A recent Delaware Supreme Court decision should be required reading for those 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.  In Dohmen v. Goodman, Del. Supr., No. 403, 2019 (June 23, 2020), Delaware’s High Court answered a question 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.

An associate at Eckert Seamans prepared this overview.

The Delaware Court of Chancery recently granted injunctive and monetary relief based on the parties’ contractual agreements and obligations. This case involves two Delaware entities that own school meal management software: inTEAM Associates, LLC (“inTEAM”), and Heartland Payment Systems, Inc. (“Heartland”). The action stems from a transaction in which Heartland bought substantially all of the assets of inTEAM’s predecessor, School Link Technologies, Inc. (“SL-Tech”). inTEAM Associates, LLC v. Heartland Payment Systems, Inc., C.A. No. 11523-VCMR (Del. Ch. Sept. 30, 2016).

Background: In the sale, Heartland acquired WebSMARTT, a program categorized by the USDA as Nutrient Analysis Software. Heartland did not acquire inTEAM’s Decision Support Toolkit (“DST”) program. Three agreements, the Asset Purchase Agreement, the Co-Marketing Agreement, and the Consulting agreement, govern the transaction. The collective agreements contain non-competition, non-solicitation, and cross-marketing provisions.

The Asset Purchase Agreement prohibited the parties from providing competitive products or soliciting customers in competition with Heartland’s business. However, inTEAM’s consulting, eLearning, and DST portions of the business were explicitly excluded from the scope of the provision (the “inTEAM carve-out”). Thus, inTEAM could still competitively pursue those aspects of its business.

The Co-Marketing Agreement also contained reciprocal non-competition provisions. Additionally, it contained a provision obligating Heartland to provide inTEAM with marketing support with respect to particular products. Heartland was allowed to terminate the Co-Marketing Agreement if inTEAM did not meet specified sales targets.

The Consulting Agreement provided that Goodman was to act as an advisor to Heartland. It also contained non-competition and non-solicitation provisions.

The parties later agreed that inTEAM could develop a new program based on DST technology: KidsChoose. Heartland was to share beneficial information in exchange for a portion of the resulting revenue. After KidsChoose failed to meet expectations, inTEAM was allowed to develop a new version of the product. Thereafter, Heartland terminated its support obligations under the Co-Marketing Agreement.

In 2014, inTEAM employees emailed a potential customer about providing an inTEAM alternative to Heartland’s WebSMARTT program. Although WebSMARTT contained POS features, inTEAM was interested in adding a POS feature to its current software. inTEAM later sent two additional emails to a school district to obtain information about their current POS software.

In 2015, Heartland and an inTEAM competitor, Colyar Technology Solutions, Inc. (“Colyar”) submitted a joint proposal to Texas for the development of meal management software. After Texas declined Heartland’s proposal, Heartland promised to “ramp up efforts with Colyar[ ]” to bid in other states.

inTEAM then revealed a new program, CN Central, which combined prior DST technology. The USDA classified CN Central as Menu Planning Tool software, as opposed to Nutrient Analysis Software, such as WebSMARTT.

Parties’ Allegations: inTEAM alleges that Heartland breached its non-competition, cross-marketing, and support obligations by partnering with Colyar and failing to support inTEAM’s software development with respect to KidsChoose. Heartland asserts that inTEAM and Goodman breached their non-competition obligations by developing CN Central in competition with WebSMARTT. Additionally, Goodman breached his non-solicitation obligations by participating in inTEAM’s efforts to solicit business from schools.

Court’s Analysis: The court found that inTEAM did not breach its non-competition obligations, as CN Central was based on DST technology covered by the inTEAM carve-out. The carve-out contemplated future versions of DST software, like CN Central, with greater functionality. The Court did not consider Heartland’s extrinsic evidence on this matter because the agreement unambiguously described the carve-out. The agreement documents plainly discussed the “future release” of DST technology, and anticipated the development of a product with functionality that did not exist at closing.

