A recent Delaware Court of Chancery ruling in Wagner v. Tesla, Inc., C.A. No. 2021-1090-JTL, transcript ruling (Del. Ch. Jan. 19, 2022), has sharpened the “tools at hand” that the Delaware courts have long exhorted corporate litigators to use before filing a plenary lawsuit–namely, DGCL § 220, which is the basis for the right of stockholders to sue for corporate records.

Readers of these pages since the 2005 launch of this blog will be forgiven if they have grown weary of the multitude of Delaware decisions on DGCL § 220 highlighted on these pages, chronicling the often long-suffering stockholders who attempt to use the frequently blunt tools at hand.

But the recent Chancery ruling in Wagner v. Tesla, Inc. provides hope to those who would like § 220 to be a sharper tool for seeking corporate records than it sometimes seems to be.

There are four especially noteworthy takeaways in this gem of a transcript ruling, in the context of a decision on a motion to expedite:

  • A reminder that § 220 complaints should be given a trial date within 90 days of the complaint being filed. The court eschews dispositive motions and other procedural obstacles to a quick trial date.  A trial date in this case was provided in about 90 days or so from the filing of the complaint, despite protestations by the company, addressed below.

 

  • The court explained that it was a mistake for companies to defend § 220 cases on the merits of a potential underlying claim for several reasons, including that a stockholder does not need to demonstrate an “actionable claim”–but rather only needs to demonstrate a credible basis. See generally AmerisourceBergen Supreme Court decision highlighted on these pages.

 

  • Because a stockholder only needs to show a credible basis and does not need to prove that it has an actionable claim, if a company does not want to “air dirty laundry” then they should not defend § 220 cases by addressing the merits of a potential underlying claim that might be brought in a later plenary action. Likewise, it was no defense in this case to seeking a trial in 90 days that the company had a federal securities trial scheduled across the country during a similar time period because a § 220 case should not be viewed as having any material impact on a plenary trial on actionable claims.[1]

 

  • A defense that the court did not squarely address, but did not allow to be used as a bar to holding a prompt § 220 trial, was that the plaintiff in this case only held “fractional shares,” although the court did provide some dicta on that issue. See generally In re Camping World Holdings, Inc. Stockholder Derivative Litigation, C.A. No. 2019-0179 (consol.), memo op. (Del. Ch. Jan. 31, 2022)(An unrelated § 220 case also considering a motion to expedite, but deferring ruling on the argument that the plaintiff lacks standing because he only owned a fractional share of stock.)

[1] The court noted that at the time of the hearing on the motion to expedite in this case, Tesla had the largest market cap in the world and had capable lawyers to handle litigation of both cases with trials in close proximity to each other.

Supplement: A few hours after this post was written, I received in the mail a law review article that discussed the consequential Section 220 decision in Woods v. Sahara Enterprises, Inc., highlighted on these pages, and the author of that article kindly quoted from my blog post on that Sahara case. See Clifford R. Wood, Jr., Note, Knowing your Rights: Stockholder Demands to Inspect Corporate Books and Records Following Woods v. Sahara Enterprises, Inc., 46 Del. J. Corp L. 45, 52 (2021)The same article also cited to a law review article I co-wrote on Section 220. Id. at 46.

By:  Francis G.X. Pileggi* and Sean M. Brennecke**

Courtesy of the Delaware Business Court Insider, which published this article in two parts (it’s 34-pages long), this is our annual review of key Delaware corporate and commercial decisions.

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, such as many rulings involving Elon Musk, Tesla and Twitter.  Links are also provided below to the actual court decisions.

This is the 18th year that Francis Pileggi has published an annual list of key corporate and commercial decisions of the Delaware Supreme Court and the Delaware Court of Chancery, often with co-authors.  This list does not attempt to include all important decisions of those two courts that were rendered in 2022.  Instead, this list highlights notable decisions that should be of widespread interest to those who work in the corporate and commercial litigation field or who follow the latest developments in this area of Delaware law.  Prior annual reviews are available at this link.

DELAWARE SUPREME COURT DECISIONS

Supreme Court Reverses Chancery and Finds that LP Manager Reasonably Relied in Good Faith on Opinion Letter

          The Delaware Supreme Court recently reversed a decision of the Delaware Court of Chancery, highlighted on these pages, that addressed whether the general partner of a limited partnership relied in good faith on the formal legal opinion of a law firm to support a going-private transaction.

          In Boardwalk Pipeline Partners, LP v. Bandera Master Funds LP, Del. Supr., No. 1, 2022 (Dec. 19, 2022), the majority of Delaware’s High Court determined, without reconsidering the finding by the Court of Chancery that one of the formal legal opinion letters involved was not done in good faith, that:  (1) the proper decision maker accepted the opinion of counsel of one of the law firms involved to exercise a call right, contrary to the Chancery opinion; and (2) that party relied in good faith on the formal opinion letter of the Skadden law firm. The court found it unnecessary to address the Chancery’s holding that the formal opinion letter of another firm was not issued in good faith. (The Chancery opinion weighed in at 194-pages long, and the Supreme Court’s opinion, including the concurrence, in total was just under 100-pages long.)

Basic Background Facts

          This case involved an intricate and extensive network of entities including Delaware Master Limited Partnerships (“MLPs”).  Under Delaware law, an MLP can be structured to eliminate fiduciary duties.  The Boardwalk Limited Partnership Agreement (“Partnership Agreement”) disclaimed the fiduciary duties of the general partner and included a conclusive presumption of good faith when relying on advice of counsel.  It also exculpated the general partner from damages under certain conditions.

          Under the Partnership Agreement, the general partner could exercise a call right for the public units if it received an opinion of counsel acceptable to the general partner that certain regulations would have a particular impact.  The Boardwalk MLP general partner received an opinion of counsel from the Baker Botts law firm that the condition to exercising the call right had been satisfied.

In addition, the Skadden law firm advised that (i) it would be reasonable for the sole member, an entity in the boardwalk MLP structure, to determine the acceptability of the opinion of counsel for the general partner; and (ii) it would be reasonable for the sole member, on behalf of the general partner, to accept the Baker Botts opinion.  The sole member followed the advice of Skadden and caused the Boardwalk MLP general partner to exercise the call right and acquire all the public units pursuant to a formula in the Partnership Agreement.

Procedural History

          The Boardwalk MLP public unitholders filed suit and claimed that the general partner improperly exercised the call right. The Court of Chancery, in a post-trial opinion, held that the opinion by the Baker Botts firm had not been issued in good faith, and also held that the wrong entity in the MLP structure determined the acceptability of the opinion, and that the general partner was not exculpated from damages.

Issues Addressed

          The Supreme Court did not address all of the issues included in the Court of Chancery’s opinion, but determined that: (1) the sole member of the MLP was the correct entity to determine the acceptability of the opinion of counsel; (2) the sole member, as the ultimate decision maker who caused the general partner to exercise the call right, reasonably relied on a formal opinion letter of the Skadden law firm; and (3) the sole member and general partner, based on the applicable agreement, are conclusively presumed to have acted in good faith in exercising the call right.  The other arguments on appeal were not reconsidered in the majority opinion.

Highlights of Key Legal Analysis

          The Supreme Court only focused on the proper decision maker and the exculpation arguments.

          The Supreme Court disagreed with the interpretation of the Partnership Agreement by the Court of Chancery and initially focused on the need to read both the Partnership Agreement and the related LLC Agreement together because both agreements described how the general partner managed Boardwalk.  See footnote 232 (citation to Delaware Supreme Court decision about reading separate agreements together when there is evidence “that might imply an intent to treat them as a unitary transaction.”)

