplemental disclosures mooted the shareholder litigation.  In the wake of the merger, shareholder plaintiff’s counsel petitioned the Court of Chancery for a $1.1 million fee award.  The company challenged the petition’s “eye-popping” size.

          Thoroughly reviewing the jurisprudential shift in M&A strike suits, the Court opined that going forward, “unless a higher authority proclaims otherwise . . . I will award mootness fees based on supplemental disclosures only when the information is material.”  Nevertheless, the Court found it “unjust” to immediately apply that standard: Delaware courts had yet to apply it and neither the company nor the petitioner briefed it.  Using only the “helpful” standard, the Court found the supplemental proxy disclosures “marginally helpful” and, “[p]utting it all together,” awarded plaintiff’s counsel a $75,000 fee.

Delaware Court of Chancery Provides Guidance on Standard for Awarding Mootness Fees | Delaware Corporate & Commercial Litigation Blog (delawarelitigation.com)

Fee-Shifting in Section 220 Case Provides Cautionary Tale

          In Seidman v. Blue Foundry Bancorp, 2023 Del. Ch. LEXIS 178 (Del. Ch. July 10, 2023), concerned over a potentially excessive director and management equity incentive plan, a shareholder demanded to inspect the company’s consulting reports and formal board materials in connection with the equity plan pursuant to DGCL § 220. The shareholder asserted purposes of “investigating mismanagement and communicating with Plaintiff’s fellow stockholders regarding any proxy contest or other corrective measures.”  Claiming the shareholder lacked a proper inspection purpose, the company rejected the demand and refused to produce a single document. The Court had a much different view of the matter.

          Emphasizing the exception to the American Rule under which the Court may discretionarily shift fees “where equity requires,” the Court noted: “To capture the sorts of vexatious activities that the bad-faith exception is intended to address, this court employs the ‘glaringly egregiousness’ standard.”  Decrying “overly aggressive litigation strategies” in the books and records context and highlighting the company’s less-than-scrupulous tactics, the Court concluded: “After [the company] declined to produce a single document to Plaintiff, forcing him to commence litigation, [the company] took a series of litigation positions that, when viewed collectively, were glaringly egregious.”  Accordingly, “[j]ustice” required fee shifting to mitigate such “serious ‘vexatious behavior.’”

Recent Chancery Decisions Provide Cautionary Tales in Section 220 Matters | Delaware Corporate & Commercial Litigation Blog (delawarelitigation.com)

Chancery Addresses Fiduciary Duty of Disclosure in Context of a Squeeze-Out

          In Cygnus Opportunity Fund, LLC v. Washington Prime Group, 302 A.3d 430 (Del. Ch. Aug. 9, 2023), after an LLC controller and board of managers squeezed-out the minority unitholders, a group of hedge fund plaintiffs challenged certain disclosures in connection with the merger and a preceding tender offer.  The Court of Chancery dove deep into Delaware’s disclosure jurisprudence in the context of what the Court referred to as the “stockholder-action duty.”  Because Delaware law “piggybacks on the federal [securities] disclosure regime,” the Court entertained the notion that “[i]f a controlling stockholder or third party makes a tender offer for the corporation’s shares, then depending on the circumstances, the directors might well have a duty to respond.  To the extent officers owe the same duties as directors, the duty could apply to them as well.”  Though the Court could not “hash these issues out at the pleading stage,”  the plaintiffs stated a “conceivable” claim because the officers disclosed nothing in connection with “a severely underpriced” tender offer.

          Moreover, examining the etymology of the word “fiduciary” and its trust law roots, the Court emphasized that “[t]he duty of disclosure is a context-specific duty, and no Delaware decision holds that fiduciaries do not owe any duty in the context of a transaction in which the fiduciaries unilaterally eliminate their investors from an enterprise.”  Because a squeeze-out is such a transaction, “the duty of loyalty could manifest as an obligation to inform the beneficiary of the material facts surrounding the transaction, regardless of whether or not the beneficiary’s approval is required.”

Chancery Addresses Fiduciary Duty of Disclosure in Context of a Squeeze-Out | Delaware Corporate & Commercial Litigation Blog (delawarelitigation.com)

Chancery Court finds collection of bad faith factors enough to keep GoDaddy suit alive

          The Court of Chancery, in IBEW Local Union 481 Defined Contribution Plan & Trust v. Winborne, 2023 Del. Ch. LEXIS 342 (Del. Ch. Aug. 24, 2023), allowed a shareholder derivative suit to survive a motion to dismiss because the plaintiff adequately pled demand futility based on the board’s alleged bad faith overpayment to settle an outstanding company liability.  Reviewing Rule 23.1’s doctrinal pillars, the Court examined the pleading standard required to withstand dismissal for want of “reasonable doubt” as to the board’s ability to properly respond to a pre-suit demand.  Focusing on the second prong of Delaware’s demand futility test, the Court considered whether at least three of the directors faced a substantial likelihood of bad faith liability for approving the settlement.

          Noting that “[c]lairvoyance plays no role,” the Court extensively reviewed the precedent detailing how Delaware measures pleadings-stage fiduciary bad faith. In sum: “Properly understood, the good faith inquiry is a holistic one.”  A court of equity can allow a case to proceed past the pleading stage when the allegations as a whole support an inference of bad faith.  The “constellation of factors”—including an almost $700 million disparity between what the company valued the settlement at and what the company actually paid for it—supported a pleading stage bad faith inference sufficient to pass demand futility review.

Chancery Court finds collection of bad faith factors enough to keep GoDaddy suit alive | Delaware Corporate & Commercial Litigation Blog (delawarelitigation.com)

Chancery Rejects Request for Specific Performance to Close Deal

          With a factual background that reads like a Hollywood thriller, in 26 Capital Acquisition Corp. v. Tiger Resort Asia Ltd., 2023 Del. Ch. LEXIS 364 (Del. Ch. Sept. 7, 2023), the Court of Chancery declined to compel an acquisition target to close a busted deal.  The acquirer sought specific performance under a de-SPAC merger agreement.  The Court meticulously weighed the factors supporting specific performance after criticizing the sponsor and its hedge fund majority shareholder’s duplicitous behavior.  Refusing to specifically enforce the merger agreement’s reasonable best efforts clause, the Court concluded that the transaction’s troubling factual backdrop disfavored such a remedy.

The Court of Chancery Declines to Save Belly Up de-SPAC

Chancery rules that Delaware allows grant of 10 votes per-share to “Up-C” CEO

          In Colon v. Bumble, Inc., 2023 Del. Ch. LEXIS 367 (Del. Ch. Sep. 12, 2023), the Court of Chancery upheld the validity of a challenged capital arrangement that layered standard Up-C and dual class voting structures into a “bespoke” capital design.  The share classes’ voting power differed depending on the holder’s identity.  If a separately referenced and defined (outside the charter) “Principal Stockholder” held a class A share, then it carried ten votes per share; otherwise, it carried only one.  And if a Principal Stockholder held a class B share, then it carried ten votes per each class A share into which it could convert; otherwise, it carried only one.  Though the Court noted that its opinion did not consider whether such an identity-based governance regime would pass Delaware’s “twice tested” review of corporate action, it concluded the challenged charter provisions and capital structure complied with the Delaware General Corporation Law.

Chancery rules that Delaware allows grant of 10 votes per-share to “Up-C” CEO | Delaware Corporate & Commercial Litigation Blog (delawarelitigation.com)

Section 225 Action Determines That Board Members Were Properly Removed

          In Barbey v. Cerego, Inc., 2023 Del. Ch. LEXIS 379 (Del. Ch. Sept. 29, 2023), after a wholly owned foreign subsidiary launched a tender offer to the shareholders of its Delaware parent, resulting in an inversion, the Court of Chancery upheld as valid the removal of the entire parent board.  A shareholder and ousted director challenged the removal under DGCL § 225, contending that the director’s failure to receive the required notice of the meeting at which the board approved the tender offer rendered the approval thereof and subsequent management change void.  The Court agreed, but nevertheless determined that the plaintiffs failed to draw a sufficient connection between the void meeting and the effect of the tender offer.  Noting that the internal affairs doctrine governed whether the foreign subsidiary enjoyed the authority to independently launch the tender offer without the parent’s approval, the Court concluded that the plaintiffs failed to timely meet their burden, and upheld the board’s removal.

Chancery Determines in Section 225 Action: Board Members Properly Removed | Delaware Corporate & Commercial Litigation Blog (delawarelitigation.com)

Entire Fairness Test Applied, But No Damages

          The Court of Chancery in In re Straight Path Communications Inc. Consolidated Stockholder Litigation, 2023 Del. Ch. LEXIS 387 (Del. Ch. Oct. 3, 2023),held that a controlling shareholder drove a not-entirely-fair transaction and breached fiduciary duties he owed to the minority.  Yet, the Court found that the transaction, while unfair under Delaware’s “unified fairness review, considering both price and process,” caused the minority no actual damages.  Nevertheless, finding the controller steered the transaction “in a manifestly unfair manner,” the transaction thus “was not entirely fair.”  Pointing out that a claim for breach of fiduciary duties does not require proving actual damages, the Court awarded the minority class nominal damages.

Unfair Process Incurs Nominal Damages Under Entire Fairness Review

Chancellor “X”s out Twitter investor’s claim he spurred Musk’s social media mind change

          In Crispo v. Musk, 2023 Del. Ch. LEXIS 466 (Del. Ch. Oct. 31, 2023), the Court of Chancery declined to award a mootness fee because the plaintiff shareholder filed an unmeritorious claim.  The decision turned on whether a merger agreement’s lost premium carve-out to its general no third-party beneficiaries clause conferred standing on the shareholder seeking damages for the then-failed merger agreement.  Examining the development of lost premium provisions in the M&A space, the Court detailed the unique relationship between Delaware’s board-centric governance paradigm, merger agreements, and shareholder interests.  Invoking Delaware’s hesitance to confer third-party merger agreement standing on shareholders, the Court found the contractual scheme afforded the shareholder plaintiff no third-party beneficiary status, thus rendering his mooted claim unmeritorious.

Chancellor “X”s out Twitter investor’s claim he spurred Musk’s social media mind change | Delaware Corporate & Commercial Litigation Blog (delawarelitigation.com)

Lead Plaintiff Forced to Elect Remedy

          In litigation following a plenary Revlon action (in which the Delaware Court of Chancery awarded damages to a shareholder class after finding the CEO, with a private equity firm’s aiding and abetting, breached his fiduciary duty), in In re Mindbody, Inc., 2023 Del. Ch. LEXIS 575 (Del. Ch. Nov. 15, 2023), the Court concluded that Delaware law permitted the lead hedge fund class plaintiffs, who simultaneously petitioned for appraisal, to elect to receive the merger consideration and class damages remedy.  Because the appraisal-seeking hedge funds shouldered no obligation to “make a binding election as to remedy” before the plenary action’s trial, and the shareholder class included the funds, Delaware precedent allowed them to choose either.  But the Court prohibited a double recovery. If the funds elected to pursue their appraisal petition, they could not receive the class remedy.  Conversely, if the funds elected to receive the class remedy, then the Court would not appraise their shares.

The Court of Chancery Permits Concurrent Plenary Fiduciary and Appraisal Claims

Restrictive Covenants Found Unenforceable

          In Sunder Energy, LLC v. Jackson, 2023 Del. Ch. LEXIS 580 (Del. Ch. Nov. 22, 2023), the Court of Chancery denied a solar power system dealer’s application for a preliminary injunction to enforce restrictive covenants against a former minority member.  The Court found that two of the members surreptitiously procured an amendment to the LLC agreement in breach of their fiduciary duties.  The amendment rendered the resulting minority little more than mere employees and imposed onerous restrictive covenants.  Because the purported majority members breached their fiduciary duties in connection with the amendment, the Court prevented them from enforcing the covenants.  The Court further opined, assuming arguendo their threshold validity, the restrictive covenants failed to “pass muster” under Delaware law.  Reviewing the primary and additional factors governing the enforceability of restrictive covenants, the Court evaluated “all of the dimensions” of the disputed provisions “holistically and in context.”  The Court considered how they operated within the contract as a whole and declined to “tick through individual features of a restriction in insolation, because features work together synergistically.”  With reasonableness as the touchstone, the Court found the “astonishingly broad” restrictions unreasonable and refused to enforce them.

Unreasonable Restrictive Covenants Fail Delaware’s Holistic Review

Rarely Invoked Provision of DGCL Examined

          As one part of a vast, multi-jurisdictional saga between oil giants, in a decision concerning a DGCL provision that is rarely the subject of a judicial decision, the Court of Chancery in Venezuela v. PDC Holding, Inc., 2023 Del. Ch. LEXIS 582 (Del. Ch. Nov. 28, 2023),ordered a wholly-owned Delaware subsidiary to issue a replacement stock certificate to its Venezuelan parent.  The Court detailed the three requirements under section 168 of the DGCL that a shareholder must satisfy to receive a judicially-ordered replacement of a “lost, stolen, or destroyed” stock certificate.  Though the parties did not dispute the typically litigated elements, the subsidiary initially requested the parent post a bond in the neighborhood of $40 billion.  Although the Court lacked power to waive the bond requirement altogether (if the issuer requested one), the Court nevertheless enjoyed discretion to set the amount “based on the circumstances presented in each case.”  After examining the purpose for the bond-as-security requirement and the circumstances surrounding the potential ramifications of reissuing a certificate evincing ownership of the particular shares, the Court found a “nominal, unsecured” bond in the amount of $10,000 appropriate.Chancery Interprets DGCL Section 168 for Replacement Stock Certificate

Frank Reynolds, who has been covering Delaware corporate decisions for various national publications for over 35 years, prepared this article.