Heartland also argued that CN Central competed with WebSMARTT because both programs had the ability to analyze nutrients. However, CN Central, a Menu Planning Tool, could only perform a subset of the abilities of Nutrient Analysis Software, such as WebSMARTT. Heartland argued that the USDA’s software classifications were not dispositive, as the programs had overlapping functionality. However, the Court explained that the USDA classifies the various software according to their functionality. Thus, CN Central did not compete with WebSMARTT.

With respect to Heartland, the Court found that it breached its non-competition obligations when it collaborated with inTEAM’s competitor, Colyar, to produce software covered by the scope of inTEAM’s business. It did not matter that the anticipated technology never came to fruition. However, Heartland did not breach its support obligations relative to KidsChoose. KidsChoose was a brand of Heartland’s software, and Heartland validly terminated those obligations in 2013. Regardless, inTEAM did not point to any evidence that Heartland failed to provide adequate cross-marketing aid. Moreover, there was no evidence Heartland caused any problems with the unsuccessful version of the program.

Finally, with respect to Goodman, the Court found that he did not breach his non-competition obligations as a result of the inTEAM carve-out. As discussed, CN Central did not compete with WebSMARTT, despite similar functionality. Additionally, an email evidencing inTEAM’s interest in developing POS features was not proof that inTEAM was actively engaging in selling POS software. However, the Court found that Goodman did breach his non-solicitation obligations when he encouraged a school district to adversely modify its existing relationship with Heartland by proposing an alternative tool to WebSMARTT.

Conclusion: In finding that no equitable defenses applied, the Court granted inTEAM an injunction because: (1) it showed actual success on the merits; (2) breaching a covenant not to compete is an irreparable injury; and (3) the balance of equities favored inTEAM because Heartland agreed to the non-compete covenant, and inTEAM would continue to suffer harm contemplated by the agreements if the behavior continued. However, inTEAM was not entitled to costs and fees pursuant to the language of the agreements.

Similarly, Heartland was entitled to an injunction regarding Goodman. The parties contractually agreed that an injunction was the appropriate remedy for the specified violations. In balancing the equities, the court limited the injunction to six months from the execution date. Unlike inTEAM, Heartland was entitled to damages pursuant to the agreement language.

Those who follow the decisions of the Delaware Court of Chancery should also be interested in relevant information about the five members of the Court. Much has been written about the Court’s newest Chancellor. Within the last few days, several separate commentaries have been published about Chancellor Leo E. Strine, Jr., and his opinions. Two pieces seem noteworthy enough to be of particular interest to readers of this blog who follow the decisions of the Court (which of course, this blog highlights).

First, we refer to a thoughtful post by a nationally prominent corporate law scholar who has been cited many times in Delaware decisions and is both a fan and a FOCS (friend of Chancellor Strine).  Professor Stephen Bainbridge refers to the Chancellor as a prophet of sorts in his insightful post of March 1, 2012, available here. The good professor describes the good Chancellor as one of many members of the Delaware judiciary who use corporate law decisions as a type of parable to provide moral lessons and cautionary tales to guide the behavior of fiduciaries whose conduct they review. Excerpts from his post follow, but you should read the whole thing.

If the minor prophets of the Old Testament have a common message, it is their repetitive denunciation of the lust for power, the oppression of poor by the rich, and the ways in which insiders take advantage of outsiders. They were not really prophets in the Nostradamus sense of telling the future, so much as social critics pointing out injustice and ethical/moral lapses. They called society and its leaders to repentance.

Some years ago Ed Rock wrote a law review article, Saints and Sinners: How Does Delaware Corporate Law Work?, about Delaware judges that had a tremendous impact on my own thinking. In it, Ed argued that “Delaware cases can best be understood as attempts to create social norms for senior managers, directors and the lawyers who advise them.” He then explained “how these norms are transmitted to the principal actors (managers, directors and lawyers), drawing on the ‘A Memorandum to our Clients’ genre, extrajudicial judicial utterances, and popular and trade press accounts.”

