The Delaware Supreme Court, in Akorn, Inc. v. Fresenius Kabi AG, et al., Del. Supr., No. 535, 2018 (Dec. 7, 2018), affirmed in a 3-page order, two days after oral argument, the Court of Chancery’s 253-page decision which was highlighted on these pages, and which is thought to be the first Delaware decision to find that a “material adverse effect” clause was triggered in such a way as to allow an acquiring party to terminate a merger pre-closing. Much has been written in trade publications about the Akorn case. See, e.g., here and here.
Vice Chancellor J. Travis Laster of the Delaware Court of Chancery gave a lecture at the University of Iowa College of Law on “Big Law Ethics”, or lack thereof, based on findings that His Honor described in the “A” trilogy of cases in which he scored the ethical lapses of several senior partners in a few of the largest and most prestigious law firms in the country.
The presentation, at the below link, should be watched by anyone interested in the role lawyers play in society.
[For those who might want to skip the introductions and preliminary comments, the core of the presentation begins at about 13:00 of the video at the above link.]
His Honor’s presentation lasted about an hour, and it’s worth watching in its entirety, but for those who may want the highlights, a few golden nuggets can be found in the following bullet points:
- Our system depends on the integrity of lawyers.
- There is a Latin maxim that translates as: Fraud destroys everything.
- Most aspects of litigation occur outside the view of the court, so the court cannot police most of what happens in litigation, such as during the discovery process
- Ethical lapses by senior partners at the largest and most prestigious law firms in the country, as described in the three Chancery decisions known as the “A” Trilogy: Akorn; AB Stable; and Anthem (one of which was 246-pages long; another over 300 pages), suggest that the problem of ethical lapses at law firms who occupy the loftiest levels of the legal profession is not an isolated occurrence, but might portend a more widespread problem.
- Litigation will not function properly if lawyers are not honest and American society in general is based on voluntary compliance with legal obligations.
- Even otherwise good people can experience moments of weakness
Three Reasons Why Good People May Do Bad Things
- Situational Dynamics: Clients can go elsewhere and most law firm partners are expected to originate business and bring in, or keep, clients. The job of a lawyer is to advance the goals of the client (though the lawyer must rise above the sometimes base or non-existent “morals of the marketplace”.)
- Cultural Norms: Lawyers are expected to be zealous advocates (though that word is not part of the ethical rules, as compared to being referenced in the comments). This can lead to “altruistic extremism” and bad behavior that they would not likely engage in if not arguing on behalf of a client. Lawyers make arguments for a living and some of the best advocates are in Big Law (among other places.)
- Slippery Slope or Ethical Fading: Minor ethical lapses, if not checked or corrected or discouraged, can lead to larger violations. The slippery slope can be flattened if minor violations are “nipped in the bud” and corrected.
Possible Solutions Suggested by V.C. Laster
- Mentorship programs to help establish positive norms and check errant behavior, along with self-policing.
- Be ready to fire a client who insists on improper actions.
- Find supportive colleagues (e.g., American Inns of Court).
- Be attentive and “look for” ethical issues, which are not always easy to recognize.
- Use cautionary tales as lessons of behavior to avoid.
- Remember that the coverup is often worse than the behavior attempted to be hidden.
Final Words of Wisdom:
- A lawyer’s top priority should be justice. The duty to the court is higher than the duty to the client.
- In the words of Justice Brandeis: sunlight is the best disinfectant
A recent Delaware Court of Chancery decision discussed many issues of great interest to commercial and corporate litigators in connection with a finding that Boston Scientific Corporation could not justifiably terminate an acquisition agreement with the target company, including an analysis of the familiar contractual standard of “commercially reasonable efforts,” which has been held to be synonymous with the similar phrase “reasonably best efforts.” In Channel Medsystems, Inc. v. Boston Scientific Corporation, C.A. No. 2018-0673-AGB (Del. Ch. Dec. 18, 2019), a 119-page decision, Delaware’s equity court determined that Boston Scientific did not fulfill its contractual duty to use “commercially reasonable efforts” to consummate the merger.