A Delaware Supreme Court milestone ruling has revived a shareholder suit over pharmaceutical giant AmerisourceBergen Corp.’s role in the nation’s opioid crisis, finding the Court of Chancery should not have dismissed the derivative action by relying on a related federal court decision in  Lebanon County Employees’ Retirement Fund, et al. v. Collis, et al., C.A. No. 22, 2023, Dec. 18, 2023 (Del.).

Justice Gary Traynor, writing the December 18 unanimous en banc opinion that reversed the Chancery’s Dec. 22, 2022 ruling, said the Court of Chancery correctly concluded that the plaintiff pension funds supported charges that the Amerisource directors disloyally exposed the company to $6 billion in liability by favoring profits over people.  Lebanon County Employees’ Retirement Fund, et al. v. Collis, et al., C.A. No. 2021-1118-JTL (Del. Ch. Dec. 22, 2022). But Justice Traynor said the vice chancellor should not have accepted as law a West Virginia District Court’s ruling about facts that were still in dispute concerning director actions. City of Huntington v. AmerisourceBergen Drug Corp., 609 F. Supp. 3d 408, 425 (S.D. W. Va. 2022).

The high court said on that basis, the vice chancellor decided that despite his finding that the board ignored numerous red flag warnings and violated an opioid distribution monitoring pact with the government, the derivative charges must fail the pre-suit demand test because the federal court ruled that the directors faced no individual liability. 

The opinion will likely be studied by corporate law practitioners first because it:

  • Sets parameters regarding when and how to take, weigh and apply judicial notice of the facts and law contained in rulings outside the First State.
  • Updates guidelines to apply to developments in multi-faceted mega-litigation that occur after the filing of the operative complaint in a Delaware derivative suit and how they can be factored into a demand futility decision in that action, and
  • Takes a fresh look at what constitutes potential liability that could prevent directors from objectively evaluating shareholder litigation over whether they have mismanaged and financially damaged their company — known as Caremark claims after the seminal decision in In re Caremark Int’l Inc. Derivative Litig., 698 A.2d 959 (Del. Ch. 1996).

Background

AmerisourceBergen, one of three major wholesale distributors of opioid pain medication in the United States over the past two decades, found itself at the center of America’s opioid epidemic and in 2021, agreed to pay over $6 billion as part of a nationwide settlement to resolve multidistrict litigation brought against the three, additionally incurring hundreds of millions of dollars to settle other lawsuits and over $1 billion in defense costs.

Two dismissal motions

According to the court’s record, two pension funds sued in Chancery Court, contending that Amerisource’s directors and officers breached their fiduciary duties by making affirmative decisions and conscious non-decisions that led to the harm that the company has suffered. Plaintiffs sought to shift the responsibility for that harm from AmerisourceBergen to the human fiduciaries who allegedly caused it to occur.  The plaintiffs survived the directors’ motion to dismiss on grounds that the charges were filed too late.  Lebanon County Employees’ Retirement Fund, et al. v. Collis, et al., C.A. No. 2021-1118-JTL (Del. Ch. Dec. 15, 2022).

 But that novel ruling only kept the derivative suit alive for an additional week.  In a December 22 opinion, the vice chancellor agreed with the directors’ argument that under the pre-suit demand futility test, dismissal was justified because a majority of the board was not too conflicted to objectively decide whether the suit had enough merit to go forward.  Lebanon County Employees’ Retirement Fund, et al. v. Collis, et al., C.A. No. 2021-1118-JTL (Del. Ch. Dec. 22, 2022).

The Vice Chancellor found that a federal court in West Virginia, in a related bellwether test case to decide nationwide liability for damages to opioid users, had already ruled that the directors could not be held legally liable for making decisions that directly caused the damage.  He said that federal judge had considered all the evidence and testimony in the opioid damages trial and found insufficient reason to hold the directors individually liable for causing the damages.

A rare reversal

The plaintiffs’ appeal to the Supreme court argued that Vice Chancellor Laster wrongly let the federal opinion sway his decision even though it came after the operative complaint in his case had been filed and the federal court facts he relied on were still in dispute.

In a rare reversal of the Chancery Court, the justices issued the December 18 opinion four days shy of the one-year anniversary of the dismissal ruling. It essentially agreed with plaintiffs on those weight, applicability and timing issues concerning the federal court’s finding of no director liability.

Would have survived

“The Court of Chancery accepted the West Virginia Court’s findings that “‘[n]o culpable acts by defendants caused an oversupply of opioids,” finding that Amerisource  had an adequate anti- diversion program in place and that there was no evidence that it  distributed opioids to pill mills,” Justice Traynor wrote, finding that, “Without the findings, the plaintiffs’ claims would have survived; with them, they perished.” And he found the trial court’s “adjudicative judicial notice of the factual findings” in error.

Proper judicial notice

Moreover, he noted, judicial notice can be properly taken of only undisputed facts and the federal court wrongly concluded that no wrongdoing had occurred for which the defendants might be held liable, which “was, and is, reasonably disputed.”

As to the issue of the timing of the federal court’s liability ruling and the date of the complaint, the High Court stated:  ‘the Court of Chancery’s reliance on the factual findings in the West Virginia Decision changed the date at which demand futility was considered.”  The Justice concluded on behalf of the High Court that, “under the Court of Chancery’s analysis, the plaintiffs established their derivative standing as of the time the complaint was filed.  The court erred by vitiating the plaintiffs’ standing in deference to the factual findings in the West Virginia decision.”

Andrew J. Czerkawski of the Lewis Brisbois Delaware office prepared this post.

          Seeking to compel its Delaware subsidiary to issue a replacement stock certificate evincing ownership of all 1,000 of the subsidiary’s issued and outstanding shares, a foreign parent corporation filed suit in the Delaware Court of Chancery under the rarely litigated DGCL § 168, in Venezuela v. PDC Holding, Inc., 2023 Del. Ch. LEXIS 582 (Del. Ch. Nov. 28, 2023).

BRIEF FACTUAL OVERVIEW

          This action took place as one part of a vast web of internationally connected litigation sagas and geopolitical intrigue.  A non-party Canadian corporation sought to execute on its $1.2 billion international arbitration judgment against a foreign nation.  That nation’s government wholly owned the parent entity which in turn wholly owned all of the instant defendant Delaware corporation’s shares (the subsidiary itself in turn wholly owns one of the largest operating petroleum refining companies in the United States).

          In federal court, the non-party Canadian corporation successfully moved to attach and foreclose on the parent’s shares of its Delaware subsidiary, arguing the parent acts only as an alter ego of the foreign nation.  The federal court eventually ordered the sale of the foreign parent’s shares of its Delaware subsidiary to satisfy the foreign nation’s debt to the non-party Canadian corporation and required the parent to submit its original stock certificate evincing its ownership of the Delaware subsidiary shares.  If the parent could not produce the stock certificate, the order gave the option for the parent to seek the Court of Chancery’s expedited aid in procuring a replacement.  The parent did just that: it filed the instant DGCL § 168 action against its wholly owned Delaware subsidiary to compel the issuance of a replacement stock certificate (the parties aligning interests in connection with the foreign nation did not escape the Court; multiple creditors of the foreign nation filed amici curiae briefs supporting the certificate’s reissuance, pointing to the foreign parent and its Delaware subsidiary’s “repeated acts of recalcitrance” to “slow down the sales process”).

KEY ANALYSIS

          Beginning with the language itself, the Court laid out the Delaware precedent detailing Section 168’s primary requirements, the burden of which rests on the plaintiff to show: (i) the plaintiff demanded corporate management issue a replacement certificate; (ii) management refused the demand; (iii) the plaintiff lawfully owns the complained-of capital stock; and (iv) the original stock certificate “has in fact been lost, stolen, or destroyed.”  If the plaintiff satisfies her burden on these elements, then the rebuttal burden shifts to the corporation to demonstrate “good cause” in opposition to the reissue.  And if the corporation fails to carry its rebuttal burden, then the Court “shall make an order requiring the corporation to issue and deliver to the plaintiff” a new stock certificate.

           The parties left the primary elements virtually undisputed.  But, receiving the lion’s share of the Court’s attention, Section 168 also mandates the plaintiff receiving the new certificate give the corporation an indemnity bond.  Providing the “upper limit of the corporation’s liability for actions arising out of” the reissuance, the plaintiff must first “‘give the corporation a bond in such form and with such security as to the court appears sufficient to indemnify the corporation against any claim that may be made against it on account of the alleged loss, theft or destruction of any such certificate or the issuance of such new . . . certificate.’”

          The defending subsidiary initially requested the plaintiff parent post an indemnity bond “between $32 and $40 billion,” eventually settling on $1 to $2 billion.  Though the amici creditors contended the Court could dispense with the statutory indemnity bond requirement altogether, Delaware precedent held the opposite: if the issuer insists on one, the Court cannot waive the bond and security requirement altogether.

          Yet, the Court enjoys discretion to set the bond’s amount—an amount sufficient “to protect the issuer if the original stock certificate is presented.”  The Court described the reason for the bond requirement: “A bond ‘is necessary because the absence of a certificate constitutes notice to the corporation that a third party might have superior title to the underlying stock and that the corporation could be liable for conversion to one holding the original certificate in good faith under a superior title.’”  But if the issuing party appears to face little to no “cognizable harm,” the Court may set a “nominal bond.”

          Setting the discretionary bond amount required the Court to examine all the circumstances surrounding the low-but-not-zero risk posed to the subsidiary for the reissuance.  The Court pointed to a litany of reasons supporting a nominal, unsecured bond: neither party disputed the parent’s record ownership; unlike a “typical retail stockholder of a publicly traded company seeking a replacement certificate,” the particular certificate represents absolute control over one of the planet’s largest oil companies worth potentially hundreds of billions of dollars—only “Rip Van Winkle” would not know of the shares’ involvement in the tumultuous litigation sagas; no other party had claimed any interest in the shares or certificate; Delaware corporations cannot issue bearer shares, and no party had requested the subsidiary to change its books reflecting a transfer; and no adequate evidence indicated the parent secretly pledged the shares.

          Declining to “suspend disbelief” on an unrealistic threat to the subsidiary for reissuing the certificate, the Court refused to find good cause opposing the reissue and ordered the foreign parent plaintiff to post an unsecured $10,000 bond.

PRACTICAL TAKEAWAY

          Though typically arising these days in connection with a startup or closely-held company, this decision lays out a clean, succinct blueprint for Delaware investors to procure replacement stock certificates.

Rolando Diaz of the Lewis Brisbois Delaware office prepared this post.

          The Court of Chancery refused to enforce a restrictive covenant in Sunder Energy, LLC v. Jackson, 2023 Del. Ch. LEXIS 580 (Del. Ch. Nov. 22, 2023). Chancery subsequently approved, with thorough reasoning, an interlocutory appeal to the Supreme Court–which makes its own determination whether to accept the interlocutory appeal.

BRIEF FACTUAL BACKGROUND

          Sunder Energy, LLC (“Sunder”), a Delaware LLC headquartered in the State of Utah, a purveyor of residential solar power systems, had an exclusive dealer agreement with Freedom Forever LLC (“Freedom”), one of the nation’s largest installers. In the summer of 2023, Freedom encouraged Tyler Jackson, the head of sales for Sunder, who lived and worked in the State of Texas, to join Solar Pros LLC (“Solar Pros”), another solar power system dealer that referred installations to Freedom.  This led to a mass exodus of Sunder’s workforce. Nine of the twelve regional managers that reported to Jackson, as well as over three hundred sales personnel, joined Solar Pros.  On September 25, 2023, Solar Pros announced that Jackson had joined as its new President.

          Sunder asserted that Jackson—as a holder of Incentive Units—was bound by certain restrictive covenants (the “Covenants”) provided for in Sunder’s 2019 and 2021 LLC operating agreements (the “OA”) that applied to any Incentive Unit holder (the “Holder”).  The co-founders formed Sunder by filing a certificate of formation with the Delaware Secretary of State but did not execute a written operating agreement. 

In the fall of 2019, the two co-founders that together owned 60% of the membership interest of Sunder engaged a law firm to draft an LLC agreement that dramatically changed the ownership structure of the LLC; it imposed the Covenants, emasculated the minority members rights as owners, and reduced them to purely economic beneficiaries with very little rights. Communications from the majority co-founders to the minority rights holders did not explain that the two co-founders received common units with full rights while the minority holders received incentive units with little to no ownership rights. 

In a concerted effort to obfuscate reality, the majority co-founders referred to the Holders as “partners,” implying that there was some semblance of equal footing aside from the difference in percentage of interests. For the subsequent adoption of the 2021 operating agreement, the majority co-founders did not even bother to circulate a copy of the new operating agreement.  Instead they only circulated the signature page and indicated to the Holders that there were no substantive changes to the operating agreement and that the only change was the addition of a member.  This was not true.  The geographical scope of the restrictive covenant was also expanded.

          In addition to broad restriction on the use of Sunder’s confidential information, the Covenants in the OA prohibited a Holder from: (i) engaging in any competitive activity (the “Non-Compete”); (ii) soliciting Sunder’s employees and independent contractors (the “Worker Non-Solicit”); (iii) soliciting, selling to, accepting any business from, or engaging in any business relationship with any of Sunder’s customers; and (iv) inducing, influencing, advising, or encouraging any Sunder stakeholder to terminate its relationship with Sunder. Furthermore, each Covenant bound not only the Holder, but also Holder’s affiliates, defined in the OA as a Holder’s spouse, parents, siblings, and descendants, both natural and adopted. The Covenants applied while a person held incentive units and for two years thereafter.  However, a Holder had no right to transfer or divest themselves of the Incentive Units. In contrast, Sunder had the option, but not the obligation, to repurchase the Incentive Units for zero dollars upon either Sunder’s termination of Holder’s employment or if the Holder left the company without good reason.