In a powerful elaboration of Rock’s thesis, Lyman Johnson has argued that Delaware judges have used cases as parables “demanding a measure of self- restraint—when those who direct or manage company affairs press self-gain (or sloth) to the point of intolerable excess.” “In unveiling discrete stories within the master narrative, Delaware’s judges tell the tale of other protagonists—the ‘saints and sinners’ described by Edward Rock—and then offer their own assessments of those accounts.”

In other words, Delaware judges have a prophetic function. Like the minor prophets of old, Delaware judges call out sinners among the rich and powerful and hold them up as examples of what not to do.

In part, singling out the sinners for opprobrium serves as a sanction and deterrent. This function invokes the controversial question of whether shaming is an appropriate sanction in corporate law. It is an issue on which I have frankly waffled over the years. There are good arguments on both sides and, at least for present purposes, I shall therefore take an agnostic position.

At the moment, the more important point is Rock and Johnson’s thesis that shaming sinners is a way of creating social norms that influence the aspirational principles of corporate best practice. In Brehm v. Eisner, the Delaware Supreme Court referred to its “institutional aspirations that boards of directors of Delaware corporations live up to the highest standards of good corporate practices.” Rock and Johnson help us to understand how Delaware courts seek to influence the content of those practices and to incentivize corporate actors to aspire to best practice rather than the bare legal minimum.

Which brings me to Delaware Chancellor Leo Strine. In the interests of full disclosure, I should say that I’ve met Strine many times. I respect and like him. Make of that what you will….

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It would be hard to argue with the proposition that Strine has a “stingingly robust vocabulary.” One anonymous lawyer reportedly said that “‘the first word I think of with him is scary,’ … alluding to Strine’s occasional bursts of temper and penchant for cutting down lawyers who displease him.” Katrina Dewey opines that:

Strine’s brilliance is staggering, his energy enormous; a boiling rage for the law of the now that is in your face and seething. He relishes skewering fat cats like Hannibal Lecter loves fava beans and a nice Chianti.

Strine’s willingness to skewer fat cats cropped up again yesterday in his opinion in the In re El Paso Corporation Shareholder Litigation case. (Opinion here.) In brief, Goldman Sachs was on both sides of a takeover deal and Strine spanked them. Hard.

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In this use of strong rhetoric, the Delaware courts again resemble the minor prophets. As a group, they made frequent use of vituperative and vitriolic language. Consider, for example, the incredibly powerful images in Chapter 8 of Amos.

Johnson identifies an important virtue to the use of such strong language:

The moral disapproval expressed in a court of equity’s opinion is a key feature of it. Former Chancellor William Allen has written, for example, that corporate directors are “members of moral communities with allegiances to moral codes.” He also has noted that “we would be badly wrong to think that knowledge of legal rules is all that we need to understand the legal world.” Furthermore, judges are among the very few persons in our society with the moral and legal authority to warn and exhort corporate elites. …

A Chancery Court opinion, moreover—like a sermon, song, or story— has a “tone,” a “melody,” as well as words and a particular ending. Anyone who has been severely scolded and let off the hook remembers the scolding, as does anyone witnessing another person on the wrong end of a good dressing down.

All of which reminds me of the old joke about the mule trainer was asked how he was able to train such stubborn animals. “Let me show you,” he said. The trainer grabbed a 2×4 and hit the mule over the head with it. “First,” he said, “you get their attention.” Strong, even vituperative language is the Delaware courts’ 2×4….
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The members of the Court of Chancery are pictured below. Seated from left to right: Vice Chancellor John Noble, Chancellor Leo E. Strine, Jr., Vice Chancellor Donald F. Parsons, Jr. Standing from left: Vice Chancellor J. Travis Laster, Vice Chancellor Sam Glasscock III.