The court noted that Delaware case law “contains little support for distinctions” between the clause “commercially reasonable efforts” and the clause “reasonably best efforts.” See footnote 410 (citing the Delaware Supreme Court decision in Akorn, 2018 WL 4719347, at * 91.) Many prior Delaware decisions interpreting and applying that contractual standard have been highlighted on these pages. Followers of this area of the law will find the scholarly insights on this topic by Professor Bainbridge especially notable.
In the instant Chancery decision, the court relied on the Akorn case that interpreted a similar covenant to “impose obligations to take all reasonable steps to solve problems and consummate the transaction.” (citing Williams Cos. v. Energy Transfer Equity, L.P., 159 A.3d 264, 272 (Del. 2017)). The Williams case was highlighted on these pages. The court further relied on the Delaware Supreme Court decision in Akorn to provide the following guidance:
“When evaluating whether a merger partner has used reasonable best efforts, this court has looked to whether the party subject to the clause: (i) Had reasonable grounds to take the action it did; and (ii) Sought to address problems with its counter party.” See footnote 410.
The instant Chancery decision provided several examples why the record supported the holding that Boston Scientific, according to the court’s findings, made no reasonable efforts to engage with Channel, or “to take other appropriate actions to attempt to keep the deal on track . . ..” See Slip op. at 102.
The court used the reasoning of another decision when it explained that:
“Utter failure to make any meaningful attempt to confer with Channel when Boston Scientific first became concerned . . ., both constitutes a failure to use reasonable best efforts to consummate the merger and shows a lack of good faith.” See footnote 418 (citing to Hexion, 965 A.2d at 755-56.)
Finally, the court observed that even though motive to avoid a deal does not demonstrate the lack of a contractual right to do so, the evidence in this case, according to the court’s findings:
“Adds credence to and corroborates other robust factors demonstrating that Boston Scientific did not fulfill its obligation to engage with Channel in a commercially reasonable manner to vet any concerns they may have had about the findings in the Greenleaf Report and to keep the transaction on track thereafter. To the contrary, Boston Scientific simply pulled the ripcord.”
Over the last 14 years that I have published this blog, I have compiled an annual review with a list of key Delaware corporate and commercial decisions that have widespread utility to practitioners, especially those court decisions that are not widely covered by other legal publications or the mainstream press. On a few occasions, I have prepared a mid-year review. This is one of those years.
A few weeks ago, I prepared highlights of key decisions published over the last 6 months or so (and in some instances a little beyond that period), for presentation to a large law firm based on the west coast. I’m “repurposing” my materials for that presentation by providing those case highlights below. For each blurb below, there is a link to a fuller overview as well as a link to the complete court opinion.
HIGHLIGHTS OF RECENT KEY DELAWARE CORPORATE AND COMMERCIAL DECISIONS–as of May 30, 2019
DELAWARE SUPREME COURT DECISIONS
Delaware Supreme Court Clarifies Appraisal Law
The Delaware Supreme Court, in a per curiam decision, recently determined that “deal price less synergies” was the appropriate determination of fair value in the appraisal action before it. In Verition Partners Master Fund Ltd. v. Aruba Networks, Inc., C.A. No. 11448-VCL (Del. Apr. 16, 2019), the Court reversed the Court of Chancery’s holding that “unaffected market price” was the fair value on the date of the merger. This case is the third in a recent trilogy of precedent-setting Delaware appraisal cases, preceded by DFC Global Corp. v. Muirfield Value Partners, L.P., 172 A.3d 346 (Del. 2017) and Dell, Inc. v. Magnetar Global Event Driven Master Fund Ltd, 177 A.3d 1 (Del. 2017). This case has been the subject of extensive commentary by scholars and practitioners in the short time since its publication.
Company Required to Produce Emails Among Management to Stockholders
The Delaware Supreme Court recently issued an opinion that clarifies the duty of a company to produce emails among its management in a Section 220 case. In KT4 Partners LLC v. Palantir Technologies, Inc., Del. Supr., No. 281, 2018 (Jan. 29, 2019), Delaware’s High Court addressed a demand under Delaware General Corporation Law (DGCL) Section 220 by a stockholder for corporate books and records, including emails among management, to allow the stockholder to investigate possible wrongdoing, such as the reasons behind amendments to an Investors’ Rights Agreement that severely reduced the original rights granted under that agreement.