          On September 29, 2023, Sunder terminated the dealer-installation agreement with Freedom and filed an arbitration to enforce their rights against Freedom. Sunder also filed an action in the Court of Chancery against Jackson and its competitors. Sunder sought a preliminary injunction enjoining Jackson and any party acting in concert with Jackson from taking any action in breach of the Covenants. The Court denied the preliminary injunction because Sunder could not establish a reasonable likelihood of success on the merits.  The Court found (i) the restrictive covenants unenforceable under general principles of law and (ii) the competition and solicitation restrictive covenants unreasonable in their scope and effect.

KEY ANALYSIS

          First, the Court was faced with determining the Covenants’ governing law. The terms of the Covenants appeared in the OA, which governs the internal affairs of a Delaware LLC.  The OA expressly provided that Delaware law governed its terms.  Thus, a contractarian basis for the application of Delaware law existed. Under normal circumstances, the combination of the internal affairs doctrine and contract principles would require the application of Delaware law. However, for the Covenants, the drafters were not attempting to govern the internal affairs of a Delaware LLC.  Instead, the drafters were attempting to govern an employment relationship.  The Court opined:

Delaware follows the Restatement (Second) of Conflict of Laws, and Delaware courts consequently will not enforce choice of law provisions when doing so would circumvent the public policy of another state that has a greater interest in the subject matter. Consequently, when a different state’s law would govern in the absence of a choice of law provision, and if that state has established legal rules reflecting a different policy toward restrictive covenants, than Delaware’s then this court will defer to that state’s laws notwithstanding the presence of a Delaware choice of law provision.

Thus, either Utah, where Sunder is headquartered, or Texas, where Jackson worked and resided would apply in the absence of a choice of a law provision.  Under the Court’s analysis, both Texas and Utah approach the enforceability of restrictive covenants only slightly differently than Delaware. Under its conflict of laws analysis, due to the low degree of divergence between laws of the relevant forums, the Court applied Delaware law, finding that the conflict between Delaware and Utah law was a false conflict.

          Second, due to the circumstances for ratification of Sunder’s 2019 and 2021 LLC operating agreements, the Court determined that Sunder’s purported majority co-founders breached their fiduciary duty by failing to fully disclose all material information and making misleading partial disclosures to the minority.  The 2019 agreement materially and adversely impacted the rights of Sunder’s minority members; legal counsel only represented Sunder and the majority co-founders, but the co-founders made it seem as if counsel represented everyone. For the 2021 agreement, the co-founders told the minority members that the 2021 agreement contained no material changes and did not even bother to circulate a copy of the 2021 agreement to the minority members. Thus, the Court determined that due to the co-founders’ breach of fiduciary duties, the amended operating agreements themselves were invalid, and consequently, so were the restrictive covenants therein.

          Assuming, however, for the “sake of argument” that the amended LLC agreements were valid, the Court addressed the enforceability of two of the Covenants, namely, the Non-Compete and Worker Non-Solicit provisions. The Court found the Non-Compete provision extremely overbroad. The prohibited business activity covered a wide swath of the “door to door sales industry, without regard to whether Sunder markets or sells similar products.” The restriction on a Holder’s affiliates (as defined in the OA) was inane; it was not written in a manner that simply thwarts a straw man conferring the benefits to a Holder.  But, as written, a Holder’s “daughter cannot go door to door selling girl scout cookies.” Absurdly, the Covenants thus purported to bind a Holder’s wife and children. The geographic scope of the Non-Compete left only Alaska, Montana, North Dakota, and South Dakota available for a Holder as territory not restricted by the Covenants. Perhaps the most appalling factor of the Non-Compete was that since a Holder had no right to divest himself of the Incentive Units under the OA, the temporal component could continue in perpetuity. Similarly, the Court found the Worker Non-Solicit overbroad and unreasonable. It also applied to the same set of affiliates and for the same potentially “forever” time period. It extended not only to any current Sunder employee or independent contractor, but also applied to “any person employed in the past by Sunder for any period of time.” Individually, each overbroad provision was unreasonable.  And read together, the Court deemed the Covenants oppressive and refused to enforce them.

PRACTICAL TAKEAWAYS

          Delaware courts will not apply Delaware law under a theory of contract law if another state has a greater public policy interest in an issue when, absent a choice of law provision, another forum’s laws would apply. Circumstances may also dictate abandonment of the internal affairs doctrine when drafters embed employment provisions that have nothing to do with the governance of the entity into a governing agreement. Additionally, Delaware courts apply both general principles of law and a holistic analysis of restrictive covenants to determine reasonableness. This analysis can result in Delaware courts refusing to enforce restrictive covenants.

In a recent letter ruling, the Delaware Court of Chancery provided a short tutorial on the Chancery rules of procedure that describe the specific requirements for responding to discovery and the detail that the parties are obligated to provide, especially for objections. See Bocock, et al. v. Innovate Corp., et al., C.A. No. 2021-0224-PAF (Del. Ch. Dec. 6, 2023). 

For example, objections must be specific and must identify what is being withheld based on the objections. See Ct. Ch. R. 33(b)(4) (regarding interrogatories). See also Ct. Ch. R. 34 (regarding responses to requests for documents).

Highlights

  • Relying on prior Chancery decisions, the court instructed that “generic and formulaic objections are insufficient.” Slip op. at 8. 
  • The court also reminded us: that failure to assert a proper, timely objection in compliance with the rules risks waiver of objections. See Ct. Ch. R. 33(b)(4).
  • Specifically, the court referred to prior decisions that explain: “Boilerplate objections have been considered prima facie evidence of a Rule 26 violation, which causes the objecting party to waive any legitimate objections that they may or may not have had.”  Slip op. at 8-9.
  • The court instructed that “an objection must state whether the responding party is withholding or intends to withhold any responsive materials on the basis of that objection.”  Quoting Ct. Ch. R. 34(b).
  • The decision provides more examples of the failure to provide specificity or to explain the basis on which documents were being withheld. 
  • The court also emphasized why the failure to comply in this case justified waiver of all of the objections except for attorney/client privilege and work product doctrine.

Takeaway:

The Delaware Court of Chancery has emphasized the importance of specific, timely objections. Generic or formulaic objections are considered insufficient, potentially leading to waiver of objections. Failure to comply can result in waiving all objections.

Delaware Court of Chancery Rule 5.1 provides the standard and an intricate series of procedures for the parties to seek “confidential treatment” to prevent pleadings filed with the court from being publicly available. The prior version of the rule referred to this procedures as “filing under seal.”  Notably, analogous procedures in federal court employ a much different standard.

A recent pair of Orders from the Delaware Court of Chancery featured the unusual shifting of fees in connection with Rule 5.1, as an exception to the American Rule where each party pays its own fees. See Robert Garfield v. Getaround, Inc., C.A. No. 2023-0445-MTZ, Order (Del. Ch. Oct. 26, 2023). This is the first of two Orders that need to be read together to put them in context. The second Order is noted below.

The Orders understandably do not feature the typically copious background facts provided in opinions, but it includes sufficient information to make the point for purposes of this short blog post.

The noteworthiness of the Orders is that they will remind counsel that under Rule 5.1, when a party disagrees about what portions of a pleading should be designated as confidential, the party harboring the disagreement does not have the right to publicize the information sought to be kept confidential—until the court rules on the issue or unless the procedures provided in Rule 5.1 are followed.

With that background, the relatively short Order deserves to be quoted verbatim: 

“It was not for Plaintiff to unilaterally decide that information Defendant has designated and redacted as confidential in its opposition could be publicized in Plaintiff’s reply.  Defendant bore the burden of designation under Court of Chancery Rule 5.1(b)(3).  Nor was it for Plaintiff to resists Defendant’s call to withdraw Plaintiff’s Reply to publicize information Defendant had designated.  Rather, Plaintiff’s recourse was to file a Motion of Challenge to the Opposition and the Reply under Court of Chancery Rule 5.1(f).

The parties shall work with the Register in Chancery to place Plaintiff’s Reply under seal.  The parties shall follow Rule 5.1’s procedures to address any remaining disagreements as to whether information in that reply was fairly designated as confidential.”

The first Order was in response to a Motion by the Defendant to place under seal the Reply of the Plaintiff in opposition to the Defendant’s Motion to File Under Seal because that Reply was wrongly filed in a publicly available manner.

In a second Order shifting fees under the bad-faith exception to the American Rule, the Court reasoned that the Plaintiff’s:

“insistence on publicizing information Defendant designated as confidential serves no plain purpose other than agitation.  I conclude the publication in the opposition to the motion to seal was in bad faith. Fees are shifted for the Motion to Seal the Opposition.”

Garfield v. Getaround, Inc., C.A. No. 2023-0445-MTZ, Order (Del. Ch. Oct. 27, 2023)

Frank Reynolds, who has been covering Delaware corporate decisions for various national publications for over 35 years, prepared this article.

The Delaware Court of Chancery, in a key ruling on the third-party beneficiary rights of merger target shareholders, has dismissed an ex-Twitter Inc. investor’s “lost premium” suit that sought a $3 million “mootness fee” after Elon Musk reversed his decision to abandon the social media giant’s purchase in Crispo v. Musk, et al., No. 2022-0666-KSJM (Del. Ch. Oct. 31, 2023).

Chancellor Kathaleen St. Jude McCormick’s October 31 opinion found plaintiff shareholder Luigi Crispo’s suit was not meritorious when filed since he never had a valid claim that he should profit by Musk’s buy decision. She said either he lacked third-party status or those rights had not yet vested during Musk’s on-again-off-again acquisition.  But she took the occasion to comprehensively clarify the parameters of third-party shareholder beneficiary rights—which might benefit M&A practitioners.

The Chancellor noted that although the facts of this case made the decision seem deceptively simple, the complexity of the underlying rights issue has the potential to form a legal “Gordian KnoI” which requires some explanation as to how it might be cut.

Background

The litigation arose out of Elon Musk’s July 2022 decision to acquire Twitter—and his change of mind less than three months later to scrub it, resulting in a suit by Twitter for specific performance, but Musk changed his mind again in October and consummated the deal on the original terms that month.  Meanwhile Crispo, who held 5,000 shares of Twitter, sued Musk and his X Holdings Inc. I and II  acquisition companies in July for breach of the merger pact and breach of duty as the controller of Twitter,

After Chancellor McCormick dismissed most of those claims and the sale closed, Crispo’s suit was considered dead, but it “sprang back to life zombie-like” she said, when Crispo claimed partial credit for Musk’s. change-of-heart and sought a $3 million award on grounds that Musk mooted plaintiff’s breach of merger charge by keeping his deal promise after all.

Meritorious mootness suit?

Chancellor McCormick said the Delaware Supreme Court has held that mootness fees are only awarded when:

i)The suit was meritorious when filed

ii) the action that produced the benefit to the corporation “was taken by the defendant before a judicial resolution was achieved;” and

iii) “the resulting corporate benefit was causally related to the lawsuit.”

“In order for a suit to be considered meritorious when filed, the complaint must have been able to have survived a motion to dismiss, whether or not such a motion was filed,” so he must prove the remaining lost premium claim was meritorious for the suit to survive, the Chancellor pointed out; but she added that plaintiff  was not a party to the Merger Agreement, so the merits of his claim hinge on the argument that he had standing to sue for breach of the agreement as a third-party beneficiary

To allege standing as a third-party beneficiary, a plaintiff must plead that:

i) “the contracting parties . . . intended that the third party beneficiary benefit from the contract,”

ii) the benefit [was] intended as a gift or in satisfaction of a pre-existing obligation to that person, and

iii) “the intent to benefit the third party [was] a material part of the parties’ purpose in entering into the contract.”

Was the investor vested?

But the Chancellor ruled that, “[T]hird party beneficiaries, however, cannot object to the alteration or termination  of the contract before their rights against the promisor have vested.’’  and Crispo’s rights had not vested.

Moreover, she said, Delaware courts are reticent to confer third party beneficiary status to stockholders under corporate contracts for a mix of doctrinal, practical and policy reasons not the least of which is that “under Delaware law, the board of directors manages the business and affairs of the corporation, which extends to litigation assets.”  That includes Delaware’s exacting presuit demand test for shareholders who seek to sue on behalf of the corporation.

Lost Premium Provision no help

The court said Section 9.7 of the Merger Agreement is a no-third-party-beneficiaries provision which comprises a blanket prohibition disclaiming third-party beneficiaries followed by three. carve-outs but none of those provide any help for the plaintive here.  In addition, the chancellor noted, the blanket prohibition states that the Merger Agreement “shall not confer upon any Person other than the parties hereto any rights or remedies hereunder[.]”

Conclusion

Finally, she said, the parties stipulated to specific performance as to “prevent” breaches of the Merger Agreement, suggesting that a breach claim seeking lost-premium damages would not accrue unless specific performance was unavailable.  The limitation necessarily implied by the Merger Agreement is that the drafters did not intend to vest stockholders with a right to enforce lost-premium damages while the company pursues a claim for specific performance, she concluded.

Former U.S. Attorney General William Barr wrote an article in today’s Wall Street Journal arguing: Delaware is at risk of losing its prominence in corporate law because of what the former U.S. Attorney General describes as the increasing infiltration into Delaware corporate law of ESG priorities, for example via Caremark claims.

Barr describes ESG as a means to inject left-leaning policy preferences into the law. It’s not a law review article, although he refers in passing to several developments that those familiar with Delaware corporate law will recognize. Whether he is correct or not in his admonition is currently a topic of debate among various sectors in the legal profession.