          The Supreme Court engages in a thorough contract interpretation analysis in their review of several key provisions in the Partnership Agreement.  See generally footnote 252 (citing cases that incorporate defined terms into contractual provisions to make them a part of the contract.)

Determination of Proper Entity as Decision Maker

          Unlike the Court of Chancery, the Supreme Court found both the Partnership Agreement and the LLC Agreement, when read together, to be unambiguous, reasoning that words are not surplusage if there is a reasonable construction which will give them meaning, and noting the truism that simply because the parties disagree on the meaning of a term does not render that term ambiguous.  See Slip op. at 50-60 and footnotes 263 and 264.  The Supreme Court held that the Sole Member Board and not the board of the general partner was the appropriate entity to make the acceptability determination and had the ultimate authority to cause the call right to be exercised.

Reasonable Reliance on the Skadden Opinion

          Delaware’s High Court disagreed with the Court of Chancery regarding agency theory and explained that the decision in Dieckman v. Regency GP LP, 2021 WL 537325, at *36 (Del. Ch. Feb. 15, 2021), did not support extending the agency theory to an exculpation inquiry of an agreement beyond those persons who govern a partnership or limited liability company.  Slip op. at 62.  Specifically, the court observed that:  “an entity, such as [the entity involved in the Gerber case,] Enterprise Products GP, can only make decisions or take actions through the individuals who govern or manage it.”  Slip op. at 62 (quoting from Gerber v. EPE Holdings, LLP, 2013 WL 209658, at *13 (Del. Ch. Jan. 18, 2013)).  See also footnote 282 (noting that notice given to a retained lawyer-agent may be viewed as notice to the client principal, but the cases do not support imputing scienter from a lawyer to a client).

          Unlike the Court of Chancery, the Supreme Court found nothing disqualifying about the Skadden firm giving “an opinion about an opinion,” but rather found it unobjectionable for Skadden to conclude that it would be reasonable for the Sole Member Board to accept the Baker Botts Opinion.  See Slip op. at 66-67.  The court held that implicit in the acceptability opinion is Skadden’s conclusion that the Baker Botts opinion was not contrived and that it was rendered in good faith.  Slip op. at 67.

          The court also discussed the provisions in the agreement that provided for a conclusive good faith presumption which the court distinguished from a rebuttable presumption.  The court opined that a conclusive presumption of good faith is “validly triggered through reliance on expert advice . . . and no longer subject to challenge.”  Slip op. at 68-69 (footnotes omitted).

Conclusion

          The court concluded that: “having reasonably relied on Skadden’s advice, the General Partner through the Sole Member, is conclusively presumed to have acted in good faith and is exculpated from damages.”

Concurring Opinion

          Justice Valihura wrote a concurrence that would have reversed the decision of the Chancery Court that the formal legal opinion of the Baker Botts firm was not rendered in good faith.  The concurrence also noted that because the majority left the findings regarding the Baker Botts opinion in place, the Baker Botts opinion did not satisfy Section 15.1(b)(ii) of the Partnership Agreement which was a necessary precondition to the exercise of the call right.

Supreme Court Offers New Guidance on DGCL Section 220

          The Delaware Supreme Court recently provided guidance to corporate litigators regarding the nuances of DGCL Section 220, which most readers recognize as the statute that allows stockholders to demand certain corporate records if the prerequisites in the statute–and those imposed by countless court decisions–have been satisfied. In NVIDIA Corp. v. City of Westmoreland Policy and Fire Retirement System, Del. Supr., No. 259, 2021 (July 19, 2022), a divided en banc bench of Delaware’s High Court explained in a 54-page decision why the “credible basis” requirement may be satisfied in some circumstances by “reliable hearsay”.

          Regular readers of these pages will be forgiven if their reaction might be: what more can be said about the relatively simple right of stockholders to demand corporate records, in some circumstances, pursuant to DGCL Section 220–that hasn’t already been covered by the hundred or more Section 220 cases highlighted on these pages over the last 17 years, as well as the thousands of court decisions on the topic over the many decades preceding this publication? In short, when the Delaware Supreme Court speaks, those who labor in its vineyard need to listen. And one indication that this topic is not as simple as the statute might suggest, is that those with the final word on Delaware corporate law–the members of the Delaware Supreme Court–were not in complete unanimity in their decision in this case. A concurrence was not in 100% agreement with the majority opinion.

Key Takeaway

          Prior to this decision, it was not well-settled whether a stockholder could satisfy the “proper purpose” requirement under DGCL Section 220 with hearsay–instead of live testimony, for example. The Delaware Supreme Court ruled that: “The Court of Chancery did not err in holding that sufficiently reliably hearsay may be used to show proper purpose in a Section 220 litigation, but did err in allowing the stockholders in this case to rely on hearsay evidence because the stockholders’ actions deprived NVIDIA of the opportunity to test the stockholders’ stated purpose.” Slip op. at 4. (emphasis added).

Overview of Background

          After finding post-trial both a proper purpose and a credible basis for the requests, the trial court ordered the production of documents to investigate: possible wrongdoing and mismanagement; the ability of the board to consider a pre-suit demand; and to determine if the board members were fit to serve on the board. The trial court rejected the defenses that: the requests were overbroad and not tailored with rifled precision to what is necessary and essential for the stated purpose; no proper purpose was shown; no credible basis was demonstrated to infer wrongdoing; and the stockholder failed to follow the “form and manner” requirements–in part by changing the list of requested documents during the litigation.

          Several stockholders consolidated their demands prior to suit, and 530,000 pages were produced prior to the litigation. Suit was filed in February 2020 based in part on public statements made during an earnings call. Prior to trial, the stockholders were less than forthcoming about whether they would call any witnesses, or which witnesses they would call at trial to establish their proper purpose. The Supreme Court held that the lack of pre-trial transparency by the stockholders deprived the company of the option to depose witnesses to explore the proper purpose issue prior to trial.

The Basics

          Most readers are familiar with the basic Section 220 requirements, but the Court’s review provides a helpful reminder. Some of the prerequisites include:

  • Stockholders must demonstrate by a preponderance of the evidence a credible basis from which the court may “infer possible mismanagement that would warrant further investigation.” Slip op. at 18.
  • The requested documents must be “essential to the accomplishment of the stockholder’s articulated purpose of inspection.” Id.

Key Highlights and Takeaways

  • The Court of Chancery has discretion to trim overly broad requests to craft a production order circumscribed with rifled precision.
  • Although a stockholder may not broaden the scope of their requests throughout the litigation, a Section 220 plaintiff may narrow their requests if they do so in good faith and such narrowing does not prejudice the company.
  • The Court observed that Section 220 cases are “summary proceedings” and such trials do not always include live testimony. Thus, the court reasoned that: “hearsay is admissible in a Section 220 proceeding when the hearsay is sufficiently reliable.” Slip op. at 38.
  • The Court cautioned that Section 220 plaintiffs should not abuse the hearsay exception, and “must be up front about their plans regarding witnesses” in the pre-trial phase of a case. Slip op. at 41. In this case the Court held that the company was deprived of the “ability to test the stockholders’ purpose”, such as through a deposition or otherwise, because the stockholders did not give the company sufficient notice about what they would rely on at trial to establish a proper purpose. Slip op. at 42-43.
  • In dicta, the Court upheld the trial court’s inference made by “connecting the dots” that the credible basis requirement was satisfied based on a combination of: insider stock sales, public statements that may have been false, and concurrent securities litigation supported by ample research. Slip op. at 45.
  • The Court restated the law that the “credible basis threshold may be satisfied by a credible showing, through documents, logic, testimony, or otherwise, that there are legitimate issues of wrongdoing.” Slip op. at 46.