Court of Chancery

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The second article on the same day about the top jurist on Delaware’s court of equity could almost be described as a mini-biography that provides many perspectives of the multi-faceted judicial officer who until last year served as a vice chancellor on the court.
Susan Beck of American Lawyer.com penned a probing article on March 1, 2012, available here, that includes many quotes from His Honor, such as the following gems from an excerpt of the article, that relate to an argument by some that Delaware is losing cases to other states whose judges are opining on issues of Delaware law that are brought before them:

… [the Chancellor] warns that there’s a danger if other courts start routinely interpreting Delaware law. “People should stay in their own lane,” he says, using one of his favorite expressions. “How do you get accountability unless you get the answer from the horse’s mouth?” He adds: “We are the Bergdorf Goodman, not the Dollar Store, of corporate law.”

Strine doesn’t identify any particular states as running Dollar Store corporate law shops, but in the past he has parried with judges in other states over the proper place for M&A litigation. In 2007 shareholder litigation over a leveraged buyout involving The Topps Company, Inc., he basically told New York state court judge Herbert Cahn to keep his mitts off this dispute when different shareholder groups filed challenges to the deal in New York and Delaware. Although Cahn refused to step back, Strine did end up issuing the controlling ruling, in which he enjoined a shareholder meeting because he found Topps’s proxy materials misleading.

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The Susan Beck article is on the “long side” for an online piece, but it is worth reading in its entirety.

Supplement: Robert Teitelman of The Deal provides commentary that follows the foregoing train of thought, and graciously refers to this post. Professor Steven Davidoff, The Deal Professor at The New York Times, provides scholarly insights on the Chancellor’s recent El Paso decision.

POSTSCRIPT: Professor Bainbridge graciously links to this post on his blog at ProfessorBainbridge.com, available here, and I am flattered and grateful that he has designated me as his inaugural FOTB (friend of the blog). Really and truly, I’m honored.

Kurz v. Holbrook, No. 5019-VCL (Del. Ch., Feb. 9, 2010), read opinion here. This 80-page Delaware Court of Chancery opinion decided an expedited claim based on DGCL Section 225, challenging the election of board members.

Important Groundbreaking Issues Addressed.

This opinion is must reading for anyone who would seek to remove a sitting director or try to reduce the number of directors on a board. This decision addresses for the first time whether a bylaw amendment can reduce the size of a board. See, e.g., Slip op. at 24. This decision is also required reading due to its treatment of the issues that arise in connection with the right to vote shares that are held in street name, some of which are addressed authoritatively by a Delaware court for the first time. See, e.g., Slip op. at 60. The "underdeveloped" topic of "third-party vote buying" in connection with corporate elections is also addressed in a scholarly fashion, noting that the analysis is different than what might apply in the political arena. See, e.g., Slip op. at 64-65.

One of the best ways to highlight an opinion of "law review article length" for purposes of a blog, is to use the overview of the case provided by the Court itself in the opinion. The Court’s introduction to the case follows verbatim:

This post-trial opinion resolves competing requests for relief under Section 225 of the Delaware General Corporation Law (the “DGCL”). 8 Del. C. § 225. At stake is control of the board of directors (the “Board”) of EMAK Worldwide, Inc. (“EMAK” or the “Company”).

Prior to December 18, 2009, the Board had six directors and one vacancy. On December 18, one director resigned, creating a second vacancy. The plaintiffs contend that on December 20 and 21, Take Back EMAK, LLC (“TBE”) delivered sufficient consents (the “TBE Consents”) to remove two additional directors without cause and fill three of the vacancies with Philip Kleweno, Michael Konig, and Lloyd Sems. Incumbent director Donald Kurz is a member of TBE. The TBE Consents, if valid, would establish a new Board majority.

The defendants contend that on December 18, 2009, Crown EMAK Partners, LLC (“Crown”) delivered sufficient consents (the “Crown Consents”) to amend EMAK’s bylaws in two important ways. First, the Crown Consents purportedly amended Section 3.1 of the bylaws (“New Section 3.1”) to reduce the size of the Board to three directors. Because Crown has the right to appoint two directors under the terms of EMAK’s Series AA Preferred Stock, reducing the board to three, if valid, would give Crown a Board majority. Second, the Crown Consents purportedly added a new Section 3.1.1 to the bylaws (“New Section 3.1.1”) providing that if the number of sitting directors exceeds three, then the EMAK CEO will call a special meeting of stockholders to elect the third director, who will take office as the singular successor to his multiple predecessors. The defendants contend that the bylaw amendments are valid and that the next step is for the EMAK CEO to call a special meeting.

