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

The Chancellor of the Delaware Court of Chancery recently presented a challenge to controller Jeffries Financial Group Inc.’s going-private acquisition of HomeFed Corporation because Jeffries negotiated the support of a key HomeFed investor before implementing the shareholder protections of the seminal MFW decision in In Re HomeFed Corporation Stockholder Litigation, No. 2010-0592-AGB memorandum opinion issued (Del. Ch. July 13, 2020).

Chancellor Andre Bouchard’s July 13 opinion denied dismissal motions by defendant Jeffries directors, finding plaintiff HomeFed shareholders may prove the 2019 squeeze-out merger does not qualify for the deference of the business judgment rule and must be examined under the exacting entire fairness standard. That could shift the burden of proof – and the risk of losing – to the defendants.

Under the Delaware Supreme Court’s framework in Kahn v. M & F Worldwide Corp., proponents of a deal involving a controlling shareholder must prove both the negotiation and price was entirely fair unless they employed the dual protections of a fully empowered director negotiating committee and majority-of-the-minority shareholder approval. Kahn v. M & F Worldwide Corp., 88 A.3d 635 (Del. 2014).

History

The directors of Jeffries, a holding company that owned 70 percent of Delaware-charted HomeFed, a multi-state real estate developer, claimed they did just that when they sought to acquire the remaining 30 percent beginning in 2017. They argued, in support of dismissing the breach of duty charges, that the merger effectively started over again when talks with HomeFed’s special director committee resumed.

But the Chancellor pointed out that although merger talks were suspended for nearly a year in 2018, Jeffries directors continued to talk to Beck, Mack and Oliver, LLC, the largest HomeFed investor next to Jeffries and key to winning shareholder approval.

He found that whether there were two rounds of merger negotiations or just one with a pause, at the pleading stage, the plaintiffs make a reasonable case that Jeffries directors negotiated a proposed 2-for-1 stock swap proposal with BMO before they officially committed to the dual MFW protections for the deal.

MFW if-and-only-if list

Chancellor Bouchard said under MFW, 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.

“The complaint’s factual allegations support more than a reasonable inference that three of the six conditions required under MFW were not satisfied,” the Chancellor wrote.

He said that in a very recent decision in In re Dell Technologies Inc. Class V Stockholders Litigation, the court noted that the MFW decision requires the dual protections to be established at the very outset of talks. In re Dell Technologies Inc. Class V Stockholders Litigation 2020 WL 3096748, at *17 (Del. Ch. June 11, 2020).

“[T]he purpose of the words ‘ab initio,’ and other formulations like it in the MFW decisions, require the controller to self-disable before the start of substantive economic negotiations, and to have both the controller and special committee bargain under the pressures exerted on both of them by these protections,” he said, quoting the Dell decision.

Therefore, the Chancellor said, the transaction does not qualify for business judgment review and the motion to dismiss on that basis is denied.

Cornerstone doesn’t work

Finally, the court also denied a separate motion to dismiss filed by two HomeFed directors who claimed they were protected from liability by an exculpatory provision in the company’s charter. He said under the Cornerstone decision, evidence that those two board members voted against the interests of the HomeFed shareholders is enough for those claims to survive a motion to dismiss. In re Cornerstone, 115 A.3d at 1179-80.

“Plaintiffs have plead facts supporting a rational inference that, by voting to approve the transaction, Patrick Bienvenue and Paul Borden acted to advance the self-interest of an interested party (Jefferies) that stood on both sides of the transaction from which they could not be presumed to act independently,” the Chancellor said.

In addition, the complaint says Bienvenue served in a variety of executive roles for Jefferies from January 1996 until April 2011, and has served on the HomeFed Board since 1998, and Borden was a Jefferies Vice President from August 1988 to October 2000 and served as HomeFed’s President for 20 years, he noted.

 

The Delaware Supreme Court recently clarified the “ab initio” requirement announced in the Kahn v. M&F Worldwide Corp. case as part of the set of standards that would allow for the BJR standard to apply to a challenged merger. See Olenik v. Lodzinski, No. 392, 2018 (Del. Supr., rev. April 11, 2019).  The High Court determined that the requirement was not satisfied based on the facts of the instant case because the “economic bargaining took place prior to the date” when the protections announced in the Kahn v. M&F Worldwide Corp. case needed to be in place.

Much commentary has already been written about this case, so it will not be covered thoroughly on these pages, but I refer to prior decisions that have applied the ab initio requirement, for background purposes, as noted on these pages.

This post was prepared by Kevin F. Brady

Kahn v. M & F Worldwide Corp., Del. Supr., No. 334, 2013 (March 14, 2014)

The Delaware Supreme Court today affirmed the Court of Chancery’s decision granting summary judgment to the defendants under the business judgment standard of review (and not the entire fairness standard) where the controlling stockholder MacAndrews & Forbes conditioned its offer upon the MFW Board agreeing, ab initio, to two procedural protections, i.e., approval by a Special Committee and by a majority of the minority stockholders.

The Supreme Court noted that “[f]or the combination of an effective committee process and majority-of-the-minority vote to qualify (jointly) for business judgment review, each of these protections must be effective singly to warrant a burden shift.”  The Supreme Court reviewed the record and found that the defendants “have successfully established a record of independent committee effectiveness and process that warranted a grant of summary judgment entitling them to a burden shift prior to trial.”  The Supreme Court also found that the majority-of-the-minority vote was “fully informed and not coerced. That is, the Defendants also established a pretrial majority-of-the-minority vote record that constitutes an independent and alternative basis for shifting the burden of persuasion to the Plaintiffs.”

KEY QUOTE:

The Supreme Court stated:

To summarize our holding, in controller buyouts, 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.

The Court concluded that under the business judgment rule standard of review that applies to this controlling stockholder buyout, “the claims against the Defendants must be dismissed unless no rational person could have believed that the merger was favorable to MFW’s minority stockholders. In this case, it cannot be credibly argued (let alone concluded) that no rational person would find the Merger favorable to MFW’s minority stockholders.

16th Annual Review of Key Delaware Corporate and Commercial Decisions

By: Francis G.X. Pileggi and Chauna A. Abner

This is the 16th 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. This list does not attempt to include all important decisions of those two courts that were rendered in 2020. Instead, this list highlights notable decisions that should be of widespread interest to those who work in the corporate and commercial litigation field or who follow the latest developments in this area of Delaware law. Prior annual reviews are available here.

The Delaware Business Court Insider again published this year’s Annual Review though it appeared in two parts due to its length, in last week’s edition and in this week’s edition. Part I and Part II are reprinted below with the courtesy of The Delaware Business Court Insider. (c) 2020 ALM Media Properties, LLC. All rights reserved.

This year’s list focuses, with some exceptions, on the unsung heroes among the many decisions that have not already been widely discussed by the mainstream press or legal trade publications. For example, the Sciabacucchi; Solera; and AB Stable (Anbang) cases have already been the subject of extensive commentary by others. Links are also provided below to the actual court decisions and longer summaries.

DELAWARE SUPREME COURT DECISIONS

Supreme Court Instructs on Nuances of Fiduciary Duties of Disclosure and Loyalty

A Delaware Supreme Court decision from 2020 that deserves to be read by anyone interested in the nuances of Delaware law on the fiduciary duties of disclosure and loyalty of a manager or a director in connection with communications with stockholders or others to whom a fiduciary duty is owed, is Dohmen v. Goodman, No. 403, 2019 (Del. June 23, 2020), in which Delaware’s High Court answered a question on this topic certified from the U.S. Court of Appeals for the Ninth Circuit.

Key Takeaways:

There is a “per se damages rule” in Delaware that covers only those breaches of the fiduciary duty of disclosure involving requests for stockholder action that impair the economic or voting rights of investors. Importantly, this per se damages rule only covers nominal damages. Again, for emphasis: the per se damages rule does not apply to damages other than nominal damages. Therefore, in order to recover compensatory damages, one who proves a breach of the fiduciary duty of disclosure must also prove reliance, causation and damages. See Slip op. at 24.

The Court in its en banc opinion provides a useful overview of fiduciary duties in general, and addresses the many nuances–that change depending on the situation presented–of the duty of disclosure in particular as it relates to requests for action by stockholders or others to whom a fiduciary duty is owed.  See Slip op. at 9-10.

Brief Overview of the Case:

The procedural background of the case involved an issue of Delaware law that the U.S. Court of Appeals for the Ninth Circuit certified to the Delaware Supreme Court. In other words, the Ninth Circuit asked the Delaware Supreme Court to decide an issue of Delaware law that was originally presented to the Ninth Circuit.

This gem of a 24-page opinion, which is relatively short for many Delaware opinions, was decided based on stipulated facts, which in a very simplified way, decided a claim by a limited partner in a hedge fund, who as limited partner in a limited partnership was owed a duty by the fund manager, which was structured as an LLC. Among the claims by the limited partner was that the general partner of the limited partnership, the LLC manager, breached fiduciary duties by failing to disclose that the general partner was the only investor in the fund other than the suing limited partner, and related omissions or misrepresentations.

Delaware Fiduciary Duty Law:

In connection with its decision, the Delaware Supreme Court recited several useful truisms of Delaware law. For example, the agreements at issue did not disclaim the fiduciary duty of loyalty, and therefore, the general partner owed fiduciary duties to the limited partners, similar to those owed by directors of Delaware corporations. See footnotes 15 through 16.

The Court recited the very nuanced and multifaceted aspects of the fiduciary duties of care and loyalty that applied to communications with stockholders or limited partners. Those duties depend on the context of the communication, and whether the communication is to an individual stockholder or to a group of stockholders. See footnotes 18 through 32 and accompanying text.

The Court described several different types of factual situations which impact the application of the duty owed in connection with communications that involve a request for stockholder action, as compared to those that might involve merely periodic financial disclosures. The per se damages rule does not apply to the latter.

The Court discussed the most important Delaware decisions involving the duty of disclosure and how it is applied in various factual circumstances.

Bottom Line:

The Court explained that the per se damages rule only applies when a director seeks stockholder action and breaches their fiduciary duty of disclosure, in which case a stockholder may seek equitable relief or damages. That is, when directors seek stockholder action, and the directors fail to disclosure material facts bearing on that decision, a beneficiary need not demonstrate other elements of proof, such as reliance, causation or damages. This rule only applies to nominal damages and does not extend to compensatory damages. See Slip op. at 10 through 11.

Link to original post on these pages about this case.

 

Supreme Court Interprets Key Words in Agreement

A Delaware Supreme Court decision from May 2020 is noteworthy for the approach it takes in determining the meaning of a word in an agreement, for example, by parsing the syntax and sentence structure where the word at issue appears in the agreement. In Borealis Power Holdings Inc. v. Hunt Strategic Utility Investment, L.L.C., No. 68, 2020 (Del. May 22, 2020), the Delaware Supreme Court provides useful guidance about how to determine the meaning of a key word in an agreement. In this matter, despite a lengthy definition in the agreement of the word “transfer”, the parties still disputed its meaning.

Background:

The underlying dispute involved a complex constellation of interrelated entities which the Court provided a graphic description of by way of a chart. The essential facts on which the dispute was based involved the interpretation of an LLC agreement which imposed restrictions on the transfer of LLC units and provided for the right of first refusal and other provisions triggered by a “transfer.” Several terms were defined in the agreement–with rather lengthy definitions–but the definitions did not provide sufficient clarity. The most consequential definition that was disputed was the meaning in the context of the agreement of the word “transfer.”

The problem presented to the Court of Chancery was whether the sale of an interest triggered either a right of first refusal and/or a right of first offer, and if both applied, which was to be given priority.

The Court of Chancery concluded that a sale by Hunt of its shares to Borealis would be a “transfer.” The Supreme Court had a different view.

The finding by the Court of Chancery that the purchase of Hunt’s shares constituted a transfer, triggered the requirement to offer the shares to Sempra. As a result of other consequences of that holding, the Court of Chancery found that Sempra was the only party with the right to purchase the Hunt shares, and entered judgment in favor of Sempra. This expedited appeal followed an expedited trial. It remains noteworthy that this opinion came only 30 days after the final submission of the appeal to the Supreme Court.

Analysis by the Supreme Court:

The Supreme Court held that the right of first refusal in Section 3.9 of the agreement at issue is only triggered by transfers by the Minority Member and its Permitted Transferees, and that Hunt is neither. Put another way, Delaware’s High Court held that the fact that the right of first refusal is only triggered by transfers by the Minority Member is dispositive in favor of Borealis, regardless of whether the Hunt Sale could be said to effect an indirect transfer.

One of the agreements involved was governed by New York law and one was governed by Delaware law–but the Court noted that the law of both states as it relates to contract interpretation in this case is the same. See footnote 22.

Two other footnotes contain important observations of Delaware law that are especially worth remembering:

(1) The management of an LLC is vested in proportion to the then-current percentage or other interest of members in the profits of the LLC owned by all the members, and “the decision of members owning more than 50% of the said percentage or other interest in the profits [is] controlling.” Footnote 27; see Section 18-402 of the Delaware LLC Act.