Notably, the court in its opinion quoted from a law review article that yours truly co-authored on the topic, which explained why demands under DGCL Section 220 should often include electronically-stored information (ESI) such as emails. See footnote 76.
This opinion is noteworthy because it clarifies Delaware law and authoritatively describes those circumstances when a demand for books and records under DGCL Section 220 will require the company to produce ESI, such as emails among management, to the extent necessary for the proper purpose established in a Section 220 case.
The stockholder demand in this case stated as its purpose the investigation of mismanagement, including depriving investors of their right of first refusal under an investors’ agreement that was amended without the consent of all investors, as well as interfering with the sale of stock by a large stockholder. The Court of Chancery, in a decision highlighted on these pages, determined that although some books and records had to be produced, emails need not be. The Supreme Court disagreed with that ruling and affirmed in part, reversed in part, and remanded.
Importantly, the facts of this case include an acknowledgment by the company that it often did not follow corporate formalities such as preparing board resolutions and keeping minutes of board meetings, but rather often communicated by email and took action by email–including on matters that were the subject of the investigative purpose of the Section 220 demand.
Highlights of Key Aspects of the Court’s Ruling:
For busy readers, I provide bullet points of key aspects of this crucial decision, but those who need to be familiar with the nuances of this aspect of Delaware corporate litigation should read the entire 49-page opinion linked above.
- The court discussed what appeared to be an issue of first impression about the standard of review regarding a dispute over the interpretation of the stated purpose in a Section 220 demand. The court explained that the standard of review for the scope of relief is abuse of discretion, but de novo review applies to questions of law such as whether the stated purpose under Section 220 is proper. Although contract interpretation is also subject to de novo review as a question of law, fact-intensive and judgment-based determinations are reviewed for abuse of discretion, and factual determinations that underlie the trial court’s interpretation of an ambiguous written document deserve the deference given to factual findings.
- The Delaware Supreme Court found that the demand in this case did include an explicit reference to a request for electronic documents.
- The core issue identified by the High Court was whether the Court of Chancery abused its discretion in ruling that emails and other ESI were not necessary to satisfy the purpose of investigating the wrongdoing alleged in this Section 220 case.
- The court reviewed the basic principles and policy undergirding the qualified common law and statutory right to inspect corporate books and records. See Slip op. at 22 to 24.
- The court observed that the scope of documents to which a stockholder is entitled under Section 220 is limited to those that are necessary to accomplish the proper purpose as stated in the demand. See Slip op. at 24 to 25.
- In explaining why ESI should be included in appropriate Section 220 cases, the Delaware Supreme Court quoted from a law review article on this topic co-authored by your truly. See footnote 76 (quoting Francis G.X. Pileggi, et al., Inspecting Corporate “Books and Records” in a Digital World: The Role of Electronically Stored Information, 37 Del. J. Corp. L. 163, 165 (2012)).
- The court reviewed Delaware cases that previously addressed whether ESI such as emails should be included in a Section 220 request. See footnotes 71 to 74. See also Amalgamated Bank v. Yahoo!, Inc., a Chancery opinion highlighted on these pages that also cited the same law review article on this topic co-authored by yours truly that was quoted by the Supreme Court in the instant case. See, e.g., footnote 72 (citing a Court of Chancery Order allowing for imaging of a Blackberry in a Section 220 case.)
- The court also explained, based on the facts and circumstances of this case, why emails and ESI had to be produced and were needed to accomplish the stated purpose. See Slip op. at 31. For example, the court explained that the company involved did not comply with required corporate formalities such as minutes of board meetings and that it often conducted corporate business informally, including over email, regarding the issues subject to the Section 220 demand. See footnote 77 and accompanying text. The ESI at issue included, for example, an allegedly incriminating message sent via LinkedIn.