          The concurring opinion of one member of the High Court observed that Section 220 cases often involve the issue of whether the “stated purpose” is the “actual purpose”, which makes the truth of the stockholder’s statements on that point a key issue.  The concurrence also emphasized the importance of the distinction between a proper purpose and the threshold requirement of credible basis–and that a stockholder who is neither an employee nor an officer of a company will rarely have first-had knowledge of wrongdoing, but a typical stockholder “will always have knowledge of her purpose because it is, after all, her purpose.” Slip op. at 54. (emphasis in original).

In Sum

          Although this decision may make it easier in some ways for a stockholder to prove its case in a Section 220 lawsuit, companies still have several tools at their disposal to test the basis for a stockholder’s assertion of a proper purpose and other statutory and court-made prerequisites for a Section 220 demand.

The Standard for Individual Contempt for Corporate Actions

          The Delaware Supreme Court recently had occasion to address the standard to determine when a person who controls an entity—for example, through ownership of all or most of the stock of a corporation—can be personally responsible for contempt of court penalties when the corporation’s actions are in violation of a court order.

          In the matter styled TransPerfect Global Inc. v. Pincus, Del. Supr., No. 154, 2021 (June 1, 2022), Delaware’s highest court reviewed the latest appeal in a long-running bitter battle that entered the Delaware court system in 2014 with a petition under Delaware General Corporation Law Section 226 to appoint a custodian to resolve a deadlock between two co-owners who were formerly engaged to be married and who each held 50% ownership of a translation and litigation-support company. They continued to co-manage their company, in a contentious manner, despite calling off their nuptials.

Procedural Background

          For purposes of this short summary, instead of reviewing the four prior Supreme Court decisions concerning this case, and about a dozen rulings of the Delaware Court of Chancery over almost a decade, as well as several cases filed in a few other states, suffice it to say that the limited aspect of the appeal that this column focuses on is a suit filed by TransPerfect in Nevada that was in violation of an order by the Delaware Court of Chancery requiring all disputes related to this matter to be filed in the Court of Chancery.

          After the appointment of a custodian to break the deadlock, one of the 50% owners bought the other half of the company to become essentially the 100% owner (the “controller”). The controller was not a named plaintiff in the Nevada lawsuit. But the Court of Chancery found the controller in contempt for the company’s filing of that lawsuit, which the trial court held to be a violation of a prior order, as explained in a 135-page opinion by the Court of Chancery.

Key Standards of Contempt Clarified

          Delaware’s High Court began its careful analysis with a recitation of the fundamentals on which a finding of civil contempt is based, with copious footnotes to authorities that describe the prerequisites and the nuances involved in such a “weighty sanction.” Slip op. at 22–23 and footnotes 99–101 and 127.

     A trial court must explain how an individual personally violated a court order to satisfy the standard to hold a person in contempt of a court order. Specifically, there must be evidence in the record that a person who controls a company personally violated a court order, for example by directing a company he or she controls to violate that court order. In this particular appeal, there was no such evidence in the record.

          For clarification and guidance, the Delaware Supreme Court explained that “to find a corporate officer or shareholder in civil contempt of a court order, the trial court must specifically determine that the officer or shareholder bore personal responsibility for the contemptuous conduct.” Slip op. at 33. The court observed that this requirement is consistent with the prerequisite that “when an asserted violation of a court order is the basis for contempt, the party to be sanctioned must be bound by the order, have clear notice of it, and nevertheless violate it in a meaningful way.” Id. at 33–34.

          Although the sanctions for contempt were properly applied to the company, the criteria for imposing penalties for contempt on the controller were not satisfied, based on the appellate record. Therefore, the penalties imposed on the controller for contempt were vacated.

          This decision will be helpful for anyone who needs to determine if a person who controls a company may also be personally liable for actions taken by the company that may violate a court order.

Supreme Court Decides Deadline for Notice of Indemnification Claim

          A recent Delaware Supreme Court decision provides a lesson for drafters of agreements for the sale of a business by providing an example of the problems caused by a lack of clarity in describing a deadline to send notices of claims for indemnification post-closing. To paraphrase a former member of the U.S. Supreme Court, the Delaware Supreme Court is always right when it comes to deciding Delaware law not because the members of the Court are infallible, but rather because they always have the last word.  The reader can decide how that aphorism applies to the decision of a divided court in the matter of North American Leasing v. NASDI HoldingsDel. Supr., No. 192, 2020 (April 11, 2022).

          The court decided three issues in this case. First, whether the Delaware Court of Chancery erred in interpreting an agreement of sale according to the principles of Delaware contract law in connection with determining what the deadline was in the agreement for giving notices of indemnification claims. Second, the court decided whether an affirmative defense of set-off and recoupment was waived. Lastly, the court decided whether it was appropriate for the Court of Chancery not to consider evidence that the total amount of the claims should have been reduced. Three members of the Delaware Supreme Court affirmed the decision of the Court of Chancery, and two dissented from the majority opinion.

Key Background Facts

          This case involved the sale of a company that, among other things, was involved in the construction of bridges. One of the bridge projects underway at the time of the closing on the sale of the business had a bond in place that the seller posted in the approximate amount of $20 million. After the closing, because the buyer decided to discontinue work on the bridge project, the letter of credit was drawn down in the full amount of the bond. The seller sued the buyer setting forth three causes of action: breach of contract regarding an indemnity obligation; equitable subrogation; and a claim for declaratory judgment that the defendants breached their indemnity obligation.

          The Court of Chancery granted summary judgment in favor of the seller and also denied a motion for reargument. In connection with the motion for the entry of the final judgment, the Court of Chancery determined that the affirmative defense of set-off/recoupment was waived because it was not raised in response to the motion for summary judgment, or in the motion for reargument.

Legal Analysis

          The majority decision acknowledged that questions of contract interpretation on appeal are reviewed de novo. Delaware’s high court observed that Delaware law adheres to an objective theory of contracts, which means that the construction of a contract should be “that which would be understood by an objective, reasonable third party.” That theory gives priority to the intentions of the parties reflected in the four corners of the agreement, “construing the agreement as a whole and giving effect to all its provisions.”

          The majority opinion carefully considered the various provisions of the agreement at issue and examined the reasoning of the Court of Chancery which rejected the buyer’s arguments that Section 9.3(a) provided for a deadline which ended before the indemnification claim of the seller arose, which would have rendered the indemnification notice untimely.

          The decision turned in large measure on the reading of one phrase. The majority explained its reasoning for the interpretation of the phrase “but in any event” as introducing an exception to the sentence that followed—not a limitation of the phrase that followed.

          The majority also agreed with the Court of Chancery’s conclusion that the set-off/recoupment defense was waived.  The buyer argued that set-off/recoupment was a defense that pertained to damages, and damages did not need to be briefed in the motion for summary judgment.  Not so, according to those with the last word on the topic, because damages were central to the relief requested in the motion.

Regarding the last issue of damages, the Supreme Court concluded that the Court of Chancery did not err when it did not consider the evidence regarding the reduction of damages because the set-off/recoupment defense was waived.

Dissent

          Notably, both the majority and the dissent agreed on the basic contract principles of Delaware law that applied to this case, although they disagreed on the result after applying those principles to the facts.

