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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.

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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.

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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’s “Tools 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).

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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).

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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.

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.