- The court also emphasized that there may be some Section 220 cases where ESI may not be required to be produced by the company, such as those situations where the corporation has traditional, non-electronic documents that are sufficient to satisfy the needs of the Section 220 petitioner.
- In this case, the company admitted that there were no hardcopy documents that addressed all of the requests, and that there were emails and other ESI that were responsive to the requests.
- The court also provided practice tips for future litigants: there should be a cooperative effort to focus on the substantive data that should be produced–or in other words, focus on the information that is needed and that is available whether it be in hardcopy or in ESI format.
The court also addressed an unrelated issue. It rejected the argument that the company made that as a condition of production it could require the stockholder to file any suits based on the data received in the Delaware Court of Chancery. Although there have been cases that have imposed similar jurisdictional conditions, the court explained why such a condition should be the exception and not the norm.
SUPPLEMENT: Law360 published an article about this case in which they quoted my comments about the importance of the High Court’s opinion.
Supreme Court Explains the Implied Covenant of Good Faith and Fair Dealing
A recent Delaware Supreme Court decision is must-reading for those who need to know the latest iteration of Delaware law on the implied covenant of good faith and fair dealing. In Oxbow Carbon & Minerals Holdings, Inc. v. Crestview-Oxbow Acquisition, LLC, Del. Supr. No. 536, 2018 (Jan. 17, 2019), Delaware’s High Court provided the latest articulation of Delaware law on the multi-faceted doctrine of the implied covenant of good faith and fairing dealing. In connection with affirming in part and reversing in part a 176-page trial court opinion, which was highlighted on these pages, the Supreme Court agreed with the analysis of the trial court’s correct reading of the plain meaning of the LLC agreement at issue, but disagreed with the application by the trial court of the implied covenant.
Highlights of the most recent authoritative explanation of the implied covenant under Delaware law are noted in the following bullet points:
- When a board is given contractual discretion to make a choice, that is not a “gap” to be filled. Although “the vesting of a board with discretion does not relieve the board of its obligation to use that discretion consistently with the implied covenant of good faith and fair dealing,” the argument was not made in this case that the board exercised this contractual discretion in bad faith. See footnotes 92 and 93 and accompanying text.
- The court explained the two common situations where the implied covenant often applies. The first, at issue in this case, is when it is argued that a situation has arisen that was unforeseen by the parties and where the agreement’s express terms do not cover what should happen. See footnote 93.
- The next situation is when a party to the contract is given discretion to act as to a certain subject and it is argued that the discretion has been used in a way that is impliedly proscribed by the contract’s express terms. Id.
- “When a contract confers discretion on one party, the implied covenant requires that the discretion be used reasonably and in good faith.” Id.
- Delaware’s High Court explained that the “implied duty of good faith and fair dealing is not an equitable remedy for rebalancing economic interests after events that could have been anticipated, but were not, later adversely affected one party to a contract.” See footnote 109 and accompanying text.
- Rather, “the covenant is a limited and extraordinary legal remedy.” See footnote 110.
- The Supreme Court added that the implied covenant “does not apply when the contract addresses the conduct at issue, but only when the contract is truly silent concerning the matter at hand. Even where the contract is silent, an interpreting court cannot use an implied covenant to re-write the agreement between the parties, and should be most chary about implying a contractual protection when the contract could easily have been drafted to expressly provide for it.” See footnotes 110 to 113 and accompanying text.
Delaware Supreme Court Clarifies Ab Initio Requirement for BJR Review
The Delaware Supreme Court recently clarified the “ab initio” requirement announced in the Kahn v. M&F Worldwide Corp. case as part of the set of standards that would allow for the BJR standard to apply to a challenged merger. See Olenik v. Lodzinski, No. 392, 2018 (Del. Supr., rev. April 11, 2019). The High Court determined that the requirement was not satisfied based on the facts of the instant case because the “economic bargaining took place prior to the date” when the protections announced in the Kahn v. M&F Worldwide Corp. case needed to be in place.
Much commentary has already been written about this case, so it will not be covered thoroughly on these pages, but I refer to prior decisions that have applied the ab initio requirement, for background purposes, as noted on these pages.