          A substantial focus of the dissent was its different interpretation of the phrase “ in any event,” and whether: it applied to all indemnification claims; or it only applied to the “representations and warranties” claims. The majority held that the phrase created an exception, but the dissent explained why in its view the phrase introduced a limiting or qualifying clause. The dissent referred to a dictionary definition for the adjective “any” as meaning “without limitation.” The phrase “in any event” means “no matter when [an event] happens.”

          The dissenters explained that the drafters of the agreement could have used the verb “the” instead of the word “any”—if the drafters wanted to establish an exception to the deadline for sending a notice of claim.

          Moreover, the dissent noted that even if the deadline for the notice of a claim were missed, the seller could still rely on equitable subrogation as a basis for a claim. The dissent added that the availability of that remedy supports the view that an earlier notice deadline would make an indefinite period for indemnification claims unnecessary.

          The dissent included the following memorable quote: “The majority sacrifices the plain meaning of Section 9.3 on the altar of the context of the provision and the contract as a whole.” The dissent concluded by explaining that its view demonstrated more than one reasonable interpretation of the agreement, which is one definition of an ambiguous contract. Therefore, the trial court should not have granted summary judgment and, in the view of the dissenting opinion, should have considered extrinsic evidence.

Supreme Court Splits on Contract Interpretation Issue

          A majority of the Delaware Supreme Court recently ruled that a settlement agreement contained an enforceable obligation to negotiate in good faith with the goal of reaching a separate definitive contract within the parameters outlined in the settlement agreement–although the court recognized that such a contractual obligation did not assume that a definitive agreement would necessarily be reached.

          In Cox Communications, Inc. v. T-Mobile, Inc., Del. Supr., No. 340, 2021 (March 3, 2022), Delaware’s High Court explained both basic principles and sophisticated nuances of Delaware contract law that should be required reading for anyone who needs the know the latest iteration of Delaware law on this topic, especially in the context of preliminary or transitional agreements that contemplate a more comprehensive second-stage agreement.

Why This Decision Is Noteworthy:

          A common situation where familiarity with this decision will be required is when a lawsuit is settled after a long day of mediation and basic terms are signed while all the parties are present, or otherwise available, to confirm the terms of a settlement–but a more complete, formal agreement is contemplated. One lesson that this decision teaches is to make certain that the abbreviated memorialization of essential terms is expressly stated to be enforceable, in the event a more formal, comprehensive agreement is never finalized. This, of course, applies beyond settlement agreements–for example, in the context of any deal where essential terms are agreed upon before a more comprehensive, formal agreement is completed (assuming the parties may want to enforce those essential terms, which may not always be the case.)

Key issue:

          The expedited appeal in this case turned on the interpretation of a single provision in a settlement agreement and whether it should be construed as either: (i) an unenforceable “agreement to agree”, or (ii) an enforceable “Type II preliminary agreement” requiring the parties to negotiate in good faith.

Basic Background Facts

          Cox and Sprint signed a settlement agreement in 2017 that resolved litigation between the parties. T-Mobile later purchased Sprint. Section 9(e) of that settlement agreement contained a sentence that was the crux of the dispute over contract interpretation that the Court decided. The disputed provision provided that:

          “Before Cox or one of its Affiliates (the “Cox Wireless Affiliate”), begins providing Wireless Mobile Service (as defined below), the Cox Wireless Affiliate will enter into a definitive MVNO agreement with a Sprint Affiliate (the “Sprint MVNO Affiliate”) identifying the Sprint MVNO Affiliate as a “Preferred Provider” of the Wireless Mobile Service for the Cox Wireless Affiliate, on terms to be mutually agreed upon           between the parties for an initial period of 36 months (the “Initial Term”).”

          T-Mobile, as the successor to Sprint’s rights in the settlement agreement, argued that the above language required Cox to enter into an agreement with it for a term of 36 months before it could provide wireless services with any other carrier. On the other hand, Cox read the above provision to merely require it to negotiate in good faith to “try” to reach an agreement. The Court of Chancery agreed with T-Mobile’s view of the provision. The Supreme Court did not.

Basic Principles and Nuances of Delaware Contract Law Underscored

  • Delaware adheres to an objective theory of contracts. See footnotes 47-48.
  • Extrinsic evidence is only considered if the text is ambiguous. n.49.
  • A contract provision is “not rendered ambiguous simply because the parties in litigation differ as to the proper interpretation.” n.51.
  • When a provision “leaves material terms open to future negotiations” as the High Court found Section 9(e) did, it is “a paradigmatic Type II agreement” of the kind we recognized in SIGA v. PharmAthene. n.52. (That Supreme Court decision and related decisions were highlighted on these pages.)
  • Unlike the old, superseded view that an incomplete agreement was not enforceable, Delaware recognizes that “parties may make an agreement to make a contract…if the agreement specifies all the material and essential terms including those to be incorporated in the future contracts.” n.53.
  • Delaware recognizes two types of enforceable preliminary agreements: Type I and Type II.
  • Type I agreements reflect a “consensus on all the points that require negotiation” but indicate the mutual desire to memorialize the pact in a more formal document. n.55. Type I agreements are fully binding.
  • Type II agreements exist when the parties “agree on certain major terms, but leave other terms open for future negotiation.” n.56 Type II agreements “do not commit the parties to their ultimate contractual objective but rather to the obligation to negotiate the open issues in good faith.” n.57.

Selected Excerpts of Court’s Reasoning

  • The Supreme Court read Section 9(e) to leave open a number of essential terms, such as price, which barred it from being categorized as a Type I agreement. n.60. That is, it specifically contemplates a future “definitive” agreement and provides that open terms will be “mutually agreed upon between the parties”–though it is not completely open-ended. 
  • Practice note:  If the parties want a settlement agreement to be a Type I binding agreement–as compared to an agreement to negotiate in good faith–a fair observation based on the Court’s decision in this case is to avoid the reference to a future “definitive” agreement, and make sure to include essential terms such as price.
  • Type II agreements do not guarantee the parties will reach agreement on a final contract because “good faith differences in the negotiation of the open issues may preclude final agreement.” n.63
  • The provision at issue in this case did not include a promise to do anything other than negotiate in good faith–which is where the Supreme Court parted ways with the Court of Chancery’s post-trial ruling. See also n.71 (explanation of why the majority  parted ways with the dissenting justices in this case, and did not think it was necessary to address extrinsic evidence.)
  • The Court’s reasoning including diagramming of the sentence in the disputed provision to parse the syntax and structure of the language at issue, by identifying the single subject, single verb, and singled object–as well as which clause modified the predicate and which clause modified the object.
  • The quality or quantify of consideration in a contract should not be second-guessed. n.86. Moreover: “obligations to negotiate in good faith” are recognized in Delaware as “not worthless”. n.81.

Postscript: A candid observation that reasonable people can differ on these contract issues is buttressed by the fact that the brightest legal minds in Delaware who decide what the law is in Delaware were not unanimous in their view of the law as applied to the facts of this case. That is, three members of the Delaware Supreme Court saw it one way, two members of that High Court saw it another way, and a member of the Court of Chancery arguably viewed the law as applied to the facts of this case in a third way.

Supreme Court Decides Important Contract Dispute in Sale of Business

          The recent Delaware Supreme Court decision in AB Stable VIII LLC v. MAPS Hotels and Resorts One LLC, Del. Supr., No. 71, 2021 (Dec. 8, 2021), has already been the subject of many articles in the few days since it was released because it is the first definitive pronouncement by Delaware’s High Court on the breach of what is known as an “ordinary course covenant” in connection with how a business is managed between the date an agreement of sale is signed and the date of closing. The Supreme Court affirmed the Court of Chancery’s decision, 2020 WL 7024929 (Del. Ch., Nov. 30, 2020), that the Seller breached its covenant that it would not deviate from how the business was typically run–without the Buyer’s consent–notwithstanding the intervening worldwide pandemic.