UPDATE: Professor Stephen Bainbridge, one of Delaware’s favorite corporate law scholars, has written an erudite response to AG Barr’s article, with copious citations and quotes from the good professor’s own extensive scholarship on the topic, as well as the publications of other leading authorities. Among the quotes in his article linked above, is one from a former Chancellor and Delaware Supreme Court Chief Justice, described as “pro-ESG”, which follows: “It is not only hollow but also injurious to social welfare to declare that directors can and should do the right thing by promoting interests other than stockholder interests.”

SECOND UPDATE: The Chancellor of the Delaware Court of Chancery, as reported in an article by Reuters, responded during a seminar to the referenced article by AG Barr, and Vice Chancellor Travis Laster also provided a rebuttal on LinkedIn, and invited AG Barr to a debate, as described in follow-up commentary by Professor Bainbridge–which includes, as usual, copious citations to his own extensive scholarship and the publications of other corporate law scholars.

The Delaware Court of Chancery recently addressed a litany of claims that the buyer of a business breached its contractual and fiduciary duties by diverting new deals that deprived the sellers from reaching milestones in the purchaser’s new entity that would have triggered increased value. 

In MALT Family Trust v. 777 Partners LLC, C.A. No. 2022-0652-MTZ (Del. Ch. Nov. 13, 2023), the court addressed a long list of claims that provide corporate litigators with a refresher course on basic claims and defenses often encountered in Delaware’s court of equity in connection with the sale of a business.

This short blog post will provide highlights by way of bullet points.

Highlights

  • The court recited the familiar elements of a claim for fraudulent inducement, as well as the specificity requirement of Rule 9(b) for fraud claims. See Slip op. at 10.
  • The court reviewed the well-settled Delaware law on the objective theory of contract interpretation.  See Slip op. at 15.
  • The court explained that the LLC agreement did not include any of the alleged express representations or warranties on which the Plaintiff’s allegations were based. Nor was the purpose clause a “representation or warranty.” See also the court’s application of the contract interpretation principle known by the Latin phrase: expressio unius est exclusio alteris. See Slip op. at 17.
  • The court observed that an LLC agreement is not required to have a “purpose clause,” but that if a purpose clause limits the scope of authorized activity of the LLC, only the company can breach that clause. In this matter, the allegations were against the individual members.  Slip op. at 17-20.
  • Court of Chancery Rule 8 allows duplicative claims in the alternative to be pled, but a nuanced approach applies when the breach of the implied covenant of good faith and fair dealing is contradicted by the expressed terms in an agreement.  Slip op. at 22-25.
  • The well-settled principle that fiduciary duties of an LLC manager and controllers of the LLC must be waived with specific clarity supported the court’s reasoning that the corporate opportunity doctrine was not waived.  Slip op. at 27-31.
  • This opinion regales the reader with a quote and citation to a reference book that should be on the shelves of every corporate and commercial litigator.  At footnote 101 of the opinion, the court cited to Justice Antonin Scalia’s book that he co-authored with Bryan Garner entitled:  Reading Law: The Interpretation of Legal Texts 126-27 (2012). In that same footnote the court also cited to Kenneth A. Adams, “A Manual of Style for Contract Drafting,” Section 13.631 (Fifth Ed. 2023). The citations were for the purpose of interpreting a clause that included the word “Notwithstanding.”  The specific quote from the Scalia book was: 

“A dependent phrase the begins with notwithstanding indicates that the main clause that it introduces or follows derogates from the provision to which it refers.” 

The court interpreted that clause in a section involving fiduciary duties to conclude that the parties did not intend to waive fiduciary duties relating to the usurpation of “other business interests and activities.”

A recent Delaware Court of Chancery decision determined the proper members of an LLC and their respective interests pursuant to Section 18-110 of the Delaware LLC Act.  In REM OA Holdings, LLC v. Northern Gold Holdings, LLC, C.A. No. 2022-0582-LWW (Del. Ch. Sept. 20, 2023), the court determined in a post-trial opinion that at least one of the two initial 50/50 members lied while testifying during trial, but the court nonetheless reached a conclusion based on all the admissible evidence.

Although the entire decision should be read carefully for the factual context, this short blog post will only provide a few key takeaways.

Highlights

  • Despite one of the initial 50/50 members not being provided with all of the documents that described the loan terms that diluted his interest–before he signed a document agreeing to those terms–the court found that  he would still be bound by a written consent to loan terms that would admit a new member.
  • Without reference to the conduct of the counterparty who failed to provide all the terms, the member was nonetheless bound  by the documents he signed.
  • The court relied on several cases for the well-established principle that ignorance of the terms in an agreement signed and consented to is no defense to their enforceability. Slip op. at 49.
  • This basic principle that one generally is bound by the document she signs, also extends to the terms of documents incorporated by reference—even if they were not supplied prior to signing.  See footnote 274.
  • The court determined that several arguments were unavailing to prevent enforceability, including: (1) unilateral mistake; (2) fraudulent inducement; and (3) breach of fiduciary duty.
  • Regarding the breach of fiduciary duty argument, the court observed that fiduciary duties under the LLC agreement only applied to controllers or managers of the LLC, but the claimant in this case was neither.  See Slip op. at page 52-54.

Of course, there is much more to commend the reading of this entire opinion, but these bullet points were the most useful takeaways with the most widespread applicability. 

In a targeted proceeding pursuant to Section 225 of the DGCL with the limited purpose of determining whether members of the board of directors were properly removed, the Delaware Court of Chancery determined that the plaintiff did not establish its burden of proof to challenge the removal of board members. In Barbey v. Cerego, Inc., C.A. No. 2022-0107-PAF (Del. Ch., Sept. 29, 2023), the Court found that the removal of the entire board, and their replacement by a new sole director, was effective.

The Delaware Supreme Court affirmed this decision on June11, 2024.

This gem of an opinion provides several key principles of Delaware corporate law, and corporate litigation, that can be applied in other Section 225 actions, and other litigation generally.

Very Brief Overview of Background

The factual background of this case is somewhat tortuous, but for purposes of these short highlights I will only provide a few key points for context. The case involves a corporate inversion effected through a tender offer whereby the subsidiary would swap its shares in exchange for the outstanding shares of the parent, with the goal of giving the subsidiary a supermajority of the parent’s outstanding shares.  Once that was accomplished, the subsidiary took action to remove the existing board of directors of the parent.  The subsidiary was a company formed in Japan. The parent was a Delaware corporation.

The plaintiffs challenged the removal based on the argument that the inversion was invalid.  Specifically, the plaintiffs argued that the parent purported to authorize the subsidiary to commence a tender offer at a special meeting of the board for which adequate notice was not given according to bylaws of the parent.

The key factual and legal findings of the Court for purposes of this Section 225 action were: (i) although a regular meeting did not require notice under the bylaws, a special meeting did require notice which—based on the facts presented—was not properly given, thereby making the actions taken at the special meeting void.

Nonetheless, the Court found that, even though the plaintiffs did not anticipate or address the issue of whether the inversion and tender offer even required approval by the parent’s board, board action was not required to authorize the subsidiary’s tender offer that resulted in the subsidiary becoming the majority stockholder of the parent. Therefore, the actions taken by the new majority stockholder to remove the board and appoint a new sole director were effective.

Highlights of Key Legal Aspects of the Court’s Opinion

●       Section 225 of the DGCL permits any stockholder or director to apply to the Court of Chancery to determine the validity of any election, appointment, removal or resignation of any director or officer of any corporation.  These are “in rem proceedings” which only exert jurisdiction over the corporation, and may only provide relief concerning the corporate office.  Slip op. at 15.

●       Other types of ultimate relief beyond what is necessary to determine the proper holder of a corporate office may only be obtained through a plenary action through which the court would exercise jurisdiction over affected parties. Id.

●       Notably, the party challenging the removal of a director bears the burden of proving by a preponderance of the evidence that a director’s removal was invalid.  Id.

●       In order to resolve the issues presented, the court had to determine whether a board meeting at issue was a regular meeting of the board or a special meeting of the board. Only a special meeting required notice.  There is a useful and cogent analysis of the bylaws to determine whether the meeting held was properly described as a regular meeting or a special meeting, as well as the notice requirements under the bylaws.

●       The Court instructed that:  “The production of weak evidence when strong is, or should have been, available can lead only to the conclusion that the strong would have been adverse.”  Slip op. at 20. As applied to the facts of this case, the Court determined that the dispositive original emails in their native format, with metadata, should have or could have been produced instead of a simple screen shot, which did not contain any metadata.  The Court then applied an adverse inference that: if the stronger evidence were produced, it would have been harmful to the person with the burden of proof.

●       The Court also reiterated the principle: “it is, of course, fundamental that a special meeting held without due notice to all the directors is not lawful, and all acts done at such meeting are void.”  The Court emphasized that it was only making this determination solely for the purpose of determining the proper composition of the board, and noted that unlike a plenary proceeding, the issues that a court can address in a Section 225 proceeding are limited. Slip op. at 21-22.

●       The Court explained that the burden of the proof was on the plaintiffs to determine that even if the board action was ineffective, the transaction which gave the subsidiary a majority ownership of  the parent and the ability to replace the board was still not effective.

●       The Court reasoned that the subsidiary was a separate legal entity from the parent and observed the truism that: Delaware law respects corporate separateness even when there is common ownership and even if there is total ownership and total control of one corporation by another, absent a showing of fraud or the existence of an alter-ego.  Slip op. at 23.

●       Interestingly, on a procedural but key note, neither of the companies involved entered an appearance in the case, and only one of the board members involved intervened.

Conclusion

In sum, the Court explained that the plaintiff merely focused its case on whether or not there was proper notice for a special board meeting and whether the actions taken at the meeting were void, but even though the Court found that meeting to be void, the Vice Chancellor also held that the corporate inversion making the subsidiary the majority stockholder properly authorized it to remove the all board members.

Lastly, the Court found that the plaintiff failed to timely raise the issue of foreign law under Court of Chancery Rule 44.1, therefore that argument was waived.

Frank Reynolds, who has been covering Delaware corporate decisions for various national publications for over 35 years, prepared this article.

The Delaware Court of Chancery, in a guidepost ruling on the power to bestow super-voting stock, has dismissed a shareholder’s “identity-based voting” suit over Bumble Inc.’s decision to designate ten-votes-per-share only for the stock of the relationship-nurturing software company’s CEO/founder and his financial backer in Colon v. Bumble Inc. et al., C.A. No. 2022-0824-JTL (Del. Ch. Sept. 12, 2023).

Vice Chancellor Travis Laster’s September 12 summary judgment opinion dismissed breach-of duty charges against Bumble and its CEO, finding that granting the allegedly discriminatory 10X-power voting stock did not conflict with either key provisions or rulings governing that action.  He ruled that the defendants had the right to designate a super voting stock class under the certificate of incorporation — or they could give the directors the right to make that designation at some future time.

The vice chancellor said the challenged action was not invalid because it did not violate Sections 212(a) and 151(a) of the Delaware General Corporation Law and had properly structured a dual-voting class “Up-C” company/partnership entity to enable two insiders to validly gain the control benefit of 10 votes per-share and a tax benefit.

An Up-C structure enables insiders to gain the benefits associated with a public listing without giving up the benefits associated with pass-through tax treatment. To eat that cake and still have it requires two entities: an umbrella partnership and a C corporation. It also requires that the C corporation issue two classes of stock.

Background

Defendant CEO Whitney Herd founded Bumble in 2014 as a web software company that enabled internet clients to cultivate business, friendship and romantic relationships and took it public in 2021 with the financial backing of Blackstone Inc.  Kyrstyn Colon filed suit in 2022 on behalf of all common shareholders claiming that an action that bestowed ten votes per-share on Herd and Blackstone, as the only “principal shareholders” was invalid “identity-based voting.”

Both parties sought summary judgment and Vice Chancellor Laster granted the defendants’ motion—which resulted in a decision that the vote grant was valid and the challenge must be dismissed.

A comprehensive review

The court used the occasion to comprehensively review the scope of the applicable sections of the DGCL and the parameters of the UP-C dual voting class entity structure.

The court reasoned that if the corporation will issue stock that has special attributes, then Section 102(a)(4) provides two alternatives for memorializing the special attributes in the certificate of incorporation.  One alternative is to specify the special attributes directly. The other is to empower the board of directors to bestow super-voting stock at a future time.

8 Del. C. § 151(a) generally authorizes a corporation to issue multiple classes of stock and makes clear that they may either carry default rights by implication, have some or all the default rights specified expressly in the charter, or have whatever special rights are allowed.

Section 212(a) provides that if the certificate of incorporation is otherwise silent, then each share of stock carries one vote by default. Section 212(c) also provides that if the certificate of incorporation calls for greater or lesser voting power, then references in the DGCL refer to that level of voting power.

A trio of key decisions

The Delaware Supreme Court and the Court of Chancery have approved charter provisions that allocate voting power using a formula or procedure, and the Delaware Supreme Court upheld a scaled voting structure in which the number of votes appurtenant to a share varied depending upon the total number of shares that the owner held, he said.

The vice chancellor said, “the Delaware Supreme Court and this court have approved charter provisions that allocate voting power using a formula or procedure.  In Providence & Worcester Co. v. Baker, 378 A.2d 121 (Del. 1977), the Delaware Supreme Court upheld a scaled voting structure in which the number of votes appurtenant to a share varied depending upon the total number of shares that the owner held.”

In Williams v. Geier, 1987 WL 11285 (Del. Ch. May 20, 1987), this court dismissed a challenge to a tenured voting mechanism, holding that it complied with the DGCL, the Vice Chancellor said.