Supreme Court Affirms Akorn Decision
The Delaware Supreme Court, in Akorn, Inc. v. Fresenius Kabi AG, et al., Del. Supr., No. 535, 2018 (Dec. 7, 2018), affirmed in a 3-page order, two days after oral argument, the Court of Chancery’s 253-page decision which was highlighted on these pages, and which is thought to be the first Delaware decision to find that a “material adverse effect” clause was triggered in such a way as to allow an acquiring party to terminate a merger pre-closing. Much has been written in trade publications about the Akorn case. See, e.g., here and here .
COURT OF CHANCERY DECISIONS
Chancery Instructs on DGCL Merger Requirements
A recent Delaware Court of Chancery opinion began by describing the complaint as reading like a law school exam designed to test the knowledge of a student regarding the requirements in the DGCL that must be satisfied in connection with a merger, and the court commented that the company would not have done well on the exam.
In Mehta v. Mobile Posse, Inc., C.A. No. 2018-0355-KSJM (Del. Ch. May 8, 2019), the court identified the six primary issues in this case as follows:
(1) Whether DGCL Section 262 was not complied with in connection with the failure to notify stockholders of their appraisal rights within the required timeframe;
(2) Whether DGCL Section 228 was not complied with due to the failure to send prompt notice of the written stockholder consents;
(3) Whether the merger agreement, or documents it incorporates, failed to comply with DGCL Section 251 by not including the amount of cash the preferred stockholders would receive for their shares;
(4) Whether the stockholder consents did not enjoy the ratifying effect under DGCL Section 144;
(5) Whether the director defendants breached their fiduciary duty of disclosure; and
(6) Whether the director defendants breached the fiduciary duty of loyalty because the merger was a self-dealing transaction and not entirely fair. With one small exception, the court found that the statutory violations were sufficiently established at the early procedural stage of a motion for judgment on the pleadings.
Key Highlights of Decision:
- As an initial procedural matter, in connection with this motion for judgment on the pleadings, the court observed that it was not well-established in Delaware case law or Rules of Civil Procedure whether a “supplemental notice” attached to a motion for judgment on the pleadings could be considered “part of the record or pleadings.” Based on this opinion, however, it is now established that under Delaware law, under some circumstances, it is now possible for such a supplemental notice to be included as part of the pleadings in such a procedural posture. See, e.g., footnotes 1 through 6 and accompanying text.
DGCL Section 262:
- The company sought a “do-over” or a “mulligan” for its statutory errors, because it purported to send proper notices required by DGCL Section 262–only after suit was filed. Three problems with that approach are that: (i) Such a “replicated remedy proposal” had never before been blessed by a Delaware court; (ii) Even the supplemental notice proposed was itself wrong (in part because it quoted the statute of another statute); and (iii) trying to make a “supplemental notice” sent after the lawsuit was filed does not always make it part of the pleadings, although as noted above–in some circumstances–based on the opinion in this case, it is now possible to do so. See Slip op. at 13.
DGCL Section 228:
- Based on an amendment to the statute passed in 2017, Section 228 no longer requires that the written consent of stockholders be dated next to each signature. See Slip op. at 19.
- The court addressed the “less than bright-line rule” about whether or to what extent disclosures are required in connection with written consents of stockholders pursuant to Section 228, but cases cited by the court in this opinion support the view that in this case the company is not entitled to judgment on the pleadings on this issue in light of the lack of material data, or their supplying of incorrect data, with the solicitations for consents that were sent to the minority stockholders in this case.
DGCL Section 228(e)–Prompt Notice Requirement:
- The prompt notice requirement under Section 228(e) requires that notice of action by written consent of stockholders to those who did not consent must be prompt. Nonetheless, the exact timetable for such “prompt notice” is not defined in the statute. One case found that five months was not prompt. In this matter, notice was given after the Section 262 appraisal deadline, which the court found as a sufficient basis to deny the motion for judgment on the pleadings filed by the company (rather audaciously) in this case.
DGCL Section 251(b):
- This section of the DGCL requires that a merger agreement include specified details about the deal terms, including compensation to stockholders, but the company failed to comply with this requirement.