(2) Also noteworthy is the observation by the Court that an argument that was only raised in a footnote would justify “passing over it” because footnotes, according to Delaware Supreme Court Rules, “shall not be used for argument ordinarily included in the body of a brief.” Footnote 28. See Del. Sup. Ct. R. 14 (d)(iv).

The most noteworthy parts of this pithy 21-page decision are found in the last few pages which include the core of the Court’s reasoning.

In particular, the most memorable part of the Court’s reasoning is the parsing by the Court of the syntax and sentence structure of the agreement in order to interpret the meaning of a particular word in the agreement. The Court focuses on the “subject of the operative sentence” in Section 3.1, of which “the verb phrase ‘may only transfer’ serves as the predicate.” The Court further explains that the subject of the operative sentence is neither accidental nor unimportant because it is the same subject for which the verb phrase “intends to transfer” serves as the predicate in section 3.9.

The Court added that the subject, which is stated conjunctively, does not include Hunt. Therefore, the Court reasoned that it was unnecessary and inappropriate to parse the definition of transfer, as defined in the agreement, to determine the scope of Section 3.1 and Section 3.9, because: “the subjects of the opening sentences in both of those sections do that for us.” See Slip Op. at 20 – 21.

In sum:

Although the detailed factual background needs to be reviewed more closely in order to fully understand the Court’s reasoning, for anyone who wants to understand Delaware law regarding proper contract interpretation, and interpretation of the meaning of a word, even when it is defined in an agreement, this opinion is must-reading.

Link to original post.

 

Delaware Supreme Clarifies Contract-Based Right to Corporate Records

A Delaware Supreme Court opinion issued in July 2020 should be required reading for anyone interested in the latest iteration of Delaware law on the contract-based right to demand “books and records” in the alternative entity context. Delaware’s High Court ruled in Murfey v. WHC Ventures, LLC, No. 294, 2019 (Del. July 13, 2020), that the Court of Chancery erred by interjecting into a limited partnership agreement a statutory requirement from Section 17-805 of the Delaware LLC Act that did not appear in the parties’ agreement.

The great importance of this ruling can best be appreciated by emphasizing that the Court did not opine in any manner on the statutory requirements for demanding books and records of a business entity–about which we recently provided an overview of key decisions on this topic, with the title of: Demands for Corporate Documents Not for the Fainthearted.

We will add to that characterization of Delaware decisions interpreting statutory provisions for demanding corporate documents, a general observation based on the instant decision: Contract-based demands for books and records of business entities are not for the fainthearted either. A few reasons that support our observation include the following:

  • This Supreme Court decision features the en banc Justices split 3-2, along with a less-than-common reversal of a Chancery decision. So, that procedural note underscores that 6 of the best legal minds in Delaware (5 jurists on the high court and 1 in Chancery rendering opinions in this case) cannot find unanimity on this issue.
  • The original demand in this case was made on January 10, 2018. The Chancery complaint was filed in September 2018. Through no fault of the court system, this final decision on appeal came down on July 13, 2020. About 2 years is still lightening-fast for the period from filing a complaint to a final decision by a state’s highest court, but that still implies substantial legal fees and the need for financial and other types of stamina for someone who is serious about seeking corporate records.
  • Although this decision provides authoritative guidance on this nuance of Delaware business litigation, a careful parsing of the opinion still reveals a fertile field for indeterminacy–which makes it a challenge for the lawyers toiling in this vineyard who are trying to predict the outcome of this type of contract interpretation dispute–even if one need not be concerned with applying the multitude of court decisions applying the statutory provisions for inspection rights in this context.
  • We will end our introductory observations on a positive note: despite the plethora of case law interpreting the various statutory provisions for demanding books and records, such as Section 220 and Section 18-305, this decision is a welcome addition to the relatively few published Delaware opinions that address the purely contract-based right to books and records of an alternative entity.

Basic Factual Background:

Based on the assumption that readers of this post are familiar with the basics of Delaware law in this area, we are only highlighting the irreducible minimum amount of facts to provide context for the key legal principles announced.

This case followed a typical pattern. The company provided some documents initially, and at the time of trial the only issue was the very limited documents the company refused to produce.

Somewhat unusual was that only one specific type of document was the subject of the trial court decision and the appeal: the K-1 of the other limited partners in the limited partnership. Although the company allowed counsel for the plaintiff and the plaintiff’s valuation expert to review those K-1s, they refused to let the plaintiffs themselves review the K-1s of other limited partners–even subject to the common confidentiality agreement.

The limited partnership agreements involved allowed for a rather broad scope of documents to be demanded, including tax returns which were specifically listed as being subject to production. The company took the curious position that a K-1 (of other limited partners) was not part of the tax returns of the company–or at least not within the scope of documents they need to produce.

Primary Issue Addressed on Appeal:

Whether the Court of Chancery erred by injecting into the terms of the agreement that provided for a right to books and records–additional statutory prerequisites. Short answer: yes.

High Court’s Reasoning–Key Takeaways:

The majority opinion made quick work of dispensing with the defense that valuation was not a valid basis for requesting the disputed documents or that tax returns were not needed to complete a valuation. See, e.g., footnotes 65 and 66 as well as related text. More notably, the Court found that the statutory notion of a “proper purpose” was not applicable to contract-based demands. See, e.g., footnote 53 and accompanying text (quoting with approval prior decisions so holding.)

Also noteworthy is the Court’s reference to dictionary definitions of words, including prepositions, at issue in this case. See footnotes 32 and 33.

The Court reviewed many prior Delaware decisions that addressed when, if ever, it would be appropriate to infer words or conditions that do not appear in the terms of an agreement, such as statutory prerequisites. Slip op. at 18-25.

A key part of the Court’s reasoning was that: because the partnership agreements involved

… do not expressly condition the limited partner’s inspection rights on satisfying a “necessary and essential” condition [a statutory concept], and given the obvious importance of tax return and partnership capital contribution information to the Partnerships’ investors, as evidenced by the agreements, we are not persuaded that such a condition should be implied. Slip op. at 25.

The majority opinion’s “rebuttal” of the dissenting opinion deserves to be read in its entirety. Slip op. at 32 to 37. Two especially notable excerpts:

  • “The words ‘necessary and essential’ do not appear in the written agreements”. Slip op. at 35.
  • “… we also do not agree that the parties to a limited partnership agreement have to expressly disclaim any conditions applied in the Section 220 context (or the Section 17-305 context….)” Footnote 85.

Link to original post.

 

Supreme Court Rejects Two Common Defenses to Section 220 Demands

A recent decision from the Delaware Supreme Court provides hope to stockholders who seek to obtain corporate documents pursuant to Section 220 of the Delaware General Corporation Law to the extent that Delaware’s High Court removed two common defenses that companies use to oppose the production of corporate records to stockholders. In AmerisourceBergen Corporation v. Lebanon County Employees Retirement Fund, No. 60, 2020 (Del. Dec. 10, 2020), the two most important aspects of the ruling are that:

(i) A stockholder making a Section 220 demand need not demonstrate that the wrongdoing being investigated is “actionable;” and

(ii) When the purpose of a Section 220 demand is to investigate potential wrongdoing and mismanagement, the stockholder is not required to “specify the ends to which it might use” the corporate records requested (i.e., exactly what it will do with the documents it receives).

Over the last 15 years we have highlighted many of the frustrating aspects of decisions construing Section 220 to the extent that one needs stamina and economic fortitude to pursue what oftentimes is an unsatisfying result. See, e.g.,recent overview on this topic.

This decision should be in the toolbox of every corporate litigator not only because it announces a new path for Section 220 cases and reminds us of the basic prerequisites of the statute, but also in light of it partially overruling and distinguishing some prior cases. This opinion also confirms that several Chancery decisions that were not in harmony with this decision should no longer be followed.

Key Takeaways:

       One of the most important takeaways from this decision is that the Court clarified that when the purpose of a Section 220 demand is to investigate potential mismanagement, the stockholder is “not required to specify the ends to which it might use” the corporate documents requested.  See page 22.

       The second most important takeaway from this case is the Court’s holding that a stockholder pursuing a Section 220 demand need not demonstrate that the alleged wrongdoing is “actionable.” See page 25.

       The three prerequisites (not including the many nuances) for successfully pursuing a Section 220 demand to inspect a corporation’s books and records requires a stockholder to establish that: (1) such stockholder is actually a stockholder; (2) such stockholder has complied with Section 220 respecting the form and manner of making demand for inspection of such documents; and (3) the inspection such stockholder seeks is for a proper purpose. See pages 12-13.

       The Court recited the many examples of proper purposes that have been recognized to be reasonably related to the interest of the requesting stockholder. See footnote 30 for a lengthy list, which includes “to communicate with other stockholders in order to effectuate changes in management policies.”

       The Court reiterated the well-known requirement that when the proper purpose of a stockholder making a Section 220 demand is to investigate potential mismanagement, a stockholder needs to demonstrate “a credible basis” from which the court may infer that “there is possible mismanagement that would warrant more investigation.” See page 15.

       Although a credible basis of wrongdoing needs to be presented by a preponderance of the evidence to pursue the proper purpose of investigating potential wrongdoing, a company will not be permitted to mount a merits-based defense of such potential wrongdoing. See page 37.

       Moreover, while trying to harmonize prior decisions on these nuances, the Court observed that some of the decisions struck a discordant note. See footnote 109.

       The Court also affirmed the following two aspects of the Court of Chancery’s ruling: (1) regarding the scope of documents, the Court found that it was appropriate to include a requirement that the company produce officer-level materials and (2) the high Court found it was not an abuse of discretion to order a Rule 30(b)(6) deposition–because the company refused to describe the types and custodians of corporate records that it had in response to discovery requests. See pages 39 and 43.

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DELAWARE CHANCERY COURT DECISIONS

Chancery Provides Refreshing Section 220 Guidance

The Delaware Court of Chancery rendered a decision in November 2020 that belongs in the pantheon of noteworthy Court opinions addressing the nuances, first principles and practical challenges regarding Section 220 of the Delaware General Corporation Law. There are many decisions on this topic addressing the right of stockholders to demand inspection of corporate records, but few are as “blogworthy” as this decision in Pettry v. Gilead Sciences, Inc., C.A. No. 2020-0173-KSJM (Del. Ch. Nov. 24, 2020). Compare another pantheon-worthy Chancery decision earlier this year in AmerisourceBergen. See Lebanon Cnty. Emps. Ret. Fund v. AmerisourceBergen Corp., 2020 WL 132752 (Del. Ch. Jan. 13, 2020), which was affirmed by the Delaware Supreme Court.

Weighing in at 69-pages, this opinion’s length is indicative of the complexities of Section 220 that are belied by the apparent simplicity of the statute. Our favorite part of this decision is the acknowledgement that when pursuing the statutory rights that Section 220 appears to allow, one can easily be stymied by the gamesmanship of companies who can play a war of attrition, usually with impunity, in light of the asymmetrical economics involved. See Slip op. at 3-5 and footnote 6 (citing an article addressing the obstacles to pursuing Section 220 rights: James D. Cox, et al., The Paradox of Delaware’sTools at Hand Doctrine: An Empirical Investigation,” 75 Bus. Law. 2123, 2150 (2020)).

Similar observations about the practical hindrances, economic and otherwise, to utilizing Section 220 have often been the topic of blog posts over the last 15 years. See, e.g., recent blog post explaining that Section 220 cases are not for the fainthearted.

This Gilead case provides guidance on an important topic that warrants a very lengthy analysis. We provide highlights via bullet points, and then interested readers can click on the above link and read all 69-pages.

The bullet points that we find to have the most widespread applicability and importance are the following:

• The Court criticizes the trend in which companies often inappropriately litigate the underlying merits of a potential, future plenary suit as opposed to addressing whether the prerequisites have been met for a Section 220 demand, as well as the tendency of companies to otherwise prevent stockholders from using Section 220 as a “quick and easy pre-filing discovery tool.” Slip op. at 3-4.

• The Court provides many quotable explanations of the “credible basis” standard that must be satisfied in order to rely on the proper purpose of investigating suspected wrongdoing. The Court emphasizes that this “lowest possible burden of proof” does not require a stockholder to prove that any wrongdoing actually occurred; nor does it require a stockholder to show by a preponderance of the evidence that wrongdoing is even probable. Slip op. at 23, footnotes 103 and 104.

• Rather, the Court instructed that the recognized proper purpose for using Section 220 to investigate suspected wrongdoing is satisfied when there is a credible basis to suspect merely the “possibility” of wrongdoing. Id. at 24, n.106.

• The Court addresses the common tactic used by companies challenging a proper purpose when they assert that the “stated proper purpose is not the actual proper purpose for the demand.” This opinion teaches that in order to succeed in such a defense, the company must prove that the “plaintiff pursued its claim under false pretenses. Such a showing is fact intensive and difficult to establish.” See footnote 153 and accompanying text.