          Although I typically eschew highlights of decisions such as this one that have already been the focus of widespread analysis in legal publications, this decision has such widespread applicability to basic contract disputes, in addition to the sale of businesses, that I decided to provide a few pithy observations. I encourage readers to also read the copious commentary published by many others on this case that provides more detailed background facts and thorough insights.

Basic Facts

          The basic facts involved the sale of 15 hotel properties for $5.8 billion. In response to the pandemic and without the Buyer’s consent, the Seller made drastic changes to its hotel operations. The transaction also featured fraudulent deeds for some of the hotel properties. The lengthy Court of Chancery opinion provided extensive details about what the court regarded as active concealment or failure to disclose that fraud by the Seller’s law firm. The Supreme Court’s opinion references the failure to disclose the fraud, and repeats the Court of Chancery’s findings on that aspect of the case–that could be the topic for a separate article–but the High Court’s decision focuses on the impact of the violation of the ordinary course covenant as a sufficient basis to uphold Chancery’s decision. Among the changes made by the Seller without the Buyer’s approval (which could not have been unreasonably withheld) were the closure of two hotels, thirteen hotels “closed but open”, and the layoff or furlough of over 5,200 full-time-equivalent employees.

Highlights of Court’s Analysis 

  • The Court explained that an ordinary course covenant “in general prevents sellers from taking any actions that materially change the nature or quality of the business that is being purchased, whether or not those changes were related to misconduct.” See Slip op. at 25 and n. 42.
  • The agreement did not refer to what was ordinary in the industry in which the Seller operated. Rather, the ordinary course language referred only to the Seller’s operation in the ordinary course–and consistent with past practice in all material respects measured by its own operational history. Slip op. at 27 and n. 55-56.
  • The covenant did not have a reasonable efforts qualifier–although other parts of the agreement did. If the agreement referred to industry standards, it would be more akin to a commercially reasonable efforts provision, which it was not. Slip op. at 28 and n. 58
  • The High Court rejected the Seller’s reliance on FleetBoston Financial Corp. v. Advanta Corp., 2003 WL 240885 (Del. Ch. Jan. 22, 2003), as inapposite, but instead the Court relied on a Chancery decision interpreting an ordinary course covenant in Cooper Tire & Rubber Co. v. Apollo (Mauritius) Holdings Pvt. Ltd., 2014 WL 5654305 (Del. Ch. Oct. 31, 2014).
  • The Supreme Court affirmed Chancery’s reasoning that the drastic actions taken in response to the pandemic were both inconsistent with past practices and far from ordinary. Although the Seller could have timely sought the Buyer’s approval before making drastic changes in response to the pandemic, it did not. Having failed to do so, the Seller breached the ordinary course covenant and excused the Buyer from closing. Slip op. at 33.
  • The MAE provision in the agreement was written differently and had to be interpreted differently, and independently, from the ordinary course covenant, because, for example, it did not restrict a breach of the ordinary course covenant to events that would qualify as an MAE. The parties knew how to provide for such a limitation, as they did elsewhere, but they did not do so in the ordinary course covenant. Slip op. at 34.

SELECTED CHANCERY COURT DECISIONS

Chancery Examines Equitable Defenses and Restrictions on Transfer of LLC Interests

          The Delaware Court of Chancery’s recent opinion in XRI Investment Holdings LLC v. Holifield, No. 2021-0619-JTL (Del. Ch. Sept. 19, 2022), should be included in the pantheon of consequential Delaware Chancery opinions and will remain noteworthy for many reasons that deserve to be the subject of a law review article, but for purposes of this short review, I only intend to highlight a few of the many gems in this 154-page magnum opus with the most widespread applicability to those engaged in Delaware corporate and commercial litigation.

Brief Background

          The background facts are described in the first 50 pages or so of the opinion, but for purposes of this high-level short overview, this case involved a disputed transfer of interests in an LLC that were alleged to be in violation of the transfer restrictions in the LLC Agreement.  The membership interests were used as security for a loan, and upon default the membership interests were foreclosed upon in an inequitable manner.

Key Points

          This opinion engages in a deep and comprehensive analysis regarding the historical foundation of equitable defenses and their applicability to claims that are not the type of traditional claims pursued in a court of equity, as well as other key aspects of Delaware Law, including a discussion of:

  • The Step-Transaction Doctrine and when a series of transactions will be treated as a unitary whole.
  • Void and voidable transactions–and when an act will be treated as void ab initio, in which event it generally cannot be cured or defended against.
  • Equitable Defenses: Some, such as laches, can only be asserted as defenses to equitable claims–but other equitable defenses, such as acquiescence, are available to defend against both equitable and legal claims. This holding by the Court is contrary to a “smattering of recent decisions” in Chancery that did not fully address “nuances that permeate this area of the law”.
  • This decision attempts to bring more harmony and cohesiveness to that “smattering of recent decisions”.
  • The Court examines in extensive depth the somewhat ancient historical origins of the courts of equity, and the claims and defenses permitted in those courts.
  • The always useful fundamentals of contract interpretation are reviewed as well. See pages 45-47
  • The Court addresses the distinction between: (i) a “right tied to an ownership interest in an entity” and (ii) “the right to whatever cash that interest might generate once it reaches a particular person’s pocket”. See footnote 25. Also cited in the footnote is the recent Supreme Court opinion in Protech Minerals Inc. v. Dugout Team LLC, 288, 2021 (Del. Sept 2, 2022), and the important need to distinguish between the above two concepts.
  • Although the Court of Chancery faithfully (but maybe reluctantly) follows the Supreme Court’s precedent in CompoSecure LLC v. Card UX, LLC, No. 177, 2018 (Del. Nov 7, 2018), regarding void transactions, in dictum the opinion encourages the Supreme Court to reconsider its decision in CompoSecure. A polite list of reasons is offered for why Delaware’s high court should reconsider that precedent, in part because it prevented the trial court in this case from avoiding an inequitable result–and because there is a need to harmonize several areas of Delaware law at issue in this case. See page 111.
  • For example, current Supreme Court precedent allows parties to an agreement to declare certain acts as void–not voidable–and this current ability to “contract out” of equitable review and prevent a court of equity from applying its traditional equitable powers and remedies, deserves (reasoned this opinion respectfully), to be revisited.
  • Among the multi-faceted aspects of the opinion’s rationale for encouraging the  Delaware Supreme Court to reconsider its CompoSecure opinion, this opinion cites to basic contract principles under the common law that considered some contracts as void ab initio if they were violative of public policy. See footnotes 58 to 62 and related text. See also footnotes 65 to 68 regarding the aspects of corporate charters and bylaws that are subject to the limitations of the DGCL because corporations are creatures of the state.
  • This Court of Chancery decision importantly notes that the Delaware LLC Act recognizes that principles of equity apply in the LLC context. See footnote 96. (Cue: the “maxims of equity”.)
  • Even though the Court of Chancery held that its holding was “contrary to the equities of the case”, it held that the result was controlled by precedent–that should be revisited.

Chancery Addresses Fiduciary Duties of Corporate Officer

          The Delaware Court of Chancery recently published a post-trial decision involving the officer of a company who breached his fiduciary duties by, among other things, competing against the company for which he served as president. Metro Stores International LLC v. Harron, C.A. No. 2018-0937-JTL (Del. Ch. May 4, 2022), is a 128-page opinion that warrants a plenary review, but for purposes of this short review I am only highlighting a few gems of Delaware corporate and commercial law that every Delaware litigator should know.