And he noted that in Sagusa v. Magellan Petroleum Corp., 1993 WL 512487 (Del. Ch. Dec. 1, 1993), aff’d, 650 A.2d 1306 (Del. 1994) (TABLE), this court dismissed a challenge to a per capita voting provision that gave each stockholder a single vote, regardless of how many shares the stockholder held, and the Delaware Supreme Court upheld the dismissal.  Framed using the language of this decision, the certificate of incorporation used a mechanic conceptually similar to Providence.

“A strange move”

Contrary to the preceding analysis, the court said, plaintiff argued that the challenged provisions violate Section 212(a) of the DGCL, but the plaintiff did not rely on the text of the provision, but rather on language from the Providence decision.  The plaintiff asserts that under Providence, a corporation cannot create a mechanism in which shares of the same class differ in their share-based voting power depending on who holds them.

Relying primarily on Section 212(a) was a “strange move”, because that section does not authorize or restrict anything, the vice chancellor said. “Section 212(a) creates a default right of one vote per share, and it provides that if a charter departs from the default right, then any voting calculations required by the DGCL—such as the amount of voting power that would constitute a majority of the voting power outstanding—must use the voting power as determined by the charter.

Conclusion

The plaintiff views identity-based voting as an entrenched hierarchy and wants all stockholders to have equality of opportunity, the court said, noting that, “In many areas of the law, those noble sentiments could carry weight. They cannot overcome the plain language of the DGCL.” Nothing in Section 151(a) prohibits a provision that creates a closed set of holders who can exercise certain rights, the court ruled.

The Delaware Supreme Court issued a momentous decision recently that should be read by all those who want to know the latest iteration of Delaware law on the limits of judicial equitable review of LLC Agreements. 

Key Issue Addressed

In Holifield v. XRI Investment Holdings LLC, Del. Supr., No. 407, 2022 (Sept. 7, 2023), the Delaware Supreme Court determined that freedom of contract in the context of LLC agreements extends to “contractually specified incurable voidness.”  This 77-page decision from Delaware’s high court reviewed a 154-page decision of the Court of Chancery that was highlighted on these pages.

This is the type of decision that could justify a law review article, but for purposes of this short blog post, I will only highlight key parts of the decision that should justify a careful reading of the decision in its entirety.

Basic Factual Context

The background of the case involves complex, extensive facts, but for purposes of these brief highlights, the most important context involved whether or not the parties to an LLC Agreement could determine, in connection with an attempted transfer of interests, that failure to comply with certain conditions would make a transaction “incurably void” such that it would not be subject to judicial equitable review and remedies—even if it might result in an inequitable holding by the court.

Highlights

  • The trial court found that it was bound to uphold the “contractual incurable voidness” based on the Delaware Supreme Court’s CompoSecure II opinion.  Slip op. at 32. 
  • See footnote 82 noting that it was not an issue on appeal that, generally, the equitable defense of acquiescence is available as a defense to claims at law.
  • The Supreme Court explained why it would not reconsider its decision in CompoSecure II which the appellant and the trial court urged.  Slip op. at 43 – 44.
  • The Supreme Court provided guidance on why the primacy of freedom of contract embodied in the LLC Act supported the CompoSecure II decision—which endorsed private ordering to a degree “not available in the corporate context.”  Slip op. at 44.
  • The Delaware Supreme Court instructed that “. . . particularly in the alternative entity context, equity will not save a bad contract.”  Slip op. at 46.  See cases cited at footnotes 118 to 120.
  • The high court also provided a primer on basic Delaware law regarding contract interpretation principles.  Id. at 47.
  • The Supreme Court emphasized that the freedom of contract allowed in LLC agreements extends to “contractually specified incurable voidness.”  Id.
  • Although the Supreme Court acknowledged that there are limits to private ordering, and that Delaware courts retain an inherent measure of authority and equitable power regarding LLC agreements: equity cannot always override the plain language of an LLC agreement with respect to incurable voidness.  Id. at 47-48.
  • By comparison, corporate bylaws cannot alter the directors’ fiduciary obligations “and the attendant equitable standards a court will apply enforcing those obligations.”  Slip op. at 49.  See also footnotes 136 to 142 and accompanying text.
  • The Delaware Supreme Court emphasized that its CompoSecure II opinion “did not hold, or even suggest, that in every case where the parties used the word ‘void’, a non-compliant act will be incurably void.”  Id. at 65.  If the use of the word in some circumstances is ambiguous, a different analysis is possible.
  • The court declined to require “talismanic magic words to contract for incurable voidness in an LLC agreement.”  Id. at 66.
  • The case was remanded to address damages and recoupment.  Id. at 77.

This article was prepared by Frank Reynolds, who has been following Delaware corporate law and writing about it in various publications for more than 35 years

The Delaware Court of Chancery has allowed GoDaddy Inc. shareholders to continue their suit that claims their directors exhibited bad faith by disloyally rubber-stamping the under-valued buyout of a tax asset business that allegedly cost the web hosting company $850 million, in IBEW Local Union 481 Defined Contribution Plan and Trust v. Winborne, et al., C.A. No. 2022-0497-JTL (opinion issued) (Del. Ch. Aug. 24, 2023).

Vice Chancellor Travis Laster’s August 31 opinion refused to dismiss a pension fund’s derivative breach of duty and waste of assets charges, finding that, viewed as a whole, the suit contained enough particularized allegations supporting multiple reasons to believe the directors’ actions were not entitled to the protection of the business judgment rule or exculpation—due to indications of bad faith conduct.

The process by which the court made that determination should be of interest to corporate law practitioners.  The vice chancellor said one way to determine bad faith in this context is, if it appears that the transaction was “authorized for some purpose other than a genuine attempt to advance corporate welfare or is known to constitute a violation of positive law,” then a court can find bad faith.   Even if the defendants argue that the extreme transaction had a legitimate purpose, “if the decision is sufficiently extreme, then the court can still infer bad faith, but the decision must be so extreme that it could not be rationally explained on another basis” he said, citing. In re Orchard Enters., Inc. S’holder Litig., 88 A.3d 1, 34 (Del. Ch. 2014).

In fact, he explained, that type of pleading matches the standard for a claim for waste, defined as a decision “so egregious or irrational that it could not have been based on a valid assessment of the corporation’s best interests.” White v. Panic, 783 A.2d 543, 554 n.36 (Del. 2001).  The vice chancellor said that at the pleading stage, the test for bad faith is “whether the complaint alleges a constellation of particularized facts which, when viewed holistically, support a reasonably conceivable inference that an improper purpose sufficiently infected a director’s decision to such a degree that the director could be found to have acted in bad faith.”

Vice Chancellor Laster said that inference of bad faith was enough, for the purposes of the dismissal motion, to find that pre-suit demand is satisfied under Rule 23.1 because a majority of the defendants’ actions are not the type of breach of duty that can be exculpated.

Background

The source of the litigation began in 2015, when GoDaddy completed an Up-C IPO, a structure which the court said, “layers a parent- level corporation on top of a limited liability company that is treated as a partnership for tax purposes” and has a member interest in the LLC divided into a number of units – some of which are owned by GoDaddy and some by public and private equity investors. 

The opinion said the litigation arose from a complex transaction involving the buyout of the tax assets generated.  The complaint charged GoDaddy CFO Raymond Winborne significantly misstated the value of the tax asset, causing a multimillion liability payment that hurt GoDaddy’s value.     Windborne knew the value he stated was incorrect and so did the directors who voted for the tax asset scheme, the complaint by a union pension fund claims;

A holistic approach

In this case, the court said it “adopted a ‘holistic’ approach, compiling a “constellation” of various factors from the complaint’s allegations that together provide reason to doubt that the voting directors acted in good faith. The court listed those factors:

The first indicative factor is the stark contrast between the valuation of $175.3 million for the TRA Liability in GoDaddy’s audited financial statements and the $850 million payment in the TRA Buyout. The contrast between those figures is so glaring as to support a claim of waste and hence an inference of bad faith on that basis alone.

The second indicator of bad faith is the conflict between Winborne’s representations to the Audit Committee and Ernst & Young and his representations to the Special Committee and the Voting Directors.  For Winborne to have said one thing to the Audit Committee and Ernst & Young then said the opposite to the Special Committee and the Voting Directors supports an inference of bad faith.

In addition, there were no questions or objections from the directors regarding that wide discrepancy, the courts noted.  Indeed, such an exchange “is so one-sided that no businessperson of ordinary, sound judgment could conclude that the corporation has received adequate consideration.” the court said.

A third indicative factor is that that Winborne’s projections and analysis excluded any consideration of GoDaddy’s M&A-based business model and its effect on GoDaddy’s ability to use the Tax Asset. One of the main reasons why GoDaddy had not made any payments under the Tax Agreements and kept putting off when they would begin was because the Company engaged in M&A. The pleading-stage record supports an inference that the members of the Special Committee knew that Winborne’s projections rested on unrealistic assumptions.

It’s all how you look at it

In summary, the vice chancellor ruled that, at most, a claim for breach of the duty of care does not give rise to liability for pre-suit demand purposes but, “When viewed holistically, the complaint’s allegations support an inference of bad faith.”  Two members of management steered a process towards an outcome designed to favor the Founding Investors, aided by a Special Committee populated with the three outside directors most likely to sign off on the deal.

“Since the standard under Rule 12(b)(6) is less stringent than the standard under Rule 23.1, a complaint that survives a Rule 23.1 motion to dismiss generally will also survive Rule 23.1” he said.

Over the nearly two decades that I have maintained this blog, I have written about a fair number of court decisions involving statutory dissolution. The recent Delaware Court of Chancery decision styled:  In re Neworld Energy Holdings LLC, C.A. No. 2023-0282-MTZ (Del. Ch. August 24, 2023), granted a motion to dismiss based on an arbitration clause in an LLC Agreement that the court found to require arbitration of statutory dissolution claims. 

Seminal Delaware Opinion on Arbitrablity

Relying on the seminal Delaware Supreme Court decision in James & Jackson, LLC v. Willie Gary, LLC, 906 A.2d 76, 79 (Del. 2006) (highlighted on these pages here and which this author argued before the Delaware Supreme Court), the court addressed those situations where an issue of substantive arbitrability should be determined by the court or an arbitrator.  In this decision, the court explained that the arbitration provision, which incorporated the American Arbitration Association Rules, evidenced a “clear and unmistakable intent to submit arbitrability issues to an arbitrator.”  The court determined that the agreement involved in this case provided an exception for seeking equitable relief–but that did not apply to a request for statutory dissolution. 

Additional Case Law Support

The court also found support for its reasoning in two other Delaware cases that applied the Willie Gary decision:  Blackmon v. O3 Insight, Inc., 2021 WL 868559 (Del. Ch. Mar. 9, 2021, and McLaughlin v. McCann, 942 A.2d 616, 622-35 (Del. Ch. 2008).  The court also referred to the recent United States Supreme Court decision in Henry Schein, Inc. v. Archer & White Sales, Inc., 139 S.Ct. 524, 529 (2019)(highlighted on these pages here and here), regarding the position that a court possesses no power to decide an arbitrability issue when there is clear and unmistakable evidence that the parties intended to delegate issues of substantive arbitrability to an arbitrator. 

The court also noted in closing, in support of its decision. another Chancery opinion that concluded:

“There is nothing inherent in the claim for judicial dissolution that could not be fully and fairly litigated in the context of an arbitration.” (citing Johnson v. Foulk Road Med. Ctr. P’ship, 2001 WL 1563693, at *1-2 (Del. Ch. Nov. 21, 2001)).

A recent Chancery decision addressed many important issues related to a squeeze-out merger involving an LLC in which the minority member claimed that it did not receive a fair price for its minority interest.  See Cygnus Opportunity Fund, LLC v. Washington Prime Group, LLC, C.A. No. 2022-0718-JTL (Del. Ch. Aug. 9, 2023).  There are many issues in the 48-page decision that could be the subject of an extensive review, but for purposes of this relatively short blog post I will limit my discussion to the fiduciary duties of officers, which the court described as:  having “long been an undertheorized area of Delaware law.”  Slip op at 13. 

Issue Addressed

Whether the defendant-officers breached their fiduciary duties because the company provided no or few disclosures in connection with a squeeze-out merger.  The court refused to grant a motion to dismiss on that issue.  Although there was a waiver of fiduciary duties for some, there was only an exculpation clause that applied to officers.  The LLC was structured in a manner similar to corporations with a board of directors and officers.

The Fiduciary Duty of Disclosure

This decision engages in a rather deep-dive into the public policy and historical underpinnings of the fiduciary duty of officers to make disclosures.  Slip op. at 12 through 25.

The court explained that the duty of disclosure is not a separate duty but rather a contextual manifestation of the duties of care and loyalty.  Slip op. at 13.  The court instructed that the duty of disclosure arises situationally, its scope and requirements depend on context.  The court cited to cases that refer to the recurring scenarios in which the governing principles of disclosure have been developed.

Duty to Inform

The court reasoned that the duty of disclosure is a context-specific duty, and

“no Delaware decision holds that fiduciaries do not owe any duty in the context of a transaction in which the fiduciaries unilaterally eliminate their investors from an enterprise.  I personally am not prepared to rule as a matter of law that a fiduciary can take the property of its beneficiary without some level of disclosure, even in the absence of any request for action.  To the contrary, basic fiduciary principles suggest that a fiduciary cannot do that”.

Slip op. at 18-19.

The court traces the anglicized Latin word fiduciary to its meaning as trustee-like, and also traces the origin of fiduciary duties to obligations similar to those of a trustee—and the fiduciary relationship as analogous to one between an express-trustee and a beneficiary.