DGCL Section 144:
- The court held that the safe harbor under Section 144(a)(2) was not satisfied in this matter because the stockholders were not given material facts about the interests of the directors in the merger.
The court also denied the company’s motion for judgment on the pleadings regarding claims for breach of fiduciary duty.
Chancery Applies Corporate Advancement Case Law to LLC Context
A recent Delaware Court of Chancery decision interpreted the advancement provisions of an LLC Agreement by applying case law interpreting DGCL Section 145 in the corporate context. In Freeman Family LLC v. Park Avenue Landing LLC, C.A. No. 2018-0683-TMR (Del. Ch. Apr. 30, 2019), the court reviewed the applicability of “defined phrases” that are familiar prerequisites for advancement in the corporate context pursuant to DGCL Section 145, and analyzed that same language that was used in an LLC agreement provision granting advancement.
The highlights of this decision are based on the assumption that the reader is familiar with the principles of advancement for officers and directors pursuant to DGCL Section 145, and the leading Delaware court decisions on the topic–even if they are not aware that I have written several book chapters on advancement and published multiple articles on advancement and handled many advancement cases.
This case involved a request for advancement by a member (not a manager) of an LLC seeking advancement for the cost of defending a suit in New Jersey brought by the managing member of the LLC relating to the call right of the member under the LLC Agreement. (The plaintiff-member of the LLC involved in this case was itself an LLC.)
The two issues that the court addressed in this case are: (1) Does corporate case law apply to the provisions for advancement in an LLC Agreement which contains language that mirrors the corporate statute, DCGL Section 145; and (2) Whether the underlying action for which advancement is sought, arises “by reason of the fact” that the party seeking advancement acted in its “official” capacity? The court answered both questions in the affirmative.
Highlights of this Decision–Assuming Familiarity with Delaware Corporate Advancement Case Law:
- The court referenced the well-known truism that advancement cases are particularly appropriate for resolution on a paper record, such as via dispositive motions. See footnote 22 and accompanying text.
- The court cited other Delaware cases that have applied corporate case law to analyze the contractual terms of advancement in an LLC Agreement. See, e.g., Hyatt v. Al Jazeera American Holdings, II, LLC, 2016 WL 1301743 (Del. Ch. Mar. 31, 2016) (highlighted on these pages previously). See also other cases cited at footnotes 36, 37 and 38.
- The court explained that LLCs and corporations differ most pertinently in regard to indemnification: “mandating it in the case of corporate directors and officers who successfully defend themselves, but leaving the indemnification of managers or officers of LLCs to private contract.” See footnote 46 and accompanying text.
- The court recited the guidelines that the Delaware courts used to determine if someone was acting “by reason of the fact”–for purposes of being entitled to either indemnification or advancement, and restated the familiar standard that the operative phrase will be satisfied “if there is a nexus or a causal connection between any of the underlying proceedings and one’s official corporate capacity . . . without regard to one’s motivation for engaging in that conduct.” See footnotes 50 and 51 and accompanying text.
- By contrast, the court cited examples of cases where the “by reason of the fact” requirement was not satisfied, which is best exemplified by disputes involving personal contractual obligations that do not involve the exercise of judgment, discretion, or decision-making authority on behalf of the corporation. See footnote 53 and accompanying text. Because the party seeking advancement in this case was a member and not an officer or a director, the context was unusual, but the LLC Agreement clearly defined the responsibilities of the member.
- The court reasoned that the causal relationship between the official capacity of the member and the underlying lawsuit was met for several reasons: (i) The underlying case in New Jersey was about the failure of the member to carry out its responsibilities specified in the LLC Agreement: (ii) The underlying lawsuit in New Jersey is based on whether the member discharged its official duties such that the call rights could be exercised; and (iii) The underlying dispute fully implicates whether or not the member seeking advancement carried out its official duties. Thus, the court held that the “by reason of the fact” requirement and the “official capacity requirement” were met.
- The court distinguished five cases in which advancement or indemnification claims were denied because the underlying litigation involved a personal interest that lacked a sufficient connection to official duties. Those five cases that were distinguished are cited