Brief Overview

          The first 34 pages or so of the opinion describe in extensive detail the factual background. A basic outline of the facts includes an existing U.S. company that was a large player in the self-storage facility business.  They brought on a person who was assigned the job of growing the business in Brazil.  The court’s decision goes into great detail about how this person, in his capacity as president of the LLC that was responsible for the business in Brazil, in violation of his contractual and fiduciary duties, competed against the company and took confidential information from the company when he left.

Selected Key Principles of Delaware Law

  • The Court reviewed the elements that must be established in order to successfully pursue a breach of fiduciary duty claim, with a special emphasis on such a claim against the officer of a company, as compared to a director. Slip op. at 36-39.
  • The opinion describes the three potential levels of review that the court uses to determine if a fiduciary duty was breached. In this case, the court determined that the “entire fairness standard” applied.
  • The court explained that the state of the law in Delaware regarding the analysis of the duty of care of an officer applies the “Director Model”. Slip op. at 40–47.
  • The court highlighted the important difference between the provisions in an LLC Agreement that:

                     (i)  waive or limit the scope of fiduciary duties – – as compared                       with;

                     (ii)  an exculpation cause which merely limits liability for certain                             actions.  Slip op. at 47–48.

  • Notably, a clause limiting liability for certain actions does not limit fiduciary duties–and would merely bar money damages but not other potential remedies.
  • In an extensive footnote, the court explains that an officer is an agent of the company, and like all agents is a fiduciary–but not all fiduciaries are agents. See footnote 18.
  • The court expounded on the duty of loyalty and its various nuances. Slip op. at 40.
  • The court also described in great detail the duty of disclosure that an agent has. Slip op. at 55–57.
  • The court explained the very useful distinction between behavior that could be either a breach of contract and/or a breach of fiduciary duty – – and when both claims may proceed in the same case to the extent that they are not overlapping.
  • The court found that the unauthorized access to the former employer’s computer system, without authority, was not only a breach of confidentiality obligations but also a breach of a federal statute called the Stored Communications Act.  Slip op. at 120–122.
  • In particular, the court found that the federal statute involved, the Stored Communications Act, was violated because the former officer accessed an electronic communication while it was being stored, by either intentionally accessing the computer system without authorization or exceeding his authorization.  See 18 U. S. C. §2701.

Chancery Addresses Claims of Excessive Executive Compensation

          In the Delaware Court of Chancery opinion styled: Knight v. Miller, C.A. No. 2021-0581-SG (Del. Ch. April 27, 2022), the court described this case as “. . . another bloom on the hardy perennial of director compensation litigation.”  Slip op. at 2.

          The court granted some parts of a motion to dismiss, but allowed other claims to proceed based on the application of the entire fairness standard and the difficulty in securing a dismissal of claims at the initial pleadings stage when that fact-intensive standard applies, for example, when, as here, stock option awards are challenged.

Another Memorable Quote

          The opinion begins with the following eminently quotable truisms of Delaware corporate law that aptly describe how the court reviewed the allegations in this case:

          “The oft-noted fact that corporate actions are ‘twice-tested’–first in light of compliance with the DGCL, second for compliance with fiduciary duties–is neatly illustrated by directors’ actions to set their  own compensation.  Those actions are clearly authorized by statute, and just as clearly an act of self-dealing, subject to entire fairness review.”

          Slip op. at 2.

Highlights

          This case involved a challenge to the award of stock options to members of the board of directors, some of whom are considered to be controllers and insiders.

          The court noted that Section 141(h) of the Delaware General Corporation Law authorized the board to “fix the compensation of directors.”  The board in this case was implementing a stock incentive plan that vested the compensation committee with authority to award stock options in its discretion.

          The court began its consideration of the claims by describing the causes of action as requiring a “somewhat convoluted analysis” as the challenge to the stock awards implicates different standards of review for different grants.  Slip op. at 16.  Thus, the court reviewed the claims in three categories:

          (i) whether the Compensation Committee acted in bad faith as an        independent breach of fiduciary duty for granting the awards;

          (ii) alleged breach of the duty of loyalty for granting the awards generally; and

          (iii) alleged breach of the duty of loyalty for accepting the awarded stock      options.

          The court rejected the bad faith claims, and instructed that: “Bad faith is one of the hardest corporate claims to maintain.” Slip op. at 18. This version of a breach of the duty of loyalty claim typically is made when a plaintiff cannot establish lack of independence or lack of disinterestedness.

          Notably, the court observed that because the stock options were granted to individuals in “varying factual postures”:  “. . . different standards of review will apply to the Compensation Committee Defendants’ choices in making the grants.  As in nearly all pleadings stage challenges to the viability of a breach of fiduciary duty claim in the corporate context, deciding the standard of review will be outcome determinative.”  Slip op. at 20-21.

When Entire Fairness Standard of Review Applies–Absent an Exception

          Because the decision by directors to determine their own compensation is necessarily self-interested, even when done pursuant to a pre-existing equity incentive plan, such decisions are subject to the entire fairness standard of review, “unless a fully informed, uncoerced, and disinterested majority of stockholders has approved the compensation decisions and therefore ratified them.” Slip op. at 21 (citing In re Investors Bank Corp., Inc. S’holder Litig., 177 A.3d 1208).

Standard for Awards to Controllers

          The court explained that even if a controller of a company, such as a majority stockholder, is not actually a member of the compensation committee, the entire fairness standard still applies to compensation granted to a controller: “Because the underlying factors which raise the specter of impropriety can never be completely eradicated and still require careful judicial scrutiny.  The underlying risk is that the independent committee members who pass upon a transaction in question- -here the granting of equity awards- -might perceive that disapproval may result in retaliation by the controlling stockholder.”  Slip op. at 20-21.  This principle applies equally to outside directors as decisionmakers, given the controlling stockholder’s ability to elect directors.  Slip op. at 26-27.

Nascent Standard of Review–When Accepting Compensation is Allegedly “Clearly Improper”

          The court acknowledged that the standard of review for breach of fiduciary duty claims in connection with accepting compensation is “nascent in its development.”  Slip op. at 32.  With over 200 years of decisions in the Delaware Court of Chancery about fiduciary duty, it’s surprising that any aspect of caselaw about fiduciary duties is “nascent,” but so it is.

          The court discussed this aspect of the case by beginning with the definition of the duty of loyalty.  Slip op. at 29-30. The plaintiff conceded that there is a relative lack of caselaw defining what might constitute “clearly improper” to the extent that it might be a breach of fiduciary duty to accept compensation that is clearly improper.  The court found that even though the caselaw is not well developed on this issue, courts have found actions for breach of fiduciary duty for accepting compensation to survive a motion to dismiss when two factors are present:  (1) the compensation award was ultra vires, and the recipients knew it, or (2) where compensation was repriced advantageously in light of confidential and sensitive business information which the recipients knew, and which they accordingly used to the company’s detriment.

Standard for Accepting “Clearly Improper” Compensation

          The court  acknowledged that : “The ‘clearly improper’ standard, if standard it is, is nascent in its development”. Then the court asked the question: “What is the standard that must be applied to the facts when considering whether such a breach of duty has been plead?”  The court concluded that:

What is required is defendant’s knowingly wrongful acceptance of compensation, and the standard must be bad faith.  That is, there must be sufficient pleading of scienter to support a bad faith claim, which serves as a claim based on breach of the duty of loyalty.  But, as discussed above, there is an insufficient record to sustain even a claim that the Compensation Committee Defendants making the awards acted in bad faith, much less that the recipients’ acceptance violated that standard. 