The court cited to treatises and case law for the principle that a fiduciary should keep beneficiaries informed as a central aspect of a trustee’s duties at common law and:  “Even in the absence of a request for information, a trustee must communicate essential facts to beneficiaries.”  Slip op. at 19.  The court emphasized that:  “The duty to inform is not limited to trustees.  It runs through the whole law of fiduciary and confidential relations.”  Slip op. at 21.

Duty to Disclose in Context of Squeeze-Out Merger 

In the context of a squeeze-out merger, the court reasoned that:

“If the duty to inform could apply anywhere, it would apply to a transaction in which a fiduciary unilaterally effectuates a taking of a beneficiary’s interest.  In that setting, the duty of loyalty could manifest as an obligation to inform the beneficiary of the material facts surrounding the transaction, regardless of whether or not the beneficiary’s approval is required.”  Slip op. at 21.

The court further explained that even if the LLC Agreement would allow the defendants to argue that they could convert a minority interest into a right to receive the amount offered—without any explanation:  “that result would be contrary to equity.”  Slip op. at 21.

Exculpation Provision

The court discusses the exculpation provision, as contrasted with the waiver of fiduciary duties, and describes the willful conduct that is not covered by the exculpation provision. The court described those situations at the pleadings stage where the allegations of willful conduct which require insight into the state of mind, such as the intent of a person, “may be averred generally”.  Slip op at 46.  The court also observed that the degree to which a party must plead facts of this nature takes into account whether the facts lie more in the knowledge of the opposing party than of the pleading party.  Id. 

The court found that the complaint alleged facts supporting a reasonable inference that the defendants intentionally pursued a scheme to eliminate the minority at a grossly unfair price.  The court held that the difference between the transaction price and the actual value supported an inference of subjective bad faith that inferably violated the provisions of the LLC Agreement and the fiduciary duties of the officers.  The exculpation provision at this early phase of the case could not be relied upon to support a motion to dismiss.

My latest column on legal ethics for the flagship publication of the American Inns of Court, The Bencher, addresses the titular topic. During the more than 25 years that I have penned the legal ethics column, this topic may be among the most challenging. That is, do the rules of legal ethics provide any guidance on how, if at all, to respond when one is falsely accused–especially of despicable acts or statements.

Courtesy of The Bencher, my latest article is reprinted below.

Do Legal Ethics Rules Provide Guidance for Responding to False Accusations?

The Bencher | September/October 2023

By Francis G.X. Pileggi, Esquire

During the 25 years or so that I have written this ethics column, the titular topic may be the most challenging among those I have addressed. If one is falsely accused of some despicable act, with no details and no opportunity to confront the unnamed accuser, do the rules of professional responsibility suggest how a lawyer should reply? Let’s be more specific.

What if an anonymous and amorphous accusation of racist behavior, without details of specific words used or other details, is recklessly repeated without an opportunity for the accused person to confront the accuser or rebut unspecified facts? How should the ethical lawyer respond? Most lawyers, and most reasonable people, would expect that such a serious false accusation, or repeating such a false accusation, should surely be actionable in some manner.

Those who weaponize the accusation of racism for improper motives continue to make it harder for those who seek to eradicate racism where it truly exists.

Those who believe in the approach of an “eye for an eye” may seek retribution. Adherents of Stoicism might counsel a “grin and bear it” approach. Christians may counsel a “turn the other cheek” response. Others may rely on karma.

Delaware Cases

Relatedly, a Delaware Supreme Court decision found that a defamation claim based on a member of the legal profession falsely accusing a lawyer of being a racist was barred by the First Amendment guarantees of free speech and observed that “it is clear to us that Americans disagree about a long and growing list of things that to some are racist and to others are not.” Cousins v. Goodier, Del. Supr., No. 272, 2021, Slip op. at 28 (Aug. 16, 2022).

Delaware’s High Court referred to the evolving definition of racism and cited to the recently updated definition of the word in a leading dictionary that now includes systemic racism, id. at n. 103, while also noting that the term “racist” has been used so variously as to have been “drain[ed]…of its former, decidedly opprobrious meaning” and to now “fit comfortably within the immunity for name-calling.” Id. at n.104 (quoting Stevens v. Tillman, 855 F.2d 394, 402 (7th Cir. 1988)).

When an accusation is made by an unidentified person, options may be limited. In 2005, the Delaware Supreme Court reasoned in Doe v. Cahill that only in certain circumstances can one force the disclosure of the identity of an anonymous online accuser.

An activist affiliated with Harvard Law School has described Christianity as a religion guilty of systemic racism, just as many have described our criminal justice system. So what do those charges mean for Christians or those who play key roles in the criminal justice system?

ABA Opinion

The American Bar Association (ABA) Model Rules of Professional Conduct do not provide clear direction on the titular issue. In 2021, the ABA issued a formal opinion on the related topic of whether, and how, to respond to online criticism. See Standing Committee on Ethics and Professional Responsibility, Formal Opinion 496 “Responding to Online Criticism,” American Bar Association (Jan. 13, 2021).

This opinion speaks directly to lawyers faced with online attacks. The opinion focuses on the Model Rules of Professional Conduct that advise lawyers how to respond to their client, former clients, opposing counsel, and opposing counsel’s clients. The ABA recommends that in these scenarios, the lawyer either not respond to the negative posts, respond by asking the person who is posting to allow for a private discussion offline, or respond by stating that professional obligations do not permit the attorney to respond. The committee noted that any response to the negative review or comment may be counterproductive.

In sum, there is no panacea for dealing with false accusations, especially anonymous ones. One goal is not to react in a manner that would run afoul of the aphorism that two wrongs don’t make a right. Although revenge might best be served cold, a Chinese saying provides that a person who seeks revenge should dig two graves: one for the person against whom revenge is sought and one for the person seeking revenge. Life is not fair.

Francis G.X. Pileggi, Esquire, is the managing partner of the Delaware office of Lewis Brisbois Bisgaard & Smith LLP. He comments on legal ethics as well as corporate and commercial decisions at www.delawarelitigation.com.

Any litigator who has been practicing long enough will confront a challenge with a pre-trial deadline. The Delaware Bar, at least traditionally, has had a custom of freely granting reasonable requests for extensions. But in summary proceedings, where a trial is often scheduled within 90 days of a complaint being filed, special nuances need to be addressed.

Bottom line: A deadline for disclosing trial witnesses will not be extended absent good cause shown. The test is not whether the other side will be prejudiced.

In the recent decision styled PVH Polymath Venture Holdings Ltd. v. TAG Fintech, Inc., C.A. No. 2023-0502-BWD (Del. Ch. Aug. 3, 2023), Magistrate in Chancery Bonnie W. David granted a Motion in Limine to bar the introduction of an expert report at trial that was submitted after the applicable deadline.

Prior Delaware decisions highlighted on these pages exemplify how seriously Delaware courts treat deadlines, especially those enshrined in a scheduling order. See, e.g., these examples. Careful readers may recall a blog post earlier this month about two decisions enforcing deadlines (coincidentally in August of all months).

In this pithy decision, the following key points are noteworthy about a deadline issue in the most common type of summary proceeding: a DGCL Section 220 case:

Highlights

  • A deadline for disclosing trial witnesses will not be extended absent good cause shown. The test is not whether the other side will be prejudiced.
  • Scheduling Orders in summary proceeding are often shorter and less detailed than their more extensive counterparts in a plenary action–but no specifically-delineated deadline for expert witnesses simply means that the deadline for all fact discovery will also include the completion of all expert discovery.
  • The Scheduling Order in this particular case included a deadline–prior to the cutoff for fact discovery–by which witness lists needed to be exchanged, as well as those witnesses to be presented by affidavit, which is not uncommon in a Section 220 trial presented “on a paper record”.
  • Rule 44.1 regarding disclosure of foreign law experts did not supersede the deadlines in the Scheduling Order.
  • The Court explained that deadlines are essential in summary proceedings and that in order to litigate efficiently: “the parties need to cooperate with one another to tee up issues for resolution. There isn’t time for ‘overly aggressive litigation strategies’ and games of ‘gotcha'”. Slip op. at 5.
  • The Court cited an example of a prior Delaware decision the precluded the use of an expert report that was not timely disclosed. See footnote 6.

Postscript: Pursuant to Chancery Rule 144(h), the parties in this matter agreed to submit this case for a final decision by the Magistrate in Chancery.

A recent Delaware Court of Chancery ruling emphasizes the importance of meeting deadlines that are part of a scheduling order, and the consequences for not following those deadlines.  In two separate Orders in the matter of Shareholder Representative Services, LLC v. Alexion Pharmaceuticals, Inc., C.A. No. 2020-1069-MTZ, Order (Del. Ch. Mar. 23, 2023), the court granted a motion to exclude an expert report when the deadline for disclosing the subject matter of expert testimony was not met.  Specifically, six days after the deadline, the identity of the expert and his CV were produced, but not the subject matter of his proposed testimony. That was not disclosed until his expert report was provided 26 days after the deadline for disclosure–on the date that expert reports were due. Neither leave to amend the scheduling order nor consent from the other parties was sought. (FYI: Orders can be cited in briefs in Delaware.)

The court relied on Rule 6(b) which allows the court “for good cause shown” in its discretion to enlarge the period of time by which the parties are required to meet a deadline:  “if requested before it [the deadline] expires, or ‘upon motion made after the expiration of the specified period … where the failure to act was the result of excusable neglect.’’’

In the explanation on the last page of the Order, the court explained that the party involved neither sought an extension before the deadline nor moved for an extension after the deadline, nor did it try to show excusable neglect.  The court noted prior decisions of the Delaware Court of Chancery have stricken an expert report that was submitted late.  See Encite LLC v. Sony, 2011 WL 156181 (Del. Ch. Apr. 15, 2011).

In a second, separate Order in the same case, the court granted a motion in limine to exclude untimely produced documents that a party tried to use as exhibits for trial because they were not produced by the deadline.  In Shareholder Representative Services LLC v. Alexion Pharmaceuticals, Inc., C.A. No. 2020-1069-MTZ, Order (Del. Ch. June 28, 2023), the court explained that the documents requested in discovery were not produced until after the discovery deadline, and were required to be produced even though the opposing party “did not press for them.”  The court cited prior decisions where the court “excluded from trial documents that an expert relied on but were not timely produced.”  See Verition P’rs Master Fund v. Aruba Networks, C.A. No. 11448-VCL (Del. Ch. Nov. 30, 2016).  In sum, the court struck the documents that were sought to be introduced as exhibits because they were responsive to requests for production and there was a failure to timely produce them. Thus, the expert was prohibited from testifying or opining on the contents of those documents.

This article was prepared by Frank Reynolds, who has been following Delaware corporate law and writing about it in various publications for more than 35 years

The Delaware Court of Chancery has ruled that the contempt sanction of a $1,000-a-day fine is an appropriate means of forcing Hone Capital LLC to comply with the Court’s previous order to advance funds for an ex-officer’s defense of Hone’s charges that she fraudulently managed an investment  fund in Gandhi-Kapoor v. Hone Capital LLC  and CSC Upshot Ventures I LLP, No. 2022-0881-JTL Opinion issued  (Del. Ch., July 19, 2023).

Among the many cases on advancement highlighted on these pages over nearly two decades, this decision is especially noteworthy for, among other things, emphasizing the public policy reasons behind advancement and the serious consequences that might follow for not fulfilling advancement obligations–as determined by the Court to be owed.

Vice Chancellor Travis Laster’s July 19 opinion granted former Hone CFO Purvi Gandhi-Kapoor’s motion to hold Hone and its CSC Upshot Ventures I LLP fund in contempt for flouting his earlier summary judgment decision that they had no excuse for their seven month-long failure to honor an advancement agreement   He decided that the circumstances justified a fine, not as a punishment, but as just enough coercion to obtain compliance with the court order when irreparable harm was on the horizon.  And the ruling warned that a receiver could be used to force compliance.

In a decision affecting corporate and insurance law specialists, the court found that although “contempt is not generally available to enforce a money judgment,” the holder of this advancement judgment need not resort to slower collection mechanisms because, “The right to advancement is a time-sensitive remedy…A lack of timely advancements prejudices the covered person’s ability to defend the underlying litigation, potentially resulting in irremediable consequences, such as an adverse judgment or a conviction.”

Background

Gandhi-Kapoor was a member of limited liability company Hone, served as its Chief Financial Officer, and had the title of Partner. At Hone, she reported to Bixuan Wu and together with Wu, managed the Upshot Fund.

For disputed reasons, the CSC Group, the parent of Hone, terminated Wu. Gandhi-Kapoor resigned, and in 2020, caused Hone to file a lawsuit against Gandhi-Kapoor in California Superior Court accusing her of breach of fiduciary duty and fraud. That action was consolidated with Gandhi-Kapoor’s California declaratory judgment suit seeking a ruling that she was entitled to a percentage of the Upshot fund’s profits as promised compensation.

The Court awarded summary judgment in April in Gandhi-Kapoor’s advancement suit against both Hone and Upshot, at which time they owed nearly $1 million in submitted fees but neither has contested any of the billed amounts nor paid anything, the vice chancellor ruled.  He said seven months had passed since Gandhi-Kapoor had made what has been found to be a valid demand for advancement.  The companies unsuccessfully argued that there was no proof of irreparable harm.

Contempt petition ruling

In response to Gandhi-Kapoor’s petition for a contempt ruling, the Vice Chancellor decided that, “Advancement provides corporate officials with immediate interim relief from the personal out-of-pocket financial burden of paying the significant on-going expenses inevitably involved with investigations and legal proceedings,” citing Homestore, Inc. v. Tafeen (Tafeen III), 888 A.2d 204, 211 (Del. 2005). The proceeding is summary, he said, because “immediate interim relief” must be provided in timely fashion to be effective since the advancement award “is also an interim monetary award, akin to an interim award of alimony or an interim fee award,” and “the covered person faces a threat of irreparable harm.”