• The Court made quick work of dispensing with the issue of standing in Section 220 cases. The Court reasoned that the standing argument in this case was in reality a Potemkin Village (our words) for the company’s challenge to the viability of derivative claims that the plaintiffs might pursue in the future. Although the Court discussed standing under Section 220 in general, it also underscored that a Section 220 proceeding does not warrant a trial on the merits of underlying claims. Slip op. at 41–42.

• The Court instructed that generally Section 220 plaintiffs need not specify the “end-uses” of the data requested for their investigation. Slip op. at 49.

• The Court also provided helpful practical tips about the scope of production required once the preliminary prerequisites of Section 220 have been satisfied. The Court noted that in some instances the company will be required to provide more than simply formal board materials. See Slip op. at 51-54.

• The opinion acknowledged that in some instances after limited discovery in a Section 220 action, plaintiffs can refine their requests with greater precision and that in some cases the Court has asked the plaintiffs to streamline their requests. See Slip op. at 63.

• In response to the Court being vexed by the overly aggressive tactics of the company, the Court invited the plaintiff to “seek leave to move for fee shifting.” As one example of the Court’s observation that the company was taking positions for no apparent purpose other than obstructing the exercise of the statutory rights of the plaintiff, the Court noted that the company refused to produce even a single document before litigation commenced.

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Must-Read Chancery Decision for Buyers of Businesses Whose Value Depends on Retaining Customer Relationships

The Delaware Court of Chancery in August 2020 addressed the issue of whether a seller was liable for not disclosing the notification it received prior to closing that one or more key customers were terminating their relationship with the seller’s business. Swipe Acquisition Corporation v. Krauss, C.A. No. 2019-0509-PAF (Del. Ch. Aug. 25, 2020). The Court’s decision and other decisions cited below must be read by anyone who seeks a deep understanding of Delaware law on this topic.

Key Issue Addressed:

When will a fraud claim survive in connection with a purchase agreement that restricts claims for misrepresentations and limits claims for indemnification? In this case, most of the motion to dismiss was denied, but one of the reasons this decision is noteworthy is because it exposes the lack of a bright-line-rule on this issue when compared to other decisions addressing the same or similar issues–depending on the specific terms of the anti-reliance clause involved and the specific claims of fraudulent misrepresentations or omissions.

As an indication of how common this issue is, a few days before this ruling the Court of Chancery issued another decision that addressed the issue: Pilot Air Freight, LLC v. Manna Freight Systems, Inc., No. 2019-0992-VCS (Del. Ch. Sept. 18, 2020).

Key Facts of Swipe case:

This case involves a dispute over the lack of disclosure by the seller prior to closing when the seller learned that a key customer was claiming to terminate its business relationship even though the sales price was impacted by the existence of key customers. The sellers knew that if the buyers learned of the termination by the key customer involved that the deal might not close. See Slip op. at 8. Nonetheless, the sellers did not inform the buyers of the termination of the key customer at issue. Moreover, the sellers did not amend any of the financial information provided to the buyers, which had then become stale. Id. at 9. Based on weaker-than-expected performance before the closing, the buyers and the sellers did agree to reduce the purchase price even though the loss of the key customer was not disclosed.

Key Principles of Law with Widespread Applicability:

  • The Court cited to multiple cases to explain when an anti-reliance clause will not bar a fraud claim. See Slip op. at 28-29.
  • The Court also elucidates when a fraud claim and a contract claim will not be considered duplicative; when both can proceed at the preliminary stage of a case; and when a contract claim and a fraud claim will not be considered boot-strapped. See id. at 31-33.
  • The Court explained why duplicative claims may often survive at the motion to dismiss stage. See footnote 61 and accompanying text.
  • The Court explained the primacy of contract law in Delaware, and when parallel contract claims and breach of fiduciary duty claims may not proceed in tandem. See footnote 58 and accompanying text.

In addition to the cases cited above on the topic at hand, this decision should be compared with the Delaware Superior Court’s Infomedia decision that was issued just a few short weeks before this Chancery ruling. Of course, the exact terms of the applicable agreements and the detailed circumstances are often determinative, but in the unrelated Delaware Superior Court decision about a month earlier, the Court concluded that the failure to inform the sellers shortly before the execution of an asset purchase agreement that key customers intended to terminate their service contracts, even though written notice had not yet been received, would not be a sufficient basis for fraudulent misrepresentation claims due to anti-reliance provisions in an asset purchase agreement, thereby resulting in a grant of the motion to dismiss, based on the terms of the agreement involved in that case. See Infomedia Group Inc. v. Orange Health Solutions, Inc. (Del. Super. July 31, 2020).

Link to original post.

 

Chancery Determines Standard Applicable to Contested Transaction

The recent Delaware Court of Chancery decision in Salladay v. Lev, No. 2019-0048-SG (Del. Ch. Feb. 27, 2020), addressed the standards the Court may apply to review the conduct of directors in a contested transaction, and determined that the entire fairness standard applied, based on the facts of this case, resulting in a denial of a motion to dismiss.

Key Points:

This decision provides the latest iteration of Delaware law regarding the analyses the Court employs to review a challenged transaction to determine whether fiduciary duties were fulfilled.

In this case, the Court determined that the business judgment rule did not apply. The Court provides a practical, educational elucidation of why the efforts to “cleanse” the transaction did not revive the business judgment rule, in light of the failure to satisfy the prerequisites discussed in Corwin v. KKR Holdings, LLC, 125 A.3d 304 (Del. 2015); Kahn v. M & F Worldwide (MFW), 88 A.3d 635 (Del. 2014); and In re Trados, Inc. Shareholders Litigation (Trados II) 73 A.3d 17 (Del. Ch. 2013).

The Court also discusses the recent Delaware Supreme Court cases which clarified “where or when the line is drawn” for the “cleansing” criteria to be considered as being imposed “ab initio,” such that a deal will earn the deferential BJR review standard, in Flood v. Synutra International, Inc., 195 A.3d 754 (Del. 2018), as well as Olenik v. Lodzinski, 208 A.3d 704 (Del. 2019).

Link to original post.

 

Chancery Explains Proper Methods to Expand Board Size and to Fill Board Vacancies

A recent Delaware Court of Chancery decision provides a primer on the proper way to expand the size of a board of directors and the proper way to fill board vacancies, as well as explaining the difference between a de facto and a de jure director. See Stream TV Networks, Inc. v. SeeCubic, Inc., C.A. No. 2020-0310-JTL (Del. Ch. Dec. 8, 2020).

This opinion should be at the fingertips of every corporate litigator who is called upon to address whether:

(1) the size of a board of directors was properly expanded;

(2) director vacancies were properly filled; or

(3) whether the actions of a de facto board member were binding even if because of technical mistakes that director was not properly appointed such that she would qualify as a de jure director.

Many additional consequential statements of Delaware law with widespread utility are included in this consequential 52-page decision.

Highlights:

       The Court describes the well-known prerequisites for obtaining a preliminary objection. See page 16.

       The Court provides a tutorial, with copious citations to statutory and caselaw authority, to explain: (i) how to expand the size of the board of directors; (ii) who has the authority to expand the size of the board; (iii) how to fill vacancies on the board; and (iv) who is authorized to fill vacant board seats. See pages 17 to 20.

       This opinion features a maxim of equity that would be useful to have available when the situation calls for it: equity regards as done what ought to have been done. See page 20.

       The Court explained that only the charter or the bylaws can impose director qualifications, and in any event those qualifications must be reasonable. See page 21.

       The Court explained that a director could not agree to conditions of service as a board member that would be contrary to the exercise of the fiduciary duties of a director. See page 22.

       An always useful reminder of the three tiers of review of director decision-making are provided. Those three tiers are: (i) the business judgment rule; (ii) enhanced scrutiny; and (iii) entire fairness. See pages 50 to 51.

       In addition to explaining when those three tiers apply, the opinion also regales us with a classic recitation of the business judgment rule as the default standard:

” . . . the default standard of review is the business judgment rule, which presumes that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interest of the company.” See page 50.

      This decision teaches that unless one of the rule’s elements is rebutted, 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.

       The Court explains the difference between a de facto director and a de jure director, and which actions of a de facto director are binding.  See pages 23 to 25.

       Another extremely important aspect of this decision (which takes up the majority of the 50-plus pages) is a deep dive into the historical foundations of Section 271 of the Delaware General Corporation Law which applies generally to the sale of most or all of the assets of a corporation, and which would typically require stockholder approval. See page 27 through 48.

       The Court supports with detailed reasoning and extensive footnote support its conclusion that Section 271 does not apply to an insolvent corporation that transfers assets to a secured creditor. Compare DGCL Section 272 (allows directors to mortgage corporate assets).

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Delaware Court of Chancery Provides Rule 11 Insights

There are relatively few Chancery decisions on Rule 11 compared with more common corporate and commercial litigation issues that are the subject of Chancery opinions, and an October 2020 letter decision provides insights into why there are not more rulings on Rule 11. In POSCO Energy Co., Ltd. v. FuelCell Energy, Inc., Civil Action No. 2020-0713-MTZ (Del. Ch. Oct. 22, 2020), in which a motion for leave to amend under Rule 15 was granted without awarding fees, while distinguishing both the Lillis and Franklin Balance cases, the Court explained that Rule 11 should not be casually raised, but that in any event a requirement for invoking it is to provide separate written notice and an opportunity to cure, as opposed to including it as part of a motion addressing other issues as well.

The Court explained that:

FuelCell has invoked Court of Chancery Rule 11 casually and repeatedly in this matter.21 The Court may only determine if Rule 11(b) was violated “after notice and a reasonable opportunity to respond,” and a litigant may only initiate those proceedings by “[a] motion for sanctions . . . made separately from other motions or requests.”22  Under that plain language, if FuelCell seeks sanctions for conduct it believes violates Rule 11, it must do so in an independent motion, not in argument opposing unconditional leave to amend. And, in my view, it is distracting, detrimental to the famed collegiality of the Delaware bar, and counterproductive to the “just, speedy and inexpensive determination” of judicial proceedings to summon Rule 11 in rhetoric.23

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Chancery Declines to Order Reserve for Fraud Claims Against Dissolving Corporation Under DGCL Section 280

There remains a relative paucity of opinions addressing the nuances of the dissolution statute under DGCL Section 280, compared to the Delaware decisions addressing other sections of the DGCL, so we refer to a September 2020 Court of Chancery decision that denies a Motion for Reargument under Rule 59(f) of a ruling that rejected a request to set aside a reserve for a fraud claim–even though the letter ruling was barely three-pages long–in the matter styled In re Swisher Hygiene, Inc., 2018-0080-SG (Del. Ch. Sept. 4, 2020). The prior decision was highlighted here.

The Court explained that the allegations did not state a “creditor claim”, though the ruling expressly did not prejudice the right to “bring litigation to determine” the fraud claim, which related to disputed ownership of stock in the company being dissolved.

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Chancery Enforces Forum Selection Clause in Charter for Inspection Demand

One of our selected Court of Chancery decisions is almost as noteworthy for what it did not decide as for what was decided. In JUUL Labs, Inc. v. Grove, C.A. No. 2020-0005-JTL (Del. Ch. Aug. 13, 2020), Delaware’s Court of equity enforced an exclusive forum selection clause in a company charter, based at least in part on the internal affairs doctrine, to prevent a stockholder in a Delaware corporation from filing suit in California in reliance on a California statute to demand the inspection of corporate records, notwithstanding a California statute that appears to allow a stockholder to sue in California for corporate records if the Delaware company has its principal place of business in California.

What the Court did not decide is whether a stockholder may contractually waive her rights under DGCL section 220. Count this writer as a skeptic on that point. The Court reviewed several overlapping agreements, such as a stock option exercise agreement, that the stockholder signed and that purported, at least in the company’s view, to waive inspection rights under DGCL section 220. Some of the agreements were governed by Delaware law and some by California law.

This decision could be the topic of a law review article due to the many core principles of corporate law and doctrinal underpinnings the Court carefully analyzes. But, we only provide a few bullet points with an exhortation that the whole opinion be reviewed closely.

  • The Court provides an in-depth discussion of the foundational concepts that undergird the internal affairs doctrine as it applies to the request for corporate records, as well as related constitutional issues that arise.
  • But footnote 7 acknowledges contrary authority that suggests that a local jurisdiction may apply its law to a demand by a local resident for corporate records of a foreign corporation.
  • The Court compares DGCL section 220 with its counterpart in the California statutory regime.
  • The exclusive forum selection clause in the charter was addressed, and the Court explained that but for this provision, the California court would be able to apply DGCL section 220.
  • Importantly, the Court emphasized that is was not deciding whether a waiver of DGCL section 220 rights would be enforceable. Although at footnote 14 the Court provides citations to many Delaware cases that sowed doubt about the viability of that position–but then the Court also cited cases at footnote 15 that more generally recognized the ability to waive even constitutional rights.
  • Footnote 16 cites to many scholarly articles, and muses about the public policy aspects of the unilateral adoption of provisions in constitutive documents, such as forum selection clauses in Bylaws. Early in the opinion, at footnote 7, by comparison the Court waxes philosophical about the concept of the corporation as a nexus of contracts–as compared to it being viewed as a creature of the state. The latter view has implications about the exercise of one state’s power in relation to other states, especially when private ordering may be seen as private parties exercising state power by proxy.