I hold that the bylaw amendments adopted through the Crown Consents conflict with the DGCL and are void. They were therefore ineffective to shrink the Board or to require the calling of a special meeting. I hold that the TBE Consents validly effected corporate action. The Board therefore consists of incumbent directors Kurz, Jeffrey Deutschman, and Jason Ackerman, and newly elected directors Kleweno, Konig, and Sems. One vacancy remains.

In addition to seeking relief under Section 225, the parties have asserted a panoply of claims, cross-claims, and third-party claims, and they have amassed an extensive record relating to those claims. My decision addresses only the requests for relief under Section 225, and I have sought to avoid resolving factual disputes that could have collateral implications if the other claims proceed. Contemporaneously with the issuance of this opinion, I am entering a partial final judgment under Rule 54(b) to implement my decision, thereby facilitating a prompt appeal should the defendants wish to pursue it. 

Continue Reading Delaware Court of Chancery Rules on Contested Board Elections in Expedited Section 225 Suit; Addresses Issues of First Impression on Reduction in Board Size, and Voting Rights; Re: Street Name v. Stock Ledger

I am blogging today while attending the meeting in Washington, D.C., of the Business and Corporate Litigation Committee of the ABA’s Business Law Section. I am attending a panel discussion called: Institutional Investors: The Sleeping Giants or Shrugging Altases of the Corporate Democracy Debate? The panel includes Delaware Supreme Court Chief Justice Myron Steele; Prof. Larry Hamermesh; Hedge Fund Manager William Ackman of Pershing Square Capital Management, L.P.; Moderator Rolin Bissell of Young Conaway, Wilmington; Amy Goodman of Gibson Dunn, D.C.; Trevor Norwitz of Wachtell Lipton, NY; John Wilcox of TIAA-CREF and Ann Yerger of the Council of Institutional Directors.

Prof. Hamermesh noted that most commentators agree that the common goal of corporate governance is maximizing shareholder wealth. John Wilcox observed that the $380 billion in assets that TIAA-CREF manages is concerned with long-term as opposed to short-term profit.

Chief Justice Steele provided comments about the recent Stone v. Ritter  (2006 LEXIS 597 (Del. November 6, 2006)), decision of the Delaware Supreme Court. His Honor referred to that decision as making clear that good faith is not a stand-alone duty, but is a part of the duty of loyalty. Moreover, that decision–as mentioned on this blog here when the case was released–also addressed Caremark (In Re Caremark Int’l Inc. Deriv. Litig., 698 A.2d 959, 971 (Del. Ch. 1996)), issues and the board’s duty to have a compliance system in place and to monitor that system to check that it is working. Of course, however, the decision reaffirmed that the court will not second guess directors when their actions earn them the protection of the Business Judgment Rule.

 The materials handed out at the seminar include a memo dated today, Dec. 1, 2006 from Martin Lipton,  in which he advises board members that "the fundamental governance issue confronting corporations in 2007 will be the extent to which shareholders should have the ability to intervene in board actions and influence directors". The panel also discussed the surge in the support of "majority voting" requirements, as compared to plurality, and the memo of Marty Lipton basically says that majority voting requirments are here to stay.

One panel member, William Ackman,  suggested some improvments in this area: For example, the record date is often days prior to the meeting date, which means that some shareholders who sell after the record date but before the meeting and thus despite having no stake in the outcome, are still voting at the shareholders’ meeting. Prof. Hamermesh noted that is usually up to the board to determine the record date, and that the statute gives them some flexibility, though in light of modern technology making the "gap" between the record date and meeting date less necessary, it might be a good focus of consideration for the next round of DGCL revisions or updates.