The Vice Chancellor said Delaware entities are not required to provide advancement, but if they chose to, they may be compelled through contempt rather than collection procedings to make paymemts if:

*The companies are actually found to be in contempt, and “To establish civil contempt, [the movant] must demonstrate that the [opponent] violated an order of the court of which they had notice and by which they were bound.” Handels AG v. Johnston, 1997 WL 589030, at *3 (Del. Ch. Sept. 17, 1997). The standard of proof required in a civil contempt proceeding is a preponderance of the evidence, and there is no longer any doubt that the companies are in contempt, he ruled.

*The remedy is appropriate. “If the primary purpose of the remedy is to coerce compliance with the court’s order, then the remedy is civil in character.” But he noted, “a court is obligated to use the least possible power adequate to the end proposed.” TR Invs., LLC v. Genger, 2009 WL 4696062, at *18 n.74 (Del. Ch. Dec. 9, 2009).

The appropriate remedy

The Vice Chancellor said he could have chosen to use the court’s “broad power” to force advancement order compliance by employing a receiver to utilize the respondent companies’ assets to provide Gandhi-Kapoor the awarded funds—especially where there was a history of refusal without valid reason.  Delaware laws that govern corporations and limited liability companies alike urge the courts to endow the receiver with just enough power to effect compliance.

Vice Chancellor Laster took that limited power principle a step further.  He noted that Gandhi-Kapoor had submitted a new brief in support of immediate relief in the form of a daily fine, but he decided that at least initially, he could impose the fine without employing a receiver to do it.  He calculated that Hone gained $658 per day by retaining the money it owed to Gandhi-Kapoor for her defense so the $1K per-day fine would be an incentive to pay up.

However, considering new information from Gandhi-Kapoor indicating that Hone might be selling or restructuring to put assets out of the Court’s reach, he held the door open for the future appointment of a receiver with appropriate power to cope with that situation.

Over the last 18 years that I have maintained this blog, I have published highlights on these pages, and elsewhere, of about 190 or so Delaware decisions involving stockholder demands under DGCL Section 220 for books and records, as well as the analogue in the LLC context. Nowadays, I only highlight those I find to be especially noteworthy.  A case that meets that standard is Seidman v. Blue Foundry Bancorp, C.A. No. 2022-1155-MTZ (Del. Ch. July 7, 2023), in which the Court “regretfully” shifted fees for “glaringly egregious litigation conduct in defending against a books and records request.”

This is a “doubleheader” blog post. I will also highlight a second decision (by the same VC) also issued this month that addressed sanctions for failure to comply with post-trial obligations to produce a company’s books and records in the LLC context, as well as errant litigation conduct.

This short blog post assumes the reader is familiar with the basic principles applicable to these types of summary proceedings. 

Highlights

The complaint in the Seidman case was filed on December 14, 2022, and the trial was scheduled for Feb. 22, 2023.  (Notably, complaints in summary proceedings such as these need not be long, compared to complaints I have filed in plenary cases which were 100-pages long–not including voluminous exhibits.)

The demand in this case included requests for formal board materials and compensation consulting reports for the purpose of investigating mismanagement and communicating with fellow stockholders.  Defendants initially refused to produce a single document.  Moreover, the company refused to confirm or deny what, if any, formal board materials existed.

Errant Litigation Conduct

The court observed that the defendant offered no real reason for demanding a deposition in-person in Delaware, in light of the plaintiff being in Florida at the time, especially when the defendant initially did not press an improper purpose defense.

Despite his confirmation that he was not a member of the purported group, the company continued to claim that the plaintiff was a member of the “Jewish mafia.”  The plaintiff was offended by the ethnic slur. 

The company notified the plaintiff too late for the plaintiff to take discovery on the affirmative defense that plaintiff’s stated purpose was not his actual purpose, despite the plaintiff being entitled to take discovery on that issue—on which the company bears the burden.  See Woods Tr. of Avery L. Woods Tr. v. Sahara Enters., Inc., 2038 A.3d 879, 891 (Del. Ch. 2020).

Two days before trial, the parties submitted a Proposed Final Order and Judgment pursuant to which the company produced 60-pages of documents including the compensation consulting reports that were the focus of the initial demand.

Attorneys’ Fees

This decision, from page 14 to 24, discusses the request for attorneys’ fees of over $220,000 for the time period ending two-days before trial.  Included in the court’s analysis was the fact that the company was inappropriately defending the case on the merits of a future plenary action, despite Delaware law being clear that a books and records proceeding is not the time for a merits assessment of potential claims.

Rather, under settled Delaware law, a stockholder “who demonstrates a credible basis from which the court can infer wrongdoing or mismanagement need not demonstrate that the wrongdoing or mismanagement is actionable.”  See Slip op. at 19 (quoting AmerisourceBergen Corp. v. Lebanon Cnty. Emps’. Retirement Fund, 243 A.3d 417, 437 (Del. 2020)).  The court also observed that it was improper to refuse to state what exact formal board materials existed.  Id. at n.78. 

Key Points

The court highlighted the categories of the company’s litigation conduct that the court found glaringly egregious: (i) The plaintiff was forced to file suit to “secure a clearly defined and established right” to inspect the company’s books and records; (ii) “Unnecessarily prolonged or delayed litigation” by refusing to produce any documents; (iii) “Increased the litigation’s cost” by, among other things, insisting in bad faith on an in-person deposition leading to motion practice; (iv) “Completely changed its legal argument” in a way which would prevent plaintiff from taking discovery to which he was entitled; and (v) Multiple misrepresentations to the court.  Id. at 21-22.

Takeaways

Although somewhat egregious facts often are not easily applicable to more routine cases, this case serves as a cautionary tale for companies that are less cooperative than the courts require in responding to stockholder demands for books and records.

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Part two of this “doubleheader” blog post discusses another cautionary tale: the recent Chancery decision in Bruckel v. TAUC Holdings, LLC, C.A. No. 2021-0579-MTZ (Del. Ch. July 17, 2023). This opinion deals with contempt sanctions for failure to comply with a post-trial order for production of books and records.  This case is another example of how difficult it is sometimes for a plaintiff to achieve, even after trial, the production of books and records. 

Key Facts

This case involves the demand by a manager pursuant to Section 18-305 of the LLC Act, as well as a contractual right pursuant to the operating agreement.

The court issued multiple prior decisions in this case, cited in the opinion, that provide additional background details.

The defenses asserted by the company included an alleged lack of a proper purpose, and that the stated purpose was not the primary purpose, and that demand was deficient under 6 Del. C. Section 18-305(e).  The court noted that the contractual rights under the operating agreement did not require a proper purpose.

Reasons for Fee-Shifting

The court summarized its reasons for fee-shifting to include the following: the company resisted through and after trial, by:  (1) withholding books and records to which the manager had unfettered rights; (2) failing to identify whether formal board materials exist; (3) altering the way the board functions in an attempt to duck the company’s production obligations; (4) manufacturing weeks-long delays in conveying books and records; (5) over-designating documents and communications as privileged.

Highlights

This decision includes guidance that goes beyond books and records cases and includes reminders of well-settled Delaware law regarding obligations for the preparation of privilege logs and redaction logs.

Also notable is that the court required production of documents through the present, as an ongoing obligation, not limited to documents dated as of the trial.

In connection with forcing compliance, the court appointed a receiver from among three Delaware lawyers proposed by the parties.

The scope of the opinion was intended to address the contempt of the company and any further sanctions; whether the defendant waived privilege; and whether the defendant met its burden to show cause as to why fees should not be shifted.

The court reviewed the standards for imposing sanctions due to the violation of a court order.  See Slip op. at 16.

Date-Range

The court noted that it was “remarkable” that the defendant took the position that it did not owe documents dated after the trial, and that this position ignored the plaintiff’s statutory inspection rights as a manager and the contractual inspection rights based on the operating agreement. 

Exception to Board Member’s Full Access

In this 44-page decision, the court also reviewed the standard to determine whether the exception when a board member is “adverse” applied such that it would entitle a company to withhold from a director or a manager unfettered access to the books and records that a manager or a director would normally be entitled to obtain–especially to the extent that they are provided to other board members.  Slip op. at 25.  It did not.

Privilege Log

The court reviewed the obligations of a party preparing a privilege log, which include a prohibition on withholding entire documents that are only partially privileged.  Id. at 26.  The court also explained that attachments to otherwise privileged documents need to be separately analyzed and described to justify their privilege.

The court found that not disclosing board materials was “at the heart of this case” and defendants did not explain why a member of the board was adverse to the extent that the minutes of a board meeting should not be produced in their entirety.

The court applied the standard for shifting fees in these types of cases as recited in the Gilead case, which was highlighted previously on this blog. See also AmerisourceBergen case highlighted on these pages as another cautionary tale.

As an example of an improperly asserted defenses, the court repeatedly explained that the plaintiff had contractual rights under the operating agreement that did not require that it establish a proper purpose, especially in light of a manager having essentially unfettered statutory rights and, in this case, “unbounded contractual rights” to books and records.  See Slip op. at 36-37 and footnote 164.

Reasonableness of Fees The court observed that the plaintiff was requesting approximately $219,000 in fees and expenses–incurred merely for bringing the contempt motion.  The court requested that the plaintiffs’ counsel supplement the request for fees by including billing statements.  The court also determined that it would consider the request for fees pertaining to the contempt motion as part of its consideration of the request for fees shifted for the entire action,

Takeaways

The parties and their counsel should expect close scrutiny by the Court of Chancery, in all aspects of the litigation, both pre-trial and post-trial, to ensure that the procedural and substantive obligations of the parties and their counsel are being complied with in good faith, especially in what is categorized as a summary proceeding.

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U.S. Court of Appeals Judge Amul Thapar recently published a book entitled, “The People’s Justice:  Clarence Thomas and the Constitutional Stories that Define Him.”  This is not a book review.  Rather, I just wanted readers to be aware of this exemplary new publication.  The book should be read by those who seek to understand one of the greatest jurists to ever sit on the U.S. Supreme Court and whose opinions have an outsized impact on the law that impacts every American.

A former U.S. Attorney General described the book as a must-read for “anyone concerned about the country’s future.”

Often the subject of unfair and relentless criticism, this book explains through the examination of landmark cases and the people behind the cases how Justice Thomas’ originalist jurisprudence delivers equal justice under the law.  Justice Thomas is quoted as saying that “finding the right answer is often the least difficult problem.”  What is needed is “the courage to assert that answer and stand firm in the face of the constant winds of protest and criticism.”

The Delaware Court of Chancery recently published an opinion that provides guidance on the latest iteration of the standard that will be applied when the court considers an application for mootness fees in the context of stockholder litigation. In Anderson v. Magellan Health Inc., C.A.No. 2021-0202-KSJM (Del. Ch. July 6, 2023), Chancellor McCormick granted a fee award of $75,000 in response to a fee request of $1.1 million in connection with a stockholder class action challenging a merger agreement between Centene Corporation and Magellan Health, Inc. After suit was filed, Magellan took certain actions that included supplemental disclosures which mooted the action and a stipulation of dismissal was filed.

Basic Background Facts

The suit claimed that confidentiality agreements that contained “don’t-ask, don’t-waive” provisions impeded the process that led to the Centene deal and, because the provisions were not fully described in the proxy, rendered stockholder provisions materially deficient. Shortly after suit was filed, Magellan issued supplemental disclosures on the don’t-ask-don’t-waive provisions and waived its rights under three of the four confidentiality agreements. On the theory that the supplemental disclosures and waivers were corporate benefits, plaintiff’s counsel petitioned the court for an award of fees and expenses.

Key Aspects of Ruling

This decision was provided as a public service to non-Delaware courts applying Delaware law who may not have “access to the this court’s bench rulings” that reflect a doctrinal shift that resulted in an “overall decline in settlements and fee awards” for strike suits challenging M&A transactions in Delaware. Slip op. at 15.

The Chancellor described this opinion as a clarification “for their sake”. Id. Specifically, the Court explained that: “Often, pre-Trulia precedent pricing corporate benefits reflect inflated valuations and warrant careful review.” Id.

The Court’s analysis emphasized that precedent prior to the seminal decision in the matter of In Re Trulia S’holder Litig.,129 A.3d 884 (Del. Ch. 2016), was “less useful”. In particular, the Court added that: “Post-Trulia decisions awarding attorneys’ fees in suits challenging don’t-ask-don’t-waive provisions reflect the decline in fees awarded for non-monetary benefits in merger litigation.’ Id.

Supplemental Disclosures

After explaining why the waivers did not deserve a fee award, the Court focused on the value of the supplemental disclosures. Although such disclosures have been recognized as a benefit, the Court observed that: “… the standard for pricing that benefit for the purpose of awarding mootness fees warrants reexamination in view of developments in deal litigation since Trulia.” Slip op. at 16.

In response to excessive deal litigation, Delaware courts responded in several ways, including a change in substantive law. In MFW and Corwin, the Supreme Court allowed deal lawyers to invoke the business judgment rule to avoid a merits-based review under the entire fairness or enhanced scrutiny standards. See Kahn v. M & F Worldwide Corp., 88 A.3d 635 (Del. 2014) and Corwin v. KKR Fin. Hldngs LLC, 125 A.3d 304 (Del. 2015). In addition, C & J Energy Servs. Inc. v. City of Miami Gen. Empls. and Sanitation Empls. Ret. Trust, 107 A.3d 1039 (Del. 2014), “denounced the use of preliminary injunctions as a means of challenging third-party acquisitions and rerouted stockholders to ‘after-the-fact monetary damages.'” Slip op. at 17.