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Chancery Clarifies Nuances of Section 220 Stockholder Demand for Inspection Rights

A July 2020 Delaware Court of Chancery opinion provides insights into nuances of DGCL Section 220 as it relates to the rights of stockholders to inspect corporate books and records, and deserves to be in included in the pantheon of Delaware decisions on this topic. It must be read by anyone seeking a complete understanding of Delaware law on Section 220. In Woods v. Sahara Enterprises, Inc., C.A. No. 2020-0153-JTL (Del. Ch. July 22, 2020), the Court provided warmly welcomed clarity about important nuances of DGCL Section 220 with eminently quotable passages for practitioners who need to brief these issues. See generally overview of takeaways from 15 years of highlighting Section 220 cases, and compare a recent Delaware Supreme Court decision about contract-based rights to inspect corporate books and records.

This short overview will only provide several of those worthy passages in the format of bullet points.

Among the more noteworthy aspects of this notable decision are the following.

  • A consequential aspect of this jewel of a decision is the instruction by the Court that there is no basis in Delaware law to require a stockholder demanding corporate records under Section 220 to explain why the stockholder wants to value her interest in the company–in order to satisfy the recognized proper purpose of valuation. See Slip op. at 11; and 14-15.
  • The Court provided an extremely helpful list of many recognized “proper purposes” needed to be shown to satisfy Section 220. See Slip op. at 8-9.
  • The Court also recited several examples of what showing is recognized as sufficient to satisfy the “credible basis requirement” to investigate mismanagement pursuant to Section 220. See Slip op. 18-19.
  • An always useful recitation of the basic elements of the fiduciary duty of directors of a Delaware corporation and the subsidiary components of the duty of loyalty and care, are also featured. See Slip op. at 20.
  • The Court categorized the specific requests for documents in this case as follows: (i) formal board materials; (ii) informal board materials; and (iii) officer-level materials. Then the Court expounds on the different focus applicable to each category.
  • Notably, after quoting the actual document requests, the Court found that some of them were overly broad–but the Court edited and narrowed some of the requests before concluding that the company was required to produce the Court-narrowed scope of documents.

Bonus supplement: Prof. Bainbridge, a nationally prominent corporate law scholar, provides learned commentary on this case and Section 220 jurisprudence generally. Readers should recognize the good professor as the prolific author who scholarship has been cited in Delaware Court opinions.

Link to original post. 

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*Francis G.X. Pileggi is the managing partner of the Delaware office of Lewis Brisbois Bisgaard & Smith LLP, and the primary author of the Delaware Corporate and Commercial Litigation Blog at www.delawarelitigation.com.

**Chauna A. Abner is a corporate and commercial litigation associate in the Delaware office of Lewis Brisbois Bisgaard & Smith LLP.

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

The Delaware Court of Chancery recently ruled that Stimwave Technologies Inc. need not advance legal costs for its suit against its ex-CEO because she apparently doctored her indemnification agreement to falsely pre-date a charter amendment requiring officers to get a major investor group’s approval of their advancement rights in Perryman et al. v. Stimwave Technologies Inc., No. 2020-0079-SG, memorandum opinion issued (Del. Ch. Dec. 9, 2020).

Vice Chancellor Sam Glasscock’s December 9 opinion declined to order advancement for ex-CEO Laura Perryman based on his credibility issues with her testimony and documents, but he endorsed the advancement rights of her husband, director Garry Perryman, whom he found likely lacked skill to manipulate the truth or the metadata that identified his indemnification agreement.

The decision turned on the novel issue of whether the ex-CEO and director had complied with an STI charter change that purportedly gave investors in the company’s Series D Preferred stock, voting as a separate stock class, power to nullify a director or officer’s transactions, including indemnification pacts and advancement for their actions.

“Neither the bylaws nor the charter precludes the company from granting to an investor a veto right over extension of advancement benefits to its directors and officers,” the vice chancellor ruled.  Therefore, “whether Laura’s IA is valid accordingly turns on when that document was executed, which in turn determines whether such document required approval from the Series D stockholders to be valid.”

Background

Laura Perryman was a founder and CE0 of the Tucson-based marketer of wireless micro size injectable medical devices from when it was chartered in Delaware in 2010 until November 2019 when she was asked to step down amid a Department of Justice investigation.

According to the opinion, Laura sent the STI board an email the next day with an attachment that she identified as her indemnification agreement dated January 1, 2018 and based on that document, the board agreed to pay for her attorney bills for the investigation.

But the next month, STI filed its own complaint against its ex-CEO claiming she breached her fiduciary duties by directing employees to alter bills to falsely make it appear they had been paid and later added a charge that she misused company funds to pay her son’s apartment rent and bonuses to favored employees.

STI also included in the complaint what the vice chancellor found to be a “weak allegation” of breach of duty against Gary for “acting in concert” with his wife.

At a December 20 board meeting, a majority of the board concluded that the January 1, 2018 IA Laura submitted was not valid because it was actually created on November 11, 2019 —“after the DoJ’s civil investigative demand,” the opinion said.

The advancement action

Laura and Gary filed a February complaint and a petition for judgment on the pleadings to compel STI to provide indemnification and advancement.  In opposition, STI argued that both of them filed their indemnification agreements after the 2018 charter change that required Series D stockholder approval but doctored the documents to make it appear that they were signed before the amendment, so they were void ab initio under that amendment.

Gary’s advancement right

As to Gary’s right to advancement, Vice Chancellor Glasscock noted that Gary was not an executive and thus did not need to get Series D approval.  He found that even though the indemnification agreement that Gary submitted carried a date that did not jibe with his testimony, Gary had no motive for deception and was not very “engaged” in the discovery process or his role as a director.

The court found it most likely that Gary’s original IA was created before the amendment and is therefore valid.

Laura’s advancement right

STI’s document experts claimed they discovered Laura had merged her indemnification agreement with an earlier signature page and purported that its identification metadata applied to the agreement, but they said in truth, there was no metadata for her false agreement.

Vice Chancellor Glasscock found that Laura:

Has indemnification rights under the Charter, “but those may prove pyrrhic absent [advancement] funds to vindicate her legal rights”

Whether she was or was not a CEO when she signed her agreement, could not have a valid agreement if she lacked proof that it was signed before Stimwave’s July 17, 2018 charter amendment requiring Series D investor approval of benefit extension – which she did not seek.

Cannot argue that other parts of the charter always require indemnification and advancement.

“Came across as someone who had created a story to fit the facts, adjusted it as it became apparent that it would be advantageous to do so, and who was attempting to buttress that story by concocting details.”

Has failed to successfully challenge the contractual right of the company to give the Series D shareholders veto power over the extension of advancement

A time-will-tell-take-away?

Could the opinion be seen as diverging from a long trend of Chancery Court decisions that have cast a skeptical eye on any firm’s attempt to add disqualifying conditions to the indemnification/advancement rights its charter had granted?  Might the opinion encourage corporate law specialists to research more ways to attract investor groups by offering them expanded power to control executive transactions?  And might the Chancery Court of the future be asked to rule on a new species of advancement disputes as a result?

 

 

The recent Delaware Court of Chancery decision in Salladay v. Lev, No. 2019-0048-SG (Del. Ch. Feb. 27, 2020), addressed the standards the Court may apply to review the conduct of directors in a contested transaction, and determined that the entire fairness standard applied, based on the facts of this case, resulting in a denial of a motion to dismiss.

Key Points:

This decision is must reading for those who want to be familiar with the latest iteration of Delaware law regarding the analyses the court employs to review a challenged transaction to determine whether fiduciary duties were fulfilled.

In this case, the court determined that the business judgment rule did not apply. The court provides a practical, educational elucidation of why the efforts to “cleanse” the transaction did not revive the business judgment rule, in light of the failure to satisfy the prerequisites discussed in Corwin v. KKR Holdings, LLC, 125 A.3d 304 (Del. 2015); Kahn v. M & F Worldwide (MFW), 88 A.3d 635 (Del. 2014); and In re Trados, Inc. Shareholders Litigation (Trados II) 73 A.3d 17 (Del. Ch. 2013).

The court also discusses the recent Delaware Supreme Court cases which clarified “where or when the line is drawn” for  the “cleansing” criteria to be considered as being imposed “ab initio,” such that a deal will earn the deferential BJR review standard, in Flood v. Synutra International, Inc., 195 A.3d 754 (Del. 2018), as well as Olenik v. Lodzinski, 208 A.3d 704 (Del. 2019).

The following article is reprinted with permission from the Jan. 15, 2020 edition of “The Delaware Business Court Insider”, (c) 2020 ALM Media Properties, LLC. All rights reserved.

By: Francis G.X. Pileggi and Chauna A. Abner

This is the 15th year that Francis Pileggi and various co-authors have created an annual list of important corporate and commercial decisions of the Delaware Supreme Court and the Delaware Court of Chancery. This list does not attempt to include all important decisions of those two courts that were rendered in 2019. Instead, this list highlights notable decisions that should be of widespread interest to those who work in the corporate and commercial litigation field or who follow the latest developments in this area of Delaware law. Prior annual reviews are available at this hyperlink.

This list focuses, with some exceptions, on the unsung heroes among the many decisions that have not already been widely discussed by the mainstream press or legal trade publications. Links are also provided below to the actual court decisions and longer summaries.

DELAWARE SUPREME COURT DECISIONS

Company Required to Produce Emails Among Management to Stockholders

The Delaware Supreme Court recently issued an opinion that clarifies the duty of a company to produce emails among its management in a Section 220 case. In KT4 Partners LLC v. Palantir Technologies, Inc., Del. Supr., No. 281, 2018 (Jan. 29, 2019), Delaware’s high court addressed a demand under Delaware General Corporation Law (DGCL) Section 220 by a stockholder for corporate books and records, including emails and electronically-stored information (ESI) among management, to allow the stockholder to investigate possible wrongdoing, such as the reasons behind amendments to an Investors’ Rights Agreement that severely reduced the original rights granted under that agreement. This opinion quoted from a law review article co-authored by Francis Pileggi on the intersection of DGCL Section 220 and ESI.

https://www.delawarelitigation.com/2019/01/articles/delaware-supreme-court-updates/company-required-to-produce-emails-among-management-to-stockholders/

Supreme Court Explains the Implied Covenant of Good Faith and Fair Dealing

A recent Delaware Supreme Court decision is must-reading for those who need to know the latest iteration of Delaware law on the implied covenant of good faith and fair dealing. In Oxbow Carbon & Minerals Holdings, Inc. v. Crestview-Oxbow Acquisition, LLC, Del. Supr. No. 536, 2018 (Jan. 17, 2019), Delaware’s High Court provided the latest articulation of Delaware law on the multi-faceted doctrine of the implied covenant of good faith and fairing dealing. In connection with affirming in part and reversing in part a 176-page trial court opinion, which was highlighted on these pages, the Supreme Court agreed with the analysis of the trial court’s correct reading of the plain meaning of the LLC agreement at issue, but disagreed with the application by the trial court of the implied covenant.

 https://www.delawarelitigation.com/2019/01/articles/delaware-supreme-court-updates/supreme-court-explains-the-implied-covenant-of-good-faith-and-fair-dealing/

Delaware Supreme Court Clarifies Ab Initio Requirement for BJR Review

The Delaware Supreme Court recently clarified the “ab initio” requirement announced in Kahn v. M&F Worldwide Corp. case as part of the set of standards that would allow for the BJR standard to apply to a challenged merger. See Olenik v. Lodzinski, No. 392, 2018 (Del. Supr., rev. April 11, 2019).  The High Court determined that the requirement was not satisfied based on the facts of the instant case because the “economic bargaining took place prior to the date” when the protections announced in the Kahn v. M&F Worldwide Corp. case needed to be in place.

