This blog post comes to you from the ABA Business Law Section meeting in Denver, Colorado. A few highlights will be provided of the presentations most relevant to this blog.
A panel presentation by the Corporate Laws Committee and the Corporate Governance Committee included commentary by Delaware corporate litigator A. Gilchrist Sparks, III, entitled: "Delaware Developments Relating to Proxy Access Bylaws and other Annual Meeting Matters." The panel also featured Peggy Foran, V.P., Corporate Governance Officer and Corporate Secretary at Prudential.
Highlights from the presentation include the following:
- Delaware enacted in August 2009 updates to the DGCL Section 112 that allow for proxy access or the right of stockholders to put on a company’s proxy card and in the proxy statement, nominations for director spots. Flexibility gives the company the option to impose conditions. So far, only 3 corporations have taken advantage of this change, but none of the three are of any consequence (i.e., they are either shells or controlled subs).
- Why so little impact? The SEC is expected to preempt the field so there is a "wait and see" approach by many. However, it is not clear why the SEC has not acted more quickly. Two things of note: The bill proposed by Sen. Dodd may influence the development in this area. The SEC also appears to be split on the issue.
- The Kurz decision of the Delaware Supreme Court from April 21, 2010 (which was highlighted here on this blog), was mentioned for the following parts of its holding: (i) one cannot remove sitting directors by means of a bylaw amendment that reduces the size of the board (i.e., it must be done by a vote of stockholders if one seeks to remove a sitting director); and (ii) The Delaware Supreme Court ruled (contrary to the trial court’s decision) that whether the "Cede breakdown" is part of the stock ledger for voting purposes at an annual meeting or for stockholder consents (as compared to Section 220 purposes), is a matter that must be decided by the legislature, and the trial court’s decision on this point to the contrary is mere dicta. Thus, under Delaware law, the names listed on the "Cede breakdown" are not part of the stock ledger for purposes of determining who is entitled to vote.
Wilmington lawyer Louis G. Hering was a panel member on a program at 8:00 a.m. on Saturday about developments in LLCs, and he distributed helpful materials entitled: "2010 Summary of Delaware Case Law Relating to Alternative Entities".
Fiduciary Duty Cases.
- Managers and controlling members of an LLC owe the same fiduciary duties as directors and controlling shareholders in in a corporation.
- If fiduciary duties in an LLC are sought to be eliminated, the cases require that such a waiver be explicit and unequivocal.
- See Brinckerhoff case, which provides a playbook about how a Special Committee should be organized.
- Kelly v. Blum. If the LLC agreement is silent on the issue, the officers of an LLC owe the same fiduciary duties as a director and controlling shareholder of a corporation. This case involves the purchase of a radio station. The Blum group invested in the company in return for control, even though Kelly operated the company. A merger was planned to squeeze out the old entity and gave those with an interest in the old entity nominal amounts. The Court applied the corporate analysis to a "direct v. derivative" claim, and applied the corporate theory that derivative claims are lost by a merger unless fraud was the intent of the merger. The Court concluded that Kelly had direct claims and pled sufficient facts to survive a motion to dismiss that he was squeezed out without fair consideration. The claims were brought after the merger. The agreement had a clause that limited liability, or purported to do so, which required an interpretation of "wilful breach". The Court defined it as "voluntary but not malicious" but in any event under the facts of this case the controlling member breached the applicable fiduciary duty by affirming a deal that was unfair to the minority. The Court also addressed the "implied covenant of good faith and fair dealing", and noted that it "cannot be invoked to override the express terms of a contract". Commentators observe that the "contours of this covenant are not always easy to discern". These claims are rarely successful. One of the most important requirements for this cause of action is: a specific, implied obligation–and simple bad faith is not enough. It is essential to note that the implied covenant is not a sub-part of fiduciary duty. For example, in this case the Court found a fiduciary duty breach but not one for the implied covenant of good faith and fair dealing.
Implied Duty of Good Faith and Fair Dealing
- The implied covenant of good faith and fair dealing–imposed on every Delaware contract, continues to be examined by the Delaware Courts and its contours are continuing to be refined. By statute it cannot be eliminated in an LLC (unlike fiduciary duties which can be eliminated by contract in an LLC).
- Amirsaleh . This case involved a merger that gave an option for cash or shares in the new entity. The plaintiff in this case, and many others, missed the deadline to choose their option. The deadline was extended a few times but after the last extension, the plaintiff here missed the deadline. The claim was that the managers acted in an arbitrary fashion by not extending the deadline. The Court said that no contract can anticipate every issue that may arise and "the law presumes that no party every assumes the risk that the counterparty will exercise their discretion in bad faith." Note: Plaintiff needed to show bad faith in order to prove that the implied duty of good faith was breached. Question: Is acting in an arbitrary and unreasonable manner, is that the same as bad faith? The Court in this case said the behavior must be "motivated by a culpable mental state driven by an improper purpose". That standard is somewhat amorphous and very fact specific but in this case the Court was satisfied that no favoritism was shown.
- Nemec is a recent Delaware Supreme Court decision, by an unusual 3-2 vote, which indicates how difficult these issues can be. This case involved the Booz Allen firm and the redemption of shares prior to a merger. If the redemption was done after the merger, it would have made the redeemed interest much more valuable. The company had a contract right to redeem when it did so. Delaware’s High Court affirmed the Court of Chancery’s grant of a motion to dismiss based on the contract right to redeem the shares whenever it was most advantageous to the company. Thus, there was an express right by contract that the implied covenant of good faith and fair dealing cannot contradict. Notably, the benefit from the company’s decision was to make more money available for the other remaining stockholders.
General Observation: He said he was not aware of any Delaware cases where a "veil piercing claim" was successful and that the analogous theories in the corporate context, such as the requirement of fraud and similar high thresholds, are required.
Delaware Supreme Court Chief Justice Myron T. Steele was featured on a panel that addressed fiduciary duty issues that arise in connection with "no-shop" clauses in merger agreements.
- His Honor said that Delaware Courts uphold freedom of contract as a general principal and there are no presumptions that a no-shop provision is invalid. Rather, the Delaware Courts will review the factual context of each individual case.
- Another panel member referred to the anti-takeover provisions of DGCL Section 203 that provide a board with some ammunition when a hostile bidder buys at least 15% of the stock.
- One panel member suggested that "in a Hobbesian world where anything can go wrong", it is prudent to bring litigators into the deal early in the process. One way to challenge a deal is to buy stock in the company of the prospective target, so there can be a basis to file suit claiming that the terms of a particular agreement are in violation of some fiduciary duty (e.g., Revlon claims).
- NACCO case. This decision of the Delaware Court of Chancery recently highlighted the risk of a claim against a jumping-bidder for interference with contractual relations.
- The Chief Justice noted that one aspect of the focus of the Delaware Courts is: whether the true motive or goal of the directors was to get the best deal for the shareholders or to entrench themselves or obtain some personal benefit not enjoyed by the other shareholders. Also, it is important to show that the Board is engaged in the process, and that it carefully considers available options and hires independent and qualified advisors.
- Other panel members observed that cure provisions in agreements are also often provided for alleged breaches of a no-shop provision