          All that is alleged is that option awards were made at what proved to be      the bottom of the market.

Slip op. at 32

          Therefore, the court granted the motion to dismiss with respect to the cause of action alleging breach of fiduciary duty by all defendants for accepting the March 2020 awards.  The court distinguished Howlan v. Kumar, 2019 WL 2479738 (Del. Ch. June 13, 2019) and Pfeiffer v. Leedle, 2013 WL 5988416 (Del. Ch. Nov. 8, 2013).  Unlike the Howlan case, the instant case does not plead nonpublic facts known to the company and the defendants that give rise to an inference of “clearly improper” compensation.  Unlike Pfeiffer, there is no allegation that the awards violate the stock incentive plan, let alone that the defendants were aware of the same.

          The court also noted that the claim against the Compensation Committee Defendants for accepting the self-dealing awards merged with the breach of duty claim against the Compensation Committee Defendants for making the awards.

Waste Claims Dismissed

          The court dismissed the corporate waste claims because in order to constitute waste, the grants must have been “without business purpose” but that cause of action was insufficiently plead.

Stock Incentive Plan Not Self-Executing

          Regarding the grant of stock options to outside director defendants, the court explained that there are other cases such as Kerbs v. California Eastern Airwaves, 90 A.2d 653 (Del. 1952), which involved a self-executing stockholder-approved plan where the equity incentive plan listed grants of unissued stock in specific amounts to named executives based on the mathematical formula which left no room for discretionary decisions by the directors.  No such formula constrained the directors in this case.

Key Point–Difficult to Win Motion to Dismiss When Entire Fairness Standard Applies

          The court instructed that when entire fairness is the applicable standard of review, dismissal of a complaint under a Rule 12(b)(6) motion is usually precluded because:  “A determination of whether the defendant has met its burden will normally be impossible by examining only the documents the court is free to consider on a motion to dismiss.”

          Although the court listed at footnote 102 the many other cases that have followed this approach–it also acknowledged at footnote 103 a few cases that have granted motions to dismiss, but “generally where a plan has failed to allege any evidence of unfair process or price.”

          The court found that the facts in this case were sufficient to raise a reasonably conceivable inference of an unfair transaction–but the finding does not preclude the Compensation Committee Defendants from establishing that the awards were entirely fair.

          The court observed that it would allow the claims against the outside directors to proceed even though it found that: the facts alleged in this case were “not overwhelming.”  Slip op. at 21-25.

Standard Applicable to Officer Defendants

          The third standard applied was to officer defendants and the court determined that the standard of review applicable to officer defendants was the business judgment rule unless the plaintiff pleads:  (1) Facts from which it may be reasonably inferred that the board or compensation committee lacked independence (for example, if they were dominated or controlled by the individual receiving the compensation); or (2) Facts from which it may be reasonably inferred that the board or compensation committee, while independent, nevertheless lacked good faith in making the award.

          The court found that the Compensation Committee Defendants did not act in bad faith in making the awards, and plaintiff did not plead facts relating to the lack of independence by the Compensation Committee for purposes of making the compensation awards.  Although the business judgment rule can be dislodged by the successful pleading of corporate waste, the court explained why that was not successfully plead here.  Therefore the motion to dismiss this claim with respect to the officer defendants was granted.

The author of this overview was co-counsel for all the defendants–and the intent of this short discussion was to provide objective highlights without any advocacy of any party’s position.

Irrevocable Proxy Too Ambiguous to Enforce

          In the Chancery decision of Hawkins v. Daniel, C.A. No. 2021-0453-JTL (Del. Ch. April 4, 2022), the court found that an irrevocable proxy was ambiguous and it did not state that it would “run with the shares” based on the “special principles of contract interpretation” applicable to proxy agreements.  This 85-page opinion needs to be read by anyone who wants to know the latest Delaware law on enforceability of proxies.

Court Allows Claims to Proceed Against Buyer Whose Payment to Seller for the Purchase of Company Stock Was Hacked–and Never Received

          In the case styled:  Sorenson Impact Foundation v. Continental Stock Transfer & Trust Co., C.A. No. 2021-0413-SG (Del. Ch. April 1, 2022), the Delaware Court of Chancery denied a motion to dismiss filed by former stockholders of an acquired company who did not receive the proceeds from the sale of their shares in their company because the wire transfer from the buyer to them for the purchase of their shares was hacked.  An intermediary transfer agent was used to disburse the funds and transfer the stock.

          This, of course, is a nightmarish situation that anyone who expects to receive wired funds wants to avoid. For a graphic display of the various parties involved and at what point the hacking occurred, a chart appears as an exhibit attached to the last page of the opinion linked above.

Chancery Declares Delaware a “Pro-Sandbagging” State

          In a recent Delaware Court of Chancery decision that addressed claims of breach of contract and fraud in connection with the sale of a business, the Court announced that Delaware law allows for sandbagging, which can be described as allowing a buyer of a business to sue for breach of a representation made in an agreement for the sale of a business even if the buyer knew that the representation was false–before closing–and when the agreement was signed.

          In Arwood v. AW Site Services, LLC, C.A. No. 2019-0904-JRS (Del. Ch. Mar. 9, 2022), while acknowledging that the Delaware Supreme Court has not definitively ruled on this issue, the Court of Chancery expressed confidence in stating that Delaware is a “pro-sandbagging state” for purposes of allowing a buyer to bring claims for breach of contractual representations in an agreement against a seller of a business even if the buyer were aware of the claim prior to closing–and at the time that the buyer signed the agreement of sale.

          This decision is consequential and noteworthy for the foregoing highlights alone, but there are also other notable aspects of this 113-page opinion that make it worth reading in its entirety.  For purposes of this short blog post, I will only provide a few bullet points.

Additional Selected Highlights

  • The Court defined sandbagging as referring colloquially to “the practice of asserting a claim based on a representation despite having had reason to suspect it was inaccurate.” See footnote 267 and related text.  The Court also explained sandbagging as “generally understood to mean to misrepresent or conceal one’s true intent, position, or potential in order to take advantage of an opponent.”  See Slip op. at 71.  See also footnotes 270-274 and accompanying text describing the etymology of the word and public policy issues implicated by the Court’s position.
  • The Court also observed that the parties are free to draft contract provisions to avoid sandbagging claims. See footnote 290 and accompanying text.
  • This ruling also instructed that a fraud claim in Delaware is the same as a claim for fraudulent inducement. Slip op. at 50.
  • In this lengthy opinion the Court chronicles in much detail the history of the deal from the first meeting of the buyer and seller through various iterations of the letter of intent, as well as through the extraordinary and unfettered access given to the buyer during the due diligence period (that helped to defeat a fraud claim), and that may serve as a cautionary tale for drafters of agreements of sale.
  • This decision also features extensive analysis and commentary regarding the competing expert reports on damages, and why the Court relied more on one expert as compared to the other.

Chancery Decision Addresses Advancement Issues

            The Delaware Court of Chancery decision in Krauss v. 180 Life Sciences Corp., C.A. No. 2021-0714-LWW (Del. Ch. Mar. 7, 2022), addressed nuances of advancement law that will be useful to those who labor in the field of corporate litigation dealing with these issues that are crucial to officers and directors.