Much commentary has already been written about this case, so a lengthy summary is not provided here, but I refer to prior decisions that have applied the ab initio requirement, for background purposes, as noted on these pages.

 https://www.delawarelitigation.com/2019/04/articles/delaware-supreme-court-updates/delaware-supreme-court-clarifies-ab-initio-requirement-for-bjr-review/

Delaware Supreme Court Clarifies Appraisal Law

The Delaware Supreme Court, in a per curiam decision, recently determined that “deal price less synergies” was the appropriate determination of fair value in the appraisal action before it.  In Verition Partners Master Fund Ltd. v. Aruba Networks, Inc., C.A. No. 11448-VCL (Del. Apr. 16, 2019), the Court reversed the Court of Chancery’s holding that “unaffected market price” was the fair value on the date of the merger. This case is the third in a recent trilogy of precedent-setting Delaware appraisal cases, preceded by DFC Global Corp. v. Muirfield Value Partners, L.P., 172 A.3d 346 (Del. 2017) and Dell, Inc. v. Magnetar Global Event Driven Master Fund Ltd, 177 A.3d 1 (Del. 2017).  This case has been the subject of extensive commentary by scholars and practitioners.

https://www.delawarelitigation.com/2019/04/articles/delaware-supreme-court-updates/delaware-supreme-court-clarifies-appraisal-law/

Delaware Supreme Court Addresses Independence of Directors

In Marchand v. Barnhil, CA. No. 2017-0586-JRS (Del. Ch. June 18, 2019), the Delaware Supreme Court addressed the meaning of the words “independence” and “disinterestedness” in the context of adequately pleading pre-suit demand futility as a prerequisite for pursuing a derivative claim against corporate directors. The court reversed the Court of Chancery’s dismissal of the case for failure to establish demand futility. This issue is one of the most nuanced and challenging in Delaware corporate litigation as indicated by the disagreement on the outcome among the experienced jurists deciding this case.

https://www.delawarelitigation.com/2019/06/articles/delaware-supreme-court-updates/delaware-supreme-court-addresses-independence-of-directors/

Delaware Supreme Court Instructs on Standards of Deposition Conduct

A recent Delaware Supreme Court opinion provides a tutorial on the standards imposed on Delaware lawyers when a deponent, who is the lawyer’s client, engages in inappropriate conduct during a deposition. In Shorenstein Hays-Nederland Theaters LLC Appeals, Nos. 596, 2018 and 620-2018 (Del. June 20, 2019), Delaware’s High Court issued its first decision on this specific issue, as compared to the rather abundant guidance that has existed for many years regarding the consequences when lawyers themselves engage in errant conduct during a deposition.

https://www.delawarelitigation.com/2019/09/articles/delaware-supreme-court-updates/delaware-supreme-court-instructs-on-standards-of-deposition-conduct/

Confidentiality Agreement Not Always Required for Section 220 Demands

For the first time, the Delaware Supreme Court decided that in a lawsuit in which a stockholder demands corporate books and records pursuant to Section 220 of the Delaware General Corporation Law, although it is typical to condition the production of records on entering into a confidentiality agreement, that the statute does not strictly require such a condition for production. The court also explained in Tiger v. Boast Apparel, Inc., No. 23, 2019 (Del. Aug. 7, 2019), that a party need not show exigent circumstances for a court to grant something less than indefinite confidentiality, and the inspection of records pursuant to Section 220 is not subject to a presumption of confidentiality.

https://www.delawarelitigation.com/2019/08/articles/delaware-supreme-court-updates/confidentiality-agreement-not-always-required-for-section-220-demands/

COURT OF CHANCERY DECISIONS

Chancery Clarifies Director’s Right to Corporate Records

A recent Delaware Court of Chancery decision addressed the important issue of the right of directors to be given access to corporate records. In Schnatter v. Papa John’s International, Inc., C.A. No. 2018-0542-AGB (Del. Ch. Jan. 15, 2019), Delaware’s court of equity considered a claim under Section 220(d) of the Delaware General Corporation Law (DGCL) by the founder and largest stockholder of the Papa John’s pizza chain who was forced out as the CEO but retained his position as a director.  He sought to obtain books and records in his capacity as a director to support an investigation that the other directors breached their fiduciary duties by improperly ousting him for unjustified reasons.

https://www.delawarelitigation.com/2019/01/articles/chancery-court-updates/chancery-clarifies-directors-right-to-corporate-records/

Chancery Finds Usurpation of Corporate Opportunity

Delaware case law is well-established regarding the aspect of the fiduciary duty of loyalty that prohibits a corporate director from usurping a corporate opportunity. A recent decision from the Delaware Court of Chancery applies that well-settled prohibition in a flexible manner to a set of facts that have apparently not been squarely addressed in prior precedent.  In Personal Touch Holding Corp. v. Glaubach, C.A. No. 11199-CB (Del. Ch. Feb. 25, 2019), the court awarded damages for the breach of this subset of fiduciary duty, as well as for other breaches of fiduciary duty.

https://www.delawarelitigation.com/2019/03/articles/chancery-court-updates/chancery-finds-usurpation-of-corporate-opportunity/

Chancery Applies Corporate Advancement Case Law to LLC Context

A recent Delaware Court of Chancery decision interpreted the advancement provisions of an LLC Agreement by applying case law interpreting DGCL Section 145 in the corporate context.  In Freeman Family LLC v. Park Avenue Landing LLC, C.A. No. 2018-0683-TMR (Del. Ch. Apr. 30, 2019), the court reviewed the applicability of “defined phrases” that are familiar prerequisites for advancement in the corporate context pursuant to DGCL Section 145, and analyzed that same language that was used in an LLC agreement provision granting advancement.

https://www.delawarelitigation.com/2019/05/articles/chancery-court-updates/chancery-applies-corporate-advancement-case-law-to-llc-context/

Chancery Instructs on DGCL Merger Requirements

A recent Delaware Court of Chancery opinion began by describing the complaint as reading like a law school exam designed to test the knowledge of a student regarding the requirements in the DGCL that must be satisfied in connection with a merger, and the court commented that the company would not have done well on the exam.

In Mehta v. Mobile Posse, Inc., C.A. No. 2018-0355-KSJM (Del. Ch. May 8, 2019), the court identified the six primary issues in this case as follows:

(1) Whether DGCL Section 262 was not complied with in connection with the failure to notify stockholders of their appraisal rights within the required timeframe;

(2) Whether DGCL Section 228 was not complied with due to the failure to send prompt notice of the written stockholder consents;

(3) Whether the merger agreement, or documents it incorporates, failed to comply with DGCL Section 251 by not including the amount of cash the preferred stockholders would receive for their shares;

(4) Whether the stockholder consents did not enjoy the ratifying effect under DGCL Section 144;

(5)  Whether the director defendants breached their fiduciary duty of disclosure; and

(6) Whether the director defendants breached the fiduciary duty of loyalty because the merger was a self-dealing transaction and not entirely fair.  With one small exception, the court found that the statutory violations were sufficiently established at the early procedural stage of a motion for judgment on the pleadings.

https://www.delawarelitigation.com/2019/05/articles/chancery-court-updates/chancery-instructs-on-dgcl-merger-requirements/

Chancery Grants Advancement on Counterclaims

A recent decision of the Delaware Court of Chancery clarifies those instances where a defensive counterclaim against a former officer and director may be covered by advancement rights. In a bench ruling in Dodelson v. AC Hold Co., Inc., C.A. No. 2019-009-SG (Transcript) (Del. Ch. May 21, 2019), the court interpreted the charter provision that included within the coverage for “indemnified parties” both former directors and officers. Notably, bench rulings may be cited as authority in briefs before the Delaware Court of Chancery.

https://www.delawarelitigation.com/2019/06/articles/chancery-court-updates/chancery-grants-advancement-on-counterclaims/

Chancery Orders Mandatory Indemnification per DGCL Section 145(c)

The recent Delaware Court of Chancery decision in Brown v. Rite Aid Corporation, C.A. No. 2017-0480-MTZ (Del. Ch. May 24, 2019), clarified the perennial issue of how the word “success” is defined for purposes of mandatory indemnification under Section 145(c) of the Delaware General Corporation Law–even if all of the arguments in the underlying litigation were not successful.

https://www.delawarelitigation.com/2019/06/articles/chancery-court-updates/chancery-orders-mandatory-indemnification-per-dgcl-section-145c/

Chancery Determines Valid LLC Managers; Rejects Bump-Out Theory of Board Replacements

The Delaware Court of Chancery left no doubt in a recent ruling that the “bump-out theory” of replacing LLC managers is not recognized in Delaware. In Llamas v. Titus, C.A. No. 2018-0516-JTL (Del. Ch. June 18, 2019), the court explained that incumbent managers need to be removed before their replacements can validly “take their seats.” The court interpreted the counterpart to DGCL Section 225, which is Section 18-110(a) of the Delaware LLC Act.

https://www.delawarelitigation.com/2019/07/articles/chancery-court-updates/chancery-determines-valid-llc-managers-rejects-bump-out-theory-of-board-replacements/

Advancement Granted for Post-Termination Use of Confidential Information

A recent Delaware Court of Chancery opinion in Ephrat v. medCPU, Inc., C.A. No. 2018-0052-MTZ (Del. Ch. June 26, 2019), will remain a noteworthy decision for two reasons: (1) It provides and anthology of prior Delaware decisions granting advancement to former directors or officers that defend claims regarding the use of confidential information acquired in a prior corporate capacity; and (2) It adds nuance to the existing abundant case law interpreting the threshold phrase “by reason of the fact,” which is one of the statutory prerequisites that must be satisfied for advancement claims to prevail pursuant to DGCL Section 145.

https://www.delawarelitigation.com/2019/07/articles/chancery-court-updates/advancement-granted-for-post-termination-use-of-confidential-information/

Chancery Addresses Personal Jurisdiction Over Co-Conspirator

In Clark v. Davenport, C.A. No. 2017-0839-JTL (Del. Ch. July 18, 2019), the court provided a noteworthy explanation of the important nuances that need to be understood when personal jurisdiction is contested, and this opinion provides an excellent analysis of the requirements for opposing personal jurisdiction based on the Delaware Long Arm Statute.

https://www.delawarelitigation.com/2019/08/articles/chancery-court-updates/chancery-addresses-personal-jurisdiction-over-co-conspirator/

Fully-Executed Contract Ruled Unenforceable

In Kotler v. Shipman Associates, LLC, C.A. No. 2017-0457-JRS (Del. Ch. Aug. 21, 2019), the Delaware Court of Chancery issued an opinion that should be read by all lawyers who seek to avoid the risk of a fully-executed contract being ruled unenforceable due to a court later finding, perhaps surprisingly, that the agreement did not accurately express the understanding of the parties.

https://www.delawarelitigation.com/2019/08/articles/chancery-court-updates/fully-executed-contract-ruled-unenforceable/

Chancery Explains Step-Transaction Doctrine and Defines “Affiliate”

An important concept known as the step-transaction doctrine, which treats the agreements in a series of formally separate but related transactions involving the transfer of property as a single transaction if all the steps are substantially linked, was explained in the recent Delaware Court of Chancery opinion in PWP Xerion Holdings III LLC v. Redleaf Resources, Inc., C.A. No. 2017-0235-JTL (Del. Ch. Oct. 23, 2019) and should be consulted by anyone who needs to understand the components of this important doctrine.

https://www.delawarelitigation.com/2019/10/articles/chancery-court-updates/chancery-explains-step-transaction-doctrine-and-defines-affiliate/

Delaware Forum Selection Clause Controls Over Foreign Exclusive Jurisdiction Statute

The recent Delaware Court of Chancery decision in AlixPartners, LP v. Mori, No. 2019-0392-KSJM (Del. Ch. Nov. 26, 2019) rejected an effort to dismiss a Delaware action notwithstanding the provision in an agreement that provided for a forum in a foreign country, and the apparent law of that foreign country that also supported exclusive jurisdiction in that country.

https://www.delawarelitigation.com/2019/12/articles/chancery-court-updates/delaware-forum-selection-clause-controls-over-foreign-exclusive-jurisdiction-statute/

Over the last 14 years that I have published this blog, I have compiled an annual review with a list of key Delaware corporate and commercial decisions that have widespread utility to practitioners, especially those court decisions that are not widely covered by other legal publications or the mainstream press. On a few occasions, I have prepared a mid-year review. This is one of those years.

A few weeks ago, I prepared highlights of key decisions published over the last 6 months or so (and in some instances a little beyond that period), for presentation to a large law firm based on the west coast. I’m “repurposing” my materials for that presentation by providing those case highlights below. For each blurb below, there is a link to a fuller overview as well as a link to the complete court opinion.

HIGHLIGHTS OF RECENT KEY DELAWARE CORPORATE AND COMMERCIAL DECISIONS–as of May 30, 2019

DELAWARE SUPREME COURT DECISIONS

Delaware Supreme Court Clarifies Appraisal Law

The Delaware Supreme Court, in a per curiam decision, recently determined that “deal price less synergies” was the appropriate determination of fair value in the appraisal action before it.  In Verition Partners Master Fund Ltd. v. Aruba Networks, Inc., C.A. No. 11448-VCL (Del. Apr. 16, 2019), the Court reversed the Court of Chancery’s holding that “unaffected market price” was the fair value on the date of the merger. This case is the third in a recent trilogy of precedent-setting Delaware appraisal cases, preceded by DFC Global Corp. v. Muirfield Value Partners, L.P., 172 A.3d 346 (Del. 2017) and Dell, Inc. v. Magnetar Global Event Driven Master Fund Ltd, 177 A.3d 1 (Del. 2017).  This case has been the subject of extensive commentary by scholars and practitioners in the short time since its publication.