Importantly, moreover, “Delaware courts … began to clamp down on disclosure-only settlements.” Id. See footnote 49 and 51 collecting cases that document this change.

Delaware Public Policy

For the avoidance of doubt, the Court underscored that Delaware public policy does not encourage plaintiffs’ counsel to: “pursue weak disclosure claims with the expectation that defendants would rationally issue supplemental disclosures and pay a modest mootness fee as a cheaper alternative to defending the litigation.” Slip op. at 22.

Delaware courts have not had much opportunity to clarify Delaware policy and law on mootness fees based on supplemental disclosures because in the wake of Trulia, the “… deal-litigation diaspora spread mainly to federal courts, where plaintiffs’ attorneys repackaged their claims for breach of the fiduciary duty of disclosure as federal securities claims.” Id.

After careful reasoning and citation to scholarship on the topic and the case law developments, the Chancellor clarified that: ” At a minimum, mootness fees should be granted for the issuance of supplemental disclosures only where the additional information was legally required.” Slip op. at 23.

Going forward, the Court gave notice that it: “… will award mootness fees based on supplemental disclosures only when the information is material”. Slip op. at 24.

The Court engaged in a thorough analysis of the precise details and impact of the supplemental disclosures in this case, and what amounts have been awarded in relevant Delaware decisions. See, e.g., footnotes 81 to 84.

Money Quote and Takeaway

After an extensive review of the facts of this case and reasoning based on the applicable cases as well as public policy considerations, including the submissions by several professors who filed amici curiae briefs, my vote for the best concluding quote of the case, that also serves as a takeaway for future guidance, follows:

Where lawsuits are not worth much, plaintiffs’ counsel should not be paid much. In this case, the award represents less than the Movants’ lodestar, which should send a signal that these sorts of cases are not worth the attorneys’ time. Moreover, had Movants been required to meet the materiality standard, it seems unlikely that there would have been any award at all.

Slip op. at 35 (emphasis added).

This blog’s favorite preeminent corporate law scholar provides learned commentary on the titular topic on his eponymous blog ProfessorBainbridge.com with citations to his prior scholarship and insights by other leading corporate law professors. They do a deep dive into the implications of Coster v. UIP Cos., Inc., Del. Supr., No. 163, 2022 (June 28, 2023).

See, e.g., Prof. Ann Lipton’s commentary on the case as well as her reference on Twitter to Vice Chancellor Laster’s very recent reference to the Coster decision and its impact on the standard of review in the context of a corporate election or a stockholder vote involving corporate control.

Typically, I don’t duplicate coverage of noteworthy Delaware corporate law decisions that have already been the subject of widespread commentary such as this one that has been analyzed extensively by leading experts.

I want to thank my partner, Sean Brennecke, for his valuable contribution to this post.

The titular holding was rendered in the context of whether substantial compliance was established as a defense to a breach of contract claim in a recent decision of the Delaware Court of Chancery in the matter styled LPPAS Representative, LLC v. ATH Holding Company, LLC, et al., C.A. No. 2022-0241-KSJM (Del. Ch., May 2, 2023).

This useful decision deserves a spot in the toolbox of all commercial litigators. It addresses several noteworthy issues beyond substantial compliance, including whether the right to participate by the indemnitee as part of a right to indemnification was honored–but for purposes of this short post I will limit my highlights to only a few aspects of the decision.

The court’s discussion begins with its holding that the defendant breached the terms of the contract it entered into with plaintiff by, among other things, not including the plaintiff in discussions with a government agency, not allowing plaintiff to review and comment on filings and submissions the defendant made to a court or government agency, and otherwise failed to allow plaintiff to participate in the defense of claims for which the defendants were providing indemnification. 

In so holding, the court rejected the defendants’ arguments, including that they substantially complied with the contract’s requirements. The court discusses the substantial compliance issue primarily from pages 34 to 39 of the slip opinion.  Initially, the court observed that the parties disagreed on whether Delaware law required a party to strictly comply with the terms of a contract or whether substantial compliance was sufficient. In footnote 163 the court reviewed the cases cited by the parties on this issue although the court did not view the parties as having “meaningfully” briefed the question and noted that the limited authority cited by the parties did not fully support their respective positions.

In order to “streamline this decision,” the court assumed that the applicable standard is substantial compliance as that is the lower standard. 

Applying that assumption, the court considered whether the defendants’ failure was “material.”  The court instructed that Delaware followed the Restatement (Second) of Contracts for determining materiality in the substantial compliance context and identified five circumstances which are particularly significant, including “the extent to which the injured party will be deprived of the benefit which he reasonably expected, and the extent to which the injured party can be adequately compensated for the part of the benefit of which he will be deprived….”  See Slip Op. at 35-36.  The court added that the materiality standard is “necessarily imprecise and flexible” and must be “applied in the light of the facts of each case in such a way as to further the purpose for securing for each party his expectations of an exchange of performance.”

The court reasoned that the plaintiff was deprived of the benefit which it reasonably expected, which in this case was the ability to participate in the defense in connection with its right to indemnification and that because that benefit was intangible, “it is hard to imagine how to adequately compensate” for the breach.  Under the circumstances of this case, the court found those factors to weigh in favor of a finding of materiality.

The defendant raised, and the court rejected, five arguments in support of their claim that their breach was immaterial.  One such argument was that their obligations to include plaintiff in critical discussions was not triggered because the plaintiff did not approach the defendant and request that they enter into joint defense agreement.  In rejecting this argument, the court held that the language of the indemnification provision did not impose an affirmative duty to contact the other party to put a joint defense agreement in place. 

The court further observed that the lack of such language in the agreement suggested that “neither party alone bears the burden of first contact.”  Slip Op. at 39.

Therefore, the court concluded that the failure to propose a joint defense agreement proactively did not necessarily absolve the defendants of their own obligation to work with the plaintiff to get one in place or honor their other contractual obligations. 

A recent decision of the Delaware Superior Court cited an article that I co-authored with Chauna Abner that provides a step-by-step guide to transferring cases from the Delaware Court of Chancery to Delaware’s trial court of general jurisdiction, the Superior Court. See RiseDelaware Inc. v. DeMatteis, C.A. No. N22C-09-526-CLS (Del. Super. May 22, 2023). 

The article is cited at footnote 8 of the opinion and was previously posted on this blog.  Footnote 8 notes that the procedure for transferring a case from the Court of Chancery to the Superior Court is similar to transferring a case from the Superior Court to the Court of Chancery. 

This recent decision provides a hard-to-find, practical explanation of the procedure, which is somewhat esoteric to the extent that it is not a well-traveled path and explanations about the nuanced procedures described for transfer between trial courts are not easy to find. That point makes this opinion required reading for any Delaware practitioner that needs to know the procedural requirements for this type of case transfer. 

The opinion’s judicial guidance is especially important in light of a recent trend in Delaware Court of Chancery decisions that employ more scrutiny, often sua sponte, in the service of jealously guarding (understandably) the famously limited subject matter jurisdiction of the Court of Chancery–which, many will be surprised to know, does not always always include requests for a permanent injunction.  See, e.g. In re Covid-Related Restrictions on Religious Services, Consol. C.A. No. 2021-1036-JTL (Del. Ch. Nov. 22, 2022), highlighted on these pages.

I recently posted my latest ethics column for The Bencher which provided a short overview of the standards for judicial recusal or disqualification applicable to federal judges. The standards for state judges are similar but based on slightly different rules.

Fortunately, there are not many decisions by the Delaware Court of Chancery on the standards applicable to judicial recusal or disqualification.

A recent Chancery decision applied the same standards to a Special Master as would apply to a judge in the matter styled: In re AMC Entertainment Holdings, Inc. Stockholder Litigation, Consol. Civil Action No. 2023-0215-MTZ (Del. Ch. May 10, 2023). The Court applied Rule 2.11 and Rule 2.11(A) of the Code of Judicial Conduct for Delaware Judges. Rule 2.11 provides in relevant part that:

(A) A judge should disqualify himself or herself in a proceeding in which the judge’s impartiality might reasonably be questioned, including but not limited to instances where:
(1) The judge has a personal bias or prejudice concerning a party[;]
(2) The judge, . . . or a person within the third degree of relationship,
calculated according to the civil law system,
. . .
(c) is known by the judge to have an interest that could be substantially affected by the outcome of the proceeding[.]6

Regarding Rule 2.11(A), the Court explained that:

Our Supreme Court has set forth the standard where one seeks disqualification of a judicial officer under Rule 2.11(A)(1):

‘[T]he judge must engage in a two-part analysis to determine if recusal is warranted. First, the judge must determine whether she is subjectively satisfied that she can hear the case free of bias or prejudice concerning the party seeking recusal. Second, “even if the judge believes that he or she is free of bias or prejudice, the judge must objectively examine whether the circumstances require recusal because ‘there is an appearance of bias sufficient to cause doubt as to the judge’s impartiality.’

For those interested in this topic, I encourage a close review of this excellent application of the standards to the facts in this case

Postscript: This topic was also recently addressed in a recent article about a motion to disqualify the judge hearing the pending case involving the Disney Company and the Florida Governor.

My latest ethics column for The Bencher, the publication of the American Inns of Court, on the titular topic, is reprinted below courtesy of the publisher. I have been writing an ethics column for The Bencher for the last 25 years.

Before I provide an overview of the basic standards that apply to inform the decision about whether a judicial officer should recuse himself or herself, or otherwise be disqualified from presiding over a particular lawsuit, I want to share some practical wisdom I have learned from several judges with whom I am close to personally—but before whom I would never appear in a courtroom to argue a case.

When a reasonable person familiar with the relevant facts earnestly believes that an issue of a judge’s impartiality might reasonably be raised in a pending lawsuit, that person should explore an appropriate informal means of presenting that issue to the presiding jurist. That approach provides an informal opportunity to the judicial officer to make his or her own assessment of the issue in an appropriate manner that might make a formal motion unnecessary.

This topic is covered in books dedicated solely to judicial disqualification, as well as in heavily footnoted law review articles, but this short ethics column is only intended to cover the highlights. Over the past 25 years of publishing these ethics columns I have, in a few instances, touched on topics that are related to the standards that regulate the judicial branch. See, e.g., Francis G.X. Pileggi, “Fifth Circuit Orders Recusal of Trial Judge,” The Bencher (July/August 2011); Francis G.X. Pileggi, “Professionalism and Judges,” The Bencher (July/August 2015) (describing earlier behavior of attorney as indication of judicial demeanor as a later member of court); Francis G.X. Pileggi, “Resources for Judicial Ethics Research,” The Bencher (January/February 2022).

Applicable standards include Canon 2 of the Code of Conduct for United States Judges, which provides that a judge should avoid impropriety and the appearance of impropriety in all activities. Canon 2(A) states that “[a]n appearance of impropriety occurs when reasonable minds, with knowledge of all the relevant circumstances disclosed by a reasonable inquiry, would conclude that the judge’s honesty, integrity, impartiality, temperament, or fitness to serve as a judge is impaired.” (emphasis added).

The rubric to avoid even the appearance of impropriety applies to both professional and personal conduct. The federal statute that governs judicial conduct requires that: “Any justice, judge, or magistrate judge of the United States shall disqualify himself in any proceeding in which his impartiality might reasonably be questioned.” 18 U.S.C. § 455(a).

“[T]he test for recusal under § 455(a) is whether a reasonable person, with knowledge of all the facts, would conclude that the judge’s impartiality might reasonably be questioned.” In re Kensington Int’l, Ltd., 368 F.3d 289, 296 (3rd Cir. 2004)(emphasis added). See generally 12 Moore’s Federal Practice-Civil § 63.35 (2022). (Although mere friendship, for example with counsel, ordinarily is insufficient to warrant recusal, unusual circumstances may require recusal.)

Section 144 of Title 18, unlike Section 455, refers specifically to the appearance of a lack of impartiality as it relates to parties—as compared to counsel. See generally Geyh, Alfini, & Sample, 1 Judicial Conduct and Ethics § 4.07[3], Matthew Bender & Co., 2020). The Comment to Rule 2.3 of the Delaware Judges’ Code of Judicial Conduct notes that manifestations of bias or prejudice can include epithets, slurs, references to personal characteristics, or threatening, intimidating, or hostile acts.

The public policy animating the disqualification rules is the need to inspire public confidence in the public perception that the due process requirement of a fair trial before a fair tribunal appears to be provided to all parties and their counsel in litigation. The emphasis is on how the circumstances appear to a reasonable person with knowledge of the relevant facts—not whether actual lack of impartiality can be proven. See, e.g., Richard E. Flamm, Judicial Disqualification: Recusal and Disqualification of Judges § 5.1, at 104 (3rd edition, Banks & Jordan, 2017).

Notwithstanding the applicable standards, appropriate efforts to informally seek the recusal of a judge, and if necessary, formal motions to disqualify, should only be pursued in those rare circumstances when one’s duty to the client, as well as broader duties, make it absolutely necessary.  Even then, they should be brought reluctantly, only after thorough research, careful analysis, extensive soul-searching, confidential vetting with colleagues, and with conscientious consideration of all the aspects and ramifications of such an unpleasant process.

Francis G.X. Pileggi, Esquire, is the managing partner of the Delaware office of Lewis Brisbois Bisgaard & Smith LLP. He comments on legal ethics as well as corporate and commercial decisions on his blog. He is the author of American Legal Ethics: A Retrospective from 1997–2018 (Outskirts Press 2018).