          The key points of law that makes this decision blogworthy are twofold: (i) it serves as a reminder that some compulsory counterclaims may be eligible for advancement; and (ii) it reinforces the longstanding interpretation in Delaware of the phrase that serves as a prerequisite to providing advancement, with an origin in § 145 of the Delaware General Corporation Law, and which was used in the provision of the Bylaws at issue in this case–namely, whether the person seeking advancement was sued “by reason of the fact” that she was an officer.

          Advancement has been a frequent topic of commentary on these pages over the last 17 years, and has been the subject of many articles and book chapters published by this writer.

Background:

          Unlike the corporate charter involved in this case, the advancement provision in the Bylaws of the company involved did not require board approval for advancement to be given for certain types of proceedings.

Highlights:

          Perennially, one of the more common defenses to a claim for advancement, and often the least successful argument–as in this case–is whether the prerequisite to the provision for advancement in the Bylaws was triggered to the extent that the litigation for which advancement was sought was prosecuted: “by reason of the fact that . . . [the plaintiff] is or was a director or officer of the company.”  See Slip op. at 8-9 and n.32.

          As the Court explained, the foregoing phrase is broadly interpreted by Delaware courts, and many published decisions have explained in many different ways why it is very easy to satisfy that condition of advancement, despite may failed attempts by companies to use it as a defense.  See Id. at 9-10.  See also footnotes 32-37.

          Also noteworthy in this case is the reminder that the court will not typically make a determination at the advancement stage about an allocation between legal fees that must be advanced–and intertwined claims in the same case that are not subject to advancement.  But rather, the parties should follow the procedure in the Danenberg v. Fitracks  decision to make advancement payments based on the good faith allocation of the parties, and a final allocation will be made at the end of the case.  See Slip op. at 12 and footnotes 44-45.

          Another noteworthy aspect of this case is the reminder that compulsory counterclaims are covered by the right to advancement when asserted to defeat or offset an underlying claim that is subject to advancement.  See Slip op. at 20 and footnote 74-81.

Chancery Ruling Underscores Basics of Stockholder Right to Demand Corporate Records under DGCL Section 220

          A Delaware Court of Chancery ruling in Wagner v. Tesla, Inc., C.A. No. 2021-1090-JTL, transcript ruling (Del. Ch. Jan. 19, 2022), has sharpened the “tools at hand” that the Delaware courts have long exhorted corporate litigators to use before filing a plenary lawsuit–namely, DGCL § 220, which is the basis for the right of stockholders to sue for corporate records.

          Readers of these pages since the 2005 launch of this blog will be forgiven if they have grown weary of the multitude of Delaware decisions on DGCL § 220 highlighted on these pages, chronicling the often long-suffering stockholders who attempt to use the frequently blunt tools at hand.

          But the recent Chancery ruling in Wagner v. Tesla, Inc. provides hope to those who would like § 220 to be a sharper tool for seeking corporate records than it sometimes seems to be.

          There are four especially noteworthy takeaways in this gem of a transcript ruling, in the context of a decision on a motion to expedite:

  • A reminder that § 220 complaints should be given a trial date within 90 days of the complaint being filed. The court eschews dispositive motions and other procedural obstacles to a quick trial date.  A trial date in this case was provided in about 90 days or so from the filing of the complaint, despite protestations by the company, addressed below. 
  • The court explained that it was a mistake for companies to defend § 220 cases on the merits of a potential underlying claim for several reasons, including that a stockholder does not need to demonstrate an “actionable claim”–but rather only needs to demonstrate a credible basis. See generally AmerisourceBergen Supreme Court decision highlighted on these pages. 
  • Because a stockholder only needs to show a credible basis and does not need to prove that it has an actionable claim, if a company does not want to “air dirty laundry” then they should not defend § 220 cases by addressing the merits of a potential underlying claim that might be brought in a later plenary action. Likewise, it was no defense in this case to seeking a trial in 90 days that the company had a federal securities trial scheduled across the country during a similar time period because a § 220 case should not be viewed as having any material impact on a plenary trial on actionable claims.[1] 
  • A defense that the court did not squarely address, but did not allow to be used as a bar to holding a prompt § 220 trial, was that the plaintiff in this case only held “fractional shares,” although the court did provide some dicta on that issue. See generally In re Camping World Holdings, IncStockholder Derivative Litigation, C.A. No. 2019-0179 (consol.), memo op. (Del. Ch. Jan. 31, 2022)(An unrelated § 220 case also considering a motion to expedite, but deferring ruling on the argument that the plaintiff lacks standing because he only owned a fractional share of stock.)

[1] The court noted that at the time of the hearing on the motion to expedite in this case, Tesla had the largest market cap in the world and had capable lawyers to handle litigation of both cases with trials in close proximity to each other.

Supplement: A few hours after this post was written, I received in the mail a law review article that discussed the consequential Section 220 decision in Woods v. Sahara Enterprises, Inc., highlighted on these pages, and the author of that article kindly quoted from my blog post on that Sahara case. See Clifford R. Wood, Jr., Note, Knowing your Rights: Stockholder Demands to Inspect Corporate Books and Records Following Woods v. Sahara Enterprises, Inc., 46 Del. J. Corp L. 45, 52. (2021)The same article also cited to a law review article I co-wrote on Section 220. Id. at 46.

______________________________________________________________________________

*Francis G.X. Pileggi is the managing partner of the Delaware office of Lewis Brisbois Bisgaard & Smith, LLP. His email address is Francis.Pileggi@LewisBrisbois.com. He comments on key corporate and commercial decisions, and legal ethics topics, at www.delawarelitigation.com

**Sean M. Brennecke is a partner in the Delaware office of Lewis Brisbois Bisgaard & Smith, LLP. His email address is Sean.Brennecke@Le

16th Annual Review of Key Delaware Corporate and Commercial Decisions

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

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

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

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

DELAWARE SUPREME COURT DECISIONS

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

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

Key Takeaways:

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

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

Brief Overview of the Case:

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

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

Delaware Fiduciary Duty Law:

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

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

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

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

Bottom Line:

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

Link to original post on these pages about this case.

 

Supreme Court Interprets Key Words in Agreement

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

Background:

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

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

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

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

Analysis by the Supreme Court:

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

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

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

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

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

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

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

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

In sum:

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

Link to original post.

 

Delaware Supreme Clarifies Contract-Based Right to Corporate Records

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

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

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

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

Basic Factual Background:

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

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

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

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

Primary Issue Addressed on Appeal:

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

High Court’s Reasoning–Key Takeaways:

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

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

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

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

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

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

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

Link to original post.

 

Supreme Court Rejects Two Common Defenses to Section 220 Demands

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

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

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

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

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

Key Takeaways:

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

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

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

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

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

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

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

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

Link to original post

 

DELAWARE CHANCERY COURT DECISIONS

Chancery Provides Refreshing Section 220 Guidance

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Link to original post

 

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

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

Key Issue Addressed:

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

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

Key Facts of Swipe case:

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

Key Principles of Law with Widespread Applicability:

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

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

Link to original post.

 

Chancery Determines Standard Applicable to Contested Transaction

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

Key Points:

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

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

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

Link to original post.

 

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

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

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

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

(2) director vacancies were properly filled; or

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

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

Highlights:

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

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

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

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

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

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

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

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

      This decision teaches that unless one of the rule’s elements is rebutted, the Court merely looks to see whether the business decision made was rational in the sense of being one logical approach to advancing the corporation’s objective.

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

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

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

Link to original post

 

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

Link to original post

 

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.

Link to original post

 

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.

Link to original post

 

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. 

———————————————————————————————————————————————

__________________________________________________________________________

*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.