Link: https://www.delawarelitigation.com/2019/04/articles/delaware-supreme-court-updates/delaware-supreme-court-clarifies-appraisal-law/

Company Required to Produce Emails Among Management to Stockholders

The Delaware Supreme Court recently issued an opinion that clarifies the duty of a company to produce emails among its management in a Section 220 case. In KT4 Partners LLC v. Palantir Technologies, Inc., Del. Supr., No. 281, 2018 (Jan. 29, 2019), Delaware’s High Court addressed a demand under Delaware General Corporation Law (DGCL) Section 220 by a stockholder for corporate books and records, including emails among management, to allow the stockholder to investigate possible wrongdoing, such as the reasons behind amendments to an Investors’ Rights Agreement that severely reduced the original rights granted under that agreement.

Notably, the court in its opinion quoted from a law review article that yours truly co-authored on the topic, which explained why demands under DGCL Section 220 should often include electronically-stored information (ESI) such as emails. See footnote 76.

This opinion is noteworthy because it clarifies Delaware law and authoritatively describes those circumstances when a demand for books and records under DGCL Section 220 will require the company to produce ESI, such as emails among management, to the extent necessary for the proper purpose established in a Section 220 case.

Brief Overview:

The stockholder demand in this case stated as its purpose the investigation of mismanagement, including depriving investors of their right of first refusal under an investors’ agreement that was amended without the consent of all investors, as well as interfering with the sale of stock by a large stockholder. The Court of Chancery, in a decision highlighted on these pages, determined that although some books and records had to be produced, emails need not be. The Supreme Court disagreed with that ruling and affirmed in part, reversed in part, and remanded.

Importantly, the facts of this case include an acknowledgment by the company that it often did not follow corporate formalities such as preparing board resolutions and keeping minutes of board meetings, but rather often communicated by email and took action by email–including on matters that were the subject of the investigative purpose of the Section 220 demand.

Highlights of Key Aspects of the Court’s Ruling:

For busy readers, I provide bullet points of key aspects of this crucial decision, but those who need to be familiar with the nuances of this aspect of Delaware corporate litigation should read the entire 49-page opinion linked above.

Procedural Background:

  • The court discussed what appeared to be an issue of first impression about the standard of review regarding a dispute over the interpretation of the stated purpose in a Section 220 demand. The court explained that the standard of review for the scope of relief is abuse of discretion, but de novo review applies to questions of law such as whether the stated purpose under Section 220 is proper. Although contract interpretation is also subject to de novo review as a question of law, fact-intensive and judgment-based determinations are reviewed for abuse of discretion, and factual determinations that underlie the trial court’s interpretation of an ambiguous written document deserve the deference given to factual findings.
  • The Delaware Supreme Court found that the demand in this case did include an explicit reference to a request for electronic documents.
  • The core issue identified by the High Court was whether the Court of Chancery abused its discretion in ruling that emails and other ESI were not necessary to satisfy the purpose of investigating the wrongdoing alleged in this Section 220 case.

Basic Principles:

  • The court reviewed the basic principles and policy undergirding the qualified common law and statutory right to inspect corporate books and records. See Slip op. at 22 to 24.
  • The court observed that the scope of documents to which a stockholder is entitled under Section 220 is limited to those that are necessary to accomplish the proper purpose as stated in the demand. See Slip op. at 24 to 25.

Emails/ESI Production:

  • In explaining why ESI should be included in appropriate Section 220 cases, the Delaware Supreme Court quoted from a law review article on this topic co-authored by your truly. See footnote 76 (quoting Francis G.X. Pileggi, et al., Inspecting Corporate “Books and Records” in a Digital World: The Role of Electronically Stored Information, 37 Del. J. Corp. L. 163, 165 (2012)).
  • The court reviewed Delaware cases that previously addressed whether ESI such as emails should be included in a Section 220 request. See footnotes 71 to 74. See also Amalgamated Bank v. Yahoo!, Inc., a Chancery opinion highlighted on these pages that also cited the same law review article on this topic co-authored by yours truly that was quoted by the Supreme Court in the instant case. See, e.g., footnote 72 (citing a Court of Chancery Order allowing for imaging of a Blackberry in a Section 220 case.)
  • The court also explained, based on the facts and circumstances of this case, why emails and ESI had to be produced and were needed to accomplish the stated purpose. See Slip op. at 31. For example, the court explained that the company involved did not comply with required corporate formalities such as minutes of board meetings and that it often conducted corporate business informally, including over email, regarding the issues subject to the Section 220 demand. See footnote 77 and accompanying text. The ESI at issue included, for example,  an allegedly incriminating message sent via LinkedIn.
  • The court also emphasized that there may be some Section 220 cases where ESI may not be required to be produced by the company, such as those situations where the corporation has traditional, non-electronic documents that are sufficient to satisfy the needs of the Section 220 petitioner.
  • In this case, the company admitted that there were no hardcopy documents that addressed all of the requests, and that there were emails and other ESI that were responsive to the requests.
  • The court also provided practice tips for future litigants: there should be a cooperative effort to focus on the substantive data that should be produced–or in other words, focus on the information that is needed and that is available whether it be in hardcopy or in ESI format.

The court also addressed an unrelated issue. It rejected the argument that the company made that as a condition of production it could require the stockholder to file any suits based on the data received in the Delaware Court of Chancery. Although there have been cases that have imposed similar jurisdictional conditions, the court explained why such a condition should be the exception and not the norm.

SUPPLEMENT: Law360 published an article about this case in which they quoted my comments about the importance of the High Court’s opinion.

Link: https://www.delawarelitigation.com/2019/01/articles/delaware-supreme-court-updates/company-required-to-produce-emails-among-management-to-stockholders/

Supreme Court Explains the Implied Covenant of Good Faith and Fair Dealing

A recent Delaware Supreme Court decision is must-reading for those who need to know the latest iteration of Delaware law on the implied covenant of good faith and fair dealing. In Oxbow Carbon & Minerals Holdings, Inc. v. Crestview-Oxbow Acquisition, LLC, Del. Supr. No. 536, 2018 (Jan. 17, 2019), Delaware’s High Court provided the latest articulation of Delaware law on the multi-faceted doctrine of the implied covenant of good faith and fairing dealing. In connection with affirming in part and reversing in part a 176-page trial court opinion, which was highlighted on these pages, the Supreme Court agreed with the analysis of the trial court’s correct reading of the plain meaning of the LLC agreement at issue, but disagreed with the application by the trial court of the implied covenant.

 Highlights of the most recent authoritative explanation of the implied covenant under Delaware law are noted in the following bullet points:

  • When a board is given contractual discretion to make a choice, that is not a “gap” to be filled. Although “the vesting of a board with discretion does not relieve the board of its obligation to use that discretion consistently with the implied covenant of good faith and fair dealing,” the argument was not made in this case that the board exercised this contractual discretion in bad faith. See footnotes 92 and 93 and accompanying text.
  • The court explained the two common situations where the implied covenant often applies. The first, at issue in this case, is when it is argued that a situation has arisen that was unforeseen by the parties and where the agreement’s express terms do not cover what should happen. See footnote 93.
  • The next situation is when a party to the contract is given discretion to act as to a certain subject and it is argued that the discretion has been used in a way that is impliedly proscribed by the contract’s express terms. Id.
  • “When a contract confers discretion on one party, the implied covenant requires that the discretion be used reasonably and in good faith.” Id.
  • Delaware’s High Court explained that the “implied duty of good faith and fair dealing is not an equitable remedy for rebalancing economic interests after events that could have been anticipated, but were not, later adversely affected one party to a contract.” See footnote 109 and accompanying text.
  • Rather, “the covenant is a limited and extraordinary legal remedy.” See footnote 110.
  • The Supreme Court added that the implied covenant “does not apply when the contract addresses the conduct at issue, but only when the contract is truly silent concerning the matter at hand. Even where the contract is silent, an interpreting court cannot use an implied covenant to re-write the agreement between the parties, and should be most chary about implying a contractual protection when the contract could easily have been drafted to expressly provide for it.” See footnotes 110 to 113 and accompanying text.

Link: https://www.delawarelitigation.com/2019/01/articles/delaware-supreme-court-updates/supreme-court-explains-the-implied-covenant-of-good-faith-and-fair-dealing/

Delaware Supreme Court Clarifies Ab Initio Requirement for BJR Review

The Delaware Supreme Court recently clarified the “ab initio” requirement announced in the Kahn v. M&F Worldwide Corp. case as part of the set of standards that would allow for the BJR standard to apply to a challenged merger. See Olenik v. Lodzinski, No. 392, 2018 (Del. Supr., rev. April 11, 2019).  The High Court determined that the requirement was not satisfied based on the facts of the instant case because the “economic bargaining took place prior to the date” when the protections announced in the Kahn v. M&F Worldwide Corp. case needed to be in place.

Much commentary has already been written about this case, so it will not be covered thoroughly on these pages, but I refer to prior decisions that have applied the ab initio requirement, for background purposes, as noted on these pages.

 Link: https://www.delawarelitigation.com/2019/04/articles/delaware-supreme-court-updates/delaware-supreme-court-clarifies-ab-initio-requirement-for-bjr-review/ 

Supreme Court Affirms Akorn Decision

The Delaware Supreme Court, in Akorn, Inc. v. Fresenius Kabi AG, et al., Del. Supr., No. 535, 2018 (Dec. 7, 2018), affirmed in a 3-page order, two days after oral argument, the Court of Chancery’s 253-page decision which was highlighted on these pages, and which is thought to be the first Delaware decision to find that a “material adverse effect” clause was triggered in such a way as to allow an acquiring party to terminate a merger pre-closing. Much has been written in trade publications about the Akorn case. See, e.g., here and here .

Link: https://www.delawarelitigation.com/2018/10/articles/chancery-court-updates/chancery-allows-termination-of-merger-agreement-based-on-material-adverse-change/

COURT OF CHANCERY DECISIONS

Chancery Instructs on DGCL Merger Requirements

A recent Delaware Court of Chancery opinion began by describing the complaint as reading like a law school exam designed to test the knowledge of a student regarding the requirements in the DGCL that must be satisfied in connection with a merger, and the court commented that the company would not have done well on the exam.

In Mehta v. Mobile Posse, Inc., C.A. No. 2018-0355-KSJM (Del. Ch. May 8, 2019), the court identified the six primary issues in this case as follows:

(1) Whether DGCL Section 262 was not complied with in connection with the failure to notify stockholders of their appraisal rights within the required timeframe;

(2) Whether DGCL Section 228 was not complied with due to the failure to send prompt notice of the written stockholder consents;

(3) Whether the merger agreement, or documents it incorporates, failed to comply with DGCL Section 251 by not including the amount of cash the preferred stockholders would receive for their shares;

(4) Whether the stockholder consents did not enjoy the ratifying effect under DGCL Section 144;

(5)  Whether the director defendants breached their fiduciary duty of disclosure; and

(6) Whether the director defendants breached the fiduciary duty of loyalty because the merger was a self-dealing transaction and not entirely fair.  With one small exception, the court found that the statutory violations were sufficiently established at the early procedural stage of a motion for judgment on the pleadings.

Key Highlights of Decision:

  • As an initial procedural matter, in connection with this motion for judgment on the pleadings, the court observed that it was not well-established in Delaware case law or Rules of Civil Procedure whether a “supplemental notice” attached to a motion for judgment on the pleadings could be considered “part of the record or pleadings.”  Based on this opinion, however, it is now established that under Delaware law, under some circumstances, it is now possible for such a supplemental notice to be included as part of the pleadings in such a procedural posture.  See, e.g., footnotes 1 through 6 and accompanying text.

DGCL Section 262:

  • The company sought a “do-over” or a “mulligan” for its statutory errors, because it purported to send proper notices required by DGCL Section 262–only after suit was filed.  Three problems with that approach are that: (i) Such a “replicated remedy proposal” had never before been blessed by a Delaware court; (ii) Even the supplemental notice proposed was itself wrong (in part because it quoted the statute of another statute); and (iii) trying to make a “supplemental notice” sent after the lawsuit was filed does not always make it part of the pleadings, although as noted above–in some circumstances–based on the opinion in this case, it is now possible to do so.  See Slip op. at 13.

DGCL Section 228:

  • Based on an amendment to the statute passed in 2017, Section 228 no longer requires that the written consent of stockholders be dated next to each signature.  See Slip op. at 19.
  • The court addressed the “less than bright-line rule” about whether or to what extent disclosures are required in connection with written consents of stockholders pursuant to Section 228, but cases cited by the court in this opinion support the view that in this case the company is not entitled to judgment on the pleadings on this issue in light of the lack of material data, or their supplying of incorrect data, with the solicitations for consents that were sent to the minority stockholders in this case.

DGCL Section 228(e)–Prompt Notice Requirement:

  • The prompt notice requirement under Section 228(e) requires that notice of action by written consent of stockholders to those who did not consent must be prompt.  Nonetheless, the exact timetable for such “prompt notice” is not defined in the statute.  One case found that five months was not prompt.  In this matter, notice was given after the Section 262 appraisal deadline, which the court found as a sufficient basis to deny the motion for judgment on the pleadings filed by the company (rather audaciously) in this case.

DGCL Section 251(b):

  • This section of the DGCL requires that a merger agreement include specified details about the deal terms, including compensation to stockholders, but the company failed to comply with this requirement.

DGCL Section 144:

  • The court held that the safe harbor under Section 144(a)(2) was not satisfied in this matter because the stockholders were not given material facts about the interests of the directors in the merger.

The court also denied the company’s motion for judgment on the pleadings regarding claims for breach of fiduciary duty.

Link: https://www.delawarelitigation.com/2019/05/articles/chancery-court-updates/chancery-instructs-on-dgcl-merger-requirements/

Chancery Applies Corporate Advancement Case Law to LLC Context

A recent Delaware Court of Chancery decision interpreted the advancement provisions of an LLC Agreement by applying case law interpreting DGCL Section 145 in the corporate context.  In Freeman Family LLC v. Park Avenue Landing LLC, C.A. No. 2018-0683-TMR (Del. Ch. Apr. 30, 2019), the court reviewed the applicability of “defined phrases” that are familiar prerequisites for advancement in the corporate context pursuant to DGCL Section 145, and analyzed that same language that was used in an LLC agreement provision granting advancement.

The highlights of this decision are based on the assumption that the reader is familiar with the principles of advancement for officers and directors pursuant to DGCL Section 145, and the leading Delaware court decisions on the topic–even if they are not aware that I have written several book chapters on advancement and published multiple articles on advancement and handled many advancement cases.   

 Brief Background:

This case involved a request for advancement by a member (not a manager) of an LLC seeking advancement for the cost of defending a suit in New Jersey brought by the managing member of the LLC relating to the call right of the member under the LLC Agreement.  (The plaintiff-member of the LLC involved in this case was itself an LLC.)

 Issues Addressed:

The two issues that the court addressed in this case are:  (1) Does corporate case law apply to the provisions for advancement in an LLC Agreement which contains language that mirrors the corporate statute, DCGL Section 145; and (2)  Whether the underlying action for which advancement is sought, arises “by reason of the fact” that the party seeking advancement acted in its “official” capacity?  The court answered both questions in the affirmative.

 Highlights of this Decision–Assuming Familiarity with Delaware Corporate Advancement Case Law:

  • The court referenced the well-known truism that advancement cases are particularly appropriate for resolution on a paper record, such as via dispositive motions.  See footnote 22 and accompanying text.
  • The court cited other Delaware cases that have applied corporate case law to analyze the contractual terms of advancement in an LLC Agreement.  See, e.g., Hyatt v. Al Jazeera American Holdings, II, LLC, 2016 WL 1301743 (Del. Ch. Mar. 31, 2016) (highlighted on these pages previously)See also other cases cited at footnotes 36, 37 and 38.
  • The court explained that LLCs and corporations differ most pertinently in regard to indemnification: “mandating it in the case of corporate directors and officers who successfully defend themselves, but leaving the indemnification of managers or officers of LLCs to private contract.”  See footnote 46 and accompanying text.
  • The court recited the guidelines that the Delaware courts used to determine if someone was acting “by reason of the fact”–for purposes of being entitled to either indemnification or advancement, and restated the familiar standard that the operative phrase will be satisfied “if there is a nexus or a causal connection between any of the underlying proceedings and one’s official corporate capacity . . . without regard to one’s motivation for engaging in that conduct.”  See footnotes 50 and 51 and accompanying text.
  • By contrast, the court cited examples of cases where the “by reason of the fact” requirement was not satisfied, which is best exemplified by disputes involving personal contractual obligations that do not involve the exercise of judgment, discretion, or decision-making authority on behalf of the corporation.  See footnote 53 and accompanying text.  Because the party seeking advancement in this case was a member and not an officer or a director, the context was unusual, but the LLC Agreement clearly defined the responsibilities of the member.
  • The court reasoned that the causal relationship between the official capacity of the member and the underlying lawsuit was met for several reasons: (i) The underlying case in New Jersey was about the failure of the member to carry out its responsibilities specified in the LLC Agreement: (ii) The underlying lawsuit in New Jersey is based on whether the member discharged its official duties such that the call rights could be exercised; and (iii) The underlying dispute fully implicates whether or not the member seeking advancement carried out its official duties.  Thus, the court held that the “by reason of the fact” requirement and the “official capacity requirement” were met.
  • The court distinguished five cases in which advancement or indemnification claims were denied because the underlying litigation involved a personal interest that lacked a sufficient connection to official duties.  Those five cases that were distinguished are cited in footnote 56–most of which have been highlighted on these pages:  Bernstein v. TractManager, Inc., 953 A.2d 1003 (Del. Ch. 2007); Cochran v. Stifel Fin. Corp., 2000 WL 1847676 (Del. Ch. Dec. 13, 2000) (rev’d in part on other grounds, 809 A.2d 555 (Del. 2002)); Lieberman v. Electrolytic Ozone, Inc., 2015 WL 5035460 (Del. Ch. Aug. 31, 2015); Dore v. Sweports, Ltd., 2017 WL 45469 (Del. Ch. Jan. 31, 2015); Charney v. Am. Apparel Inc., 2015 WL 5313769 (Del. Ch. Sept. 11, 2015).
  • Regarding whether the “undertaking” provided by the party seeking advancement satisfied the statutory undertaking requirement, the court ruled that the sufficiency of an undertaking is determined by looking at the substance–and not the form alone–of the document containing the undertaking.

 Postscript: It was recently reported by The Chancery Daily that the Vice Chancellor who wrote this opinion published it the day after giving birth to a baby boy. Wow. That’s a dedicated jurist. Congratulations to Her Honor and her family on their new addition.

Link: https://www.delawarelitigation.com/2019/05/articles/chancery-court-updates/chancery-applies-corporate-advancement-case-law-to-llc-context/

Chancery Finds Usurpation of Corporate Opportunity

Delaware case law is well-established regarding the aspect of the fiduciary duty of loyalty that prohibits a corporate director from usurping a corporate opportunity. A recent decision from the Delaware Court of Chancery applies that well-settled prohibition in a flexible manner to a set of facts that have apparently not been squarely addressed in prior precedent.  In Personal Touch Holding Corp. v. Glaubach, C.A. No. 11199-CB (Del. Ch. Feb. 25, 2019), the court awarded damages for the breach of this subset of fiduciary duty, as well as for other breaches of fiduciary duty.

Basic Background Facts:

This case involved a co-founder who also served as a president and director of a New York-based provider of healthcare services. He was removed when the company discovered various transgressions. The former director purchased an office building in his individual capacity–secretly–even though the court found that the former director had been aware that the company was interested for several years in purchasing a similar building for its own use.  The former director then offered to lease the building back to the company at what the court found to be above-market rental rates.

Key Principles of Law:

This short blog post assumes that readers are familiar with the basic principles involved with the usurpation of corporate opportunities, and will merely highlight some of the key statements of law and the court’s reasoning in this 84-page opinion.

The well-known elements of a claim based on the corporate opportunity doctrine have been stated frequently in prior Delaware cases. Those familiar with corporate litigation will recognize the following four elements of a claim for usurpation of corporate opportunity:

“ (1)      The corporation is financially able to exploit the opportunity;

(2)      The opportunity is within the corporation’s line of business;

(3)      The corporation has an interest or expectancy in the opportunity;

(4)      By taking the opportunity for his own, the corporate fiduciary will thereby be placed in a position inimicable to his duties to the corporation.”

Slip op. at 36-38.

The court explained that Delaware Supreme Court decisions have referred to some of these elements in the disjunctive even though they are often quoted as being conjunctive. Specifically, proof of either the third element or the fourth element would sustain a corporate opportunity claim.

Moreover, the court decides the viability of a corporate opportunity claim by weighing the four factors in a holistic fashion and no one factor is dispositive. Id.

Key Reasoning of the Court:

  • The court rejected the argument that the purchase of the office building was not in the line of business of the healthcare company involved, which historically leased office space, because the “line of business factor” was in either inapplicable or was satisfied because the company had a clear “interest and expectancy” in the opportunity. In addition to that factor having a flexible meaning, the court explained that latitude should be allowed for development and expansion of a business, and the Delaware courts have broadly interpreted the nature of the corporation’s business when determining whether a corporation had an interest in a opportunity.
  • Regardless, the court found that the line of business test was not relevant where, as here, the company had a clear interest and expectancy in acquiring the building, and the opportunity presented related to an operational decision about how to expand the business as opposed to an opportunity to acquire a new business.
  • The court further reasoned that even if the opportunity was not within the existing line of business, it was sufficient that the company had a “clear interest and expectancy” at the time the opportunity arose. Id. at 44-47.
  • Regarding the fourth factor, the court instructed that a corporate officer or director was prohibited from taking an opportunity for his own “if the corporate fiduciary will thereby be placed in a position inimicable to his duties to the corporation.”
  • The court elaborated by observing that the corporate opportunity doctrine is implicated where the fiduciary’s seizure of an opportunity results in a conflict between the fiduciary’s duties to the corporation and the self-interest of the director as actualized by the exploitation of the opportunity.” Id. at 47-49.
  • The court also rejected an argument that the employment agreement of the former director allowed him to pursue other business interests outside of the company, and to devote a material portion of his time to other business interests. The court found that contractual defense to be unavailing in part because that provision did not allow the defendant to compete with the company for opportunities in which the company had an interest or expectancy. In addition, the employment agreement also prohibited the former director and president from engaging in activities which were “competitive with” the business of the company.
  • The court applied the entire fairness test because the former director was on both sides of the transaction involving a lease of the building to the company, and also because the director received a personal benefit from the transaction that was not received by the shareholders generally. Id. at 53.
  • The court also explained that charging the company an above-market rate for rent was unfair self-dealing and a breach of the duty of loyalty–regardless of whether the former director acted in subjective good faith.

As a side note, the court also found a separate breach of fiduciary duty as a result of the former director engaging in a “letter-writing campaign” over a several month period in which the former director sent harassing and disturbing anonymous letters to board members, employees and the lender of the company which caused harm to the company by hurting morale and causing distraction–in addition to attempting to sabotage the company’s relationship with its primary lender. Slip op. at 76-83.

Link: https://www.delawarelitigation.com/2019/03/articles/chancery-court-updates/chancery-finds-usurpation-of-corporate-opportunity/

Chancery Clarifies Director’s Right to Corporate Records

A recent Delaware Court of Chancery decision addressed the important issue of the right of directors to be given access to corporate records. In Schnatter v. Papa John’s International, Inc., C.A. No. 2018-0542-AGB (Del. Ch. Jan. 15, 2019), Delaware’s court of equity considered a claim under Section 220(d) of the Delaware General Corporation Law (DGCL) by the founder and largest stockholder of the Papa John’s pizza chain who was forced out as the CEO but retained his position as a director.  He sought to obtain books and records in his capacity as a director to support an investigation that the other directors breached their fiduciary duties by improperly ousting him for unjustified reasons.

Key Bullet Points that Make this Case Noteworthy include the following:

  • The court required the Defendant-Directors to produce their text messages and their private emails, that they sent and received, that related to the specific issues in contention. Prior Chancery decisions have required the production of such personal communications that related to corporate business but such a ruling is still notable. For example, a few years ago, in Amalgamated Bank v. Yahoo!, Inc., highlighted on these pages, the Court of Chancery ordered a similar scope of production–and also cited to a law review article that yours truly published in which my co-authors and I explained why electronically stored information (ESI), including text messages and private emails, should often be included within the scope of a DGCL Section 220 demand. See law review article co-authored by yours truly which argued that the court should often include ESI as part of the obligation to produce records under Section 220. See 37 Del. J. Corp. L. 163, 165 (2012), highlighted on these pages here.
  • It is well-established that directors have nearly unfettered rights to access to books and records of a corporation in which they serve. Unlike a stockholder, when a director makes a demand for books and records under Section 220(d), the corporation has the burden to establish that the director’s demand for books and records is based an improper purpose.
  • Unlike the impact of a stockholder filing a plenary action before a Section 220 case is complete, when a director files a plenary action before a final ruling in a Section 220 case, that will not necessarily bar the continuation of Section 220 claims and it will not otherwise moot the Section 220 claims. See generally CHC Investments, Inc. v. FirstSun Bancorp, C.A. No. 2018-0610-KSJM (Del. Ch. Jan. 24, 2019)(Section 220 stockholder demand case dismissed due to parallel plenary action.)
  • The court observed that a director should not be required to sign a confidentiality agreement as a condition to obtaining records because a director already has a fiduciary duty to keep them confidential—as compared to stockholders who routinely are required to sign a confidentiality agreement as a condition to obtaining records pursuant to a Section 220 demand. See generally Murfey v. WHC Ventures, LLC, C.A. No. 2018-0652-MTZ (Del. Ch., Jan.23, 2019)(proposed confidentiality order rejected by Court as non-compliant with Chancery Rule 5.1 because it did not allow for filing confidential documents with the court–confidentially.)

Link: https://www.delawarelitigation.com/2019/01/articles/chancery-court-updates/chancery-clarifies-directors-right-to-corporate-records/

Advancement for Counterclaims Granted Despite Withdraw of Covered Claim

A recent transcript ruling by the Delaware Court of Chancery in Gasgarth v. TVP Investments, LLC, C.A. No. 2018-0621-JTL, transcript ruling (Del. Ch. Dec. 7, 2018), explained that the right to advancement was not extinguished by an amendment of a counterclaim to specifically withdraw breaches of fiduciary duty counterclaims and remove factual allegations relating to the service of the plaintiffs (counterclaim defendants) as directors and officers.

The court reasoned that it is not bound by the four-corners of a pleading, but rather will view the context of the litigation as a whole to determine if advancement is warranted in light of all the facts and circumstances of the case and the role that the directors and officers played in connection with the claims against them.

Relying on Delaware precedent, the court in this transcript ruling also included as part of the “fees on fees” awarded, a success bonus, which was part of the engagement letter with counsel.

Link: https://www.delawarelitigation.com/2019/01/articles/chancery-court-updates/advancement-for-counterclaims-granted-despite-withdraw-of-covered-claim/

Chancery Addresses “Commercially Reasonable Efforts” Standard

When the phrase “commercially reasonable efforts” appears as a standard of performance in contracts, it seems predetermined to generate litigation, and the recent Court of Chancery decision in Himawan v. Cephalon, Inc., C.A. No. 2018-0075-SG (Del. Ch. Dec. 28, 2018), supports that observation. Although the agreement in this case had a contractual definition for “commercially reasonable efforts”, prior Delaware decisions highlighted on these pages that discuss this phrase should be of relevance to anyone who needs to know what the Delaware cases say about this somewhat amorphous standard, and similarly-phrased “efforts clauses”.

Why this decision is noteworthy: The most notable aspect of this decision is its collection of Delaware cases interpreting various iterations of “efforts clauses”. See footnotes 83 to 85.

Brief overview: This case involved an earn-out dispute and a claim by the seller that it did not receive milestone payments pursuant to an earn-out provision because the buyer did not use commercially reasonable efforts to reach the milestones. The buyer was the pharmaceutical company Cephalon, but Teva Pharmaceuticals later bought Cephalon. The product at issue was an antibody that would allow an organism’s immune system to overcome disease-causing pathogens. As with new drugs, the process to bring antibodies to market is long, difficult and risky.

The earn-out in the merger agreement in this case was payable upon the meeting of certain milestones in the process of obtaining  approval by government agencies for the antibody to treat two different conditions. The buyer agreed to use “commercially reasonable efforts” to develop the antibody and achieve those milestones. The seller claims that the buyer did not comply with that efforts clause.

Key takeaways:

  • The Court provides an excellent collection of Delaware decisions that have wrestled with various permutations of “efforts clauses”. See footnotes 83 to 85 and accompanying text. The Court categorizes the collected decisions into the following groups, some of which are overlapping: (i) motions to dismiss (at the pleadings stage); (ii) post-trial decisions; (iii) post-merger decisions (often involving a related earn-out clause); and (iv) pre-merger decisions where the efforts clause applied to the satisfaction of a condition to closing.
  • The agreement involved in this case provided a contractual definition for “commercially reasonable efforts” as follows: “the exercise of such efforts and commitment of such resources by a company with substantially the same resources and expertise as [Cepahlon], with due regard to the nature of efforts and cost required for the undertaking at stake.”
  • The Court observed that the parties agreed that the foregoing is an “objective standard”, but the Court described the contractual definition as “inartfully” drafted and ambiguous. Also, in the context of denying a Motion to Dismiss this claim, the Court found that neither side offered a reasonable interpretation of this contract provision (as compared to another basis to deny an MTD: when both sides offer reasonable, but differing, interpretations.)
  • Based on Delaware’s version of Rule 12(b)(6)–which is not as stringent as the current Federal standard–the Court found that there was a “reasonably conceivable set of circumstances susceptible of proof” in which (allowing for factual issues at this early stage of the case), it could be shown that companies with similar resources and expertise as Cephalon are currently developing treatments for a similar antibody as the one at issue in this case.

Link: https://www.delawarelitigation.com/2018/12/articles/chancery-court-updates/chancery-addresses-commercially-reasonable-efforts-standard/

Chancery Rules on Limits of Forum-Selection Clauses in Corporate Documents

A recent seminal decision of the Delaware Court of Chancery must be included in the lexicon of every lawyer who wants to understand the boundaries of Delaware law on forum-selection clauses in corporate documents. In the case of Sciabacucchi v. Salzberg, C.A. No. 2017-0931-JTL (Del. Ch. Dec. 19, 2018), the Court determined that a forum-selection clause in a certificate of incorporation was invalid and ineffective to the extent that it purported to “require any claim under the Securities Act of 1933 to be brought in federal court” (the “Federal Forum Provisions”).

Why this Case is Noteworthy: The court reasoned in its holding that: “The constitutive documents of a Delaware corporation cannot bind a plaintiff to a particular forum when the claim does not involve rights or relationships that were established by or under Delaware’s corporate law.  In this case, the Federal Forum Provisions attempt to accomplish that feat.  They are therefore ineffective and invalid.

Overview of Key Points:

This opinion is destined to form part of the bedrock of foundational Delaware corporate decisions and could rightly be the subject of a lengthy law review article, but for purposes of this quick blog post, I will merely highlight a few of the more notable excerpts in bullet points.

  • A substantial basis for the court’s reasoning was a prior decision from the Court of Chancery which upheld the validity of corporate bylaws that required claims based on the internal affairs doctrine and related claims to be brought exclusively in the Court of Chancery. That decision by the current Chief Justice of Delaware, writing at the time as the Chancellor, was Boilermakers Local 154 Retirement Fund v. Chevron Corp., 73 A.3d 934 (Del. Ch. June 25, 2018).
  • Although the Boilermakers case involved bylaws, the Sciabacucchi decision explained why that same reasoning applied to a certificate of incorporation which is governed by similar provisions in the Delaware General Corporation Law (DGCL). The court in Sciabacucchi explained that the reasoning in Boilermakers focused on the ability to enforce forum-selection clauses that related to the internal corporate matters of a Delaware corporation as opposed to external matters, such as claims arising under the Securities Act of 1933.
  • The Court buttressed its reasoning by referring to the codification of the Boilermakers decision, shortly after its publication, by means of the adoption of a new Section 115 of the DGCL. In connection with that new DGCL section, the Delaware General Assembly also passed new amendments to Sections 102 and 109 of the DGCL which prohibit fee-shifting provisions in the certificate of incorporation or bylaws particularly in connection with claims related to the internal affairs of a corporation as defined by DGCL Section 115.
  •  The Court’s reasoning was also supported by reference to what the court referred to as “first principles.” Those first principles included several basic tenets of corporate law such as the following: (i) Although the document filed with the state that gives rise to an artificial entity such as a corporation, and confers powers on it, is a contract, it is not an ordinary private contract among private actors; (ii) The certificate of incorporation is a multi-party contract that includes the State of Delaware. Unlike an ordinary contract, it also includes terms by reference that are imposed by the DGCL; (iii) Unlike an ordinary contract, a charter can only be amended to the extent that it complies with the DGCL; (iv) The DGCL specifies what provisions a charter may or may not include; and (v) Although the courts enforce both types of contracts, when enforcing relationships created by the corporate contract, the courts use an overlay of fiduciary duty. See pages 38 to 42 and footnotes 111 to 125.
  • A thorough analysis of the contours and policy behind the internal affairs doctrine is an important feature of this opinion. See, e.g., pages 41-46.

In sum, the court reasoned that the “constitutive documents of a Delaware corporation cannot bind the plaintiff to a particular forum when the claim does not involve rights or relationships that were established by or under Delaware’s corporate law.” The opinion provides extensive citations to substantial scholarship, case law and statutes.

Prof. Ann Lipton provides extensive insights in her blog post about this case with links to her articles on the topic. The good professor’s scholarship on this issue was also cited by the court in the above opinion.

Many cases have been highlighted on this blog regarding forum-selection clauses in private agreements. See, e.g., here and here. In some of the posts on these pages about cases involving forum-selection clauses, a graphic of the Roman Forum adds color as well as an etymological connection.

SUPPLEMENT: Professor Stephen Bainbridge, a prolific corporate law scholar, kindly links to this post on his blog.

Link: https://www.delawarelitigation.com/2018/12/articles/chancery-court-updates/chancery-rules-on-limits-of-forum-selection-clauses-in-corporate-documents/

The issue presented to the Delaware Supreme Court in Flood v. Synutra International, Inc., Del. Supr., No. 101, 2018 (Oct. 9, 2018), was whether it was proper for the Court of Chancery to apply the MFW standard by: “(i) allowing for the application of the business judgment rule if the controlling stockholder conditions its bid on both of the key procedural protections at the beginning stages of the process of considering a going private proposal and before any economic negotiations commence; and (ii) requiring the Court of Chancery to apply traditional principles of due care and to hold that no litigable question of due care exists if the complaint fails to allege that an independent special committee acted with gross negligence.” See page 1.

The “MFW standard” was announced by the Delaware Supreme Court in Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014), which was highlighted on these pages.  That standard allowed for the deferential business judgment review that be applied to a merger “proposed by controlling stockholder conditioned before the start of negotiations on ‘both the approval of an independent, adequately-empowered Special Committee that fulfils its duty of care; and the uncoerced, informed vote of the majority of the minority stockholders.’” Id. at 644.

The high court concluded, in its majority opinion, that the interpretation of MFW standard based on the foregoing principles was correct, and cited with approval, for support of its conclusion, the high court’s previous affirmance in Swomley v. Schlecht, 128 A.3d 992 (Del. 2015) (Table).

Highlights:

Although this majority decision could be the subject of a lengthy analysis, especially in light of the vigorous dissenting opinion–which is an indication that reasonable people could easily differ on the conclusions in this case–I will provide highlights only in this short post, via bullet points, to allow a quick reference to key parts of the ruling. Those interested may read the whole opinion for a complete understanding of this important decision:

  • One of the issues in the case was whether or not the prerequisites that must be satisfied in order for the MFW standard to apply must be imposed as a condition of the deal at the absolute beginning of the negotiations–or if the imposition of those conditions at the “beginning” of negotiations can be more flexibly determined as a matter of chronology, as opposed to a “bright line test” requiring a specific point in time. See pages 9 to 21.
  • This issue arose because of the description in the Supreme Court’s initial announcement of the MFW decision that the prerequisites that must be a condition of the deal need to be announced “ab initio” which can be translated as “at inception” or “at the beginning.”
  • The court used several descriptions to explain why a more flexible approach should be used for exactly when in the chronology of a deal the conditions must be imposed, by referring to many situations where the word “beginning” does not refer to a specific point in time, such as the “beginning of a book” that extends beyond just the first word in a novel, and may at least include the first few pages of a novel, for example.
  • The court reasoned that a more flexible approach is sensible in terms of focusing on the more meaningful point in a deal when “substantive economic negotiations take place,” as in this case when a second offer letter was sent and no prior economic substantive negotiations had taken place after the first letter, but before the second offer letter was sent.
  • The second issue addressed was whether due care violations were pled in the complaint.
  • This ambiguity was raised by footnote 14 in the original MFW opinion of the Supreme Court, but which was clarified by this case which essentially nullified the dicta in footnote 14 of the original MFW opinion of the court. See pages 23 to 25, where the majority opinion in this case explains why that footnote 14 should not be relied on, and why no due care violation was adequately pled in this case.

A recent post on the Harvard Law School Corporate Law Blog, (on which I have published several articles as a contributing author), reviewed the Court of Chancery’s decision in Olenik v. Lozinski, C.A. 2017-0414-JRS (Del. Ch. July 20, 2018), in which a modification of the “ab initio” requirement of the MFW framework was applied in order for the challenged transaction to enjoy the benefit of the business judgment rule’s presumption. The MFW framework, and the cases that explain it, have been discussed in several posts on these pages. As the above-linked post describes it:

MFW provides for judicial review of a merger between a controller and the controlled company under the deferential business judgment rule standard (rather than “entire fairness”) if, among other things, “from the outset of negotiations” (the so-called “ab initio requirement”), the controller conditioned the transaction on approval by both an independent special committee and a majority of the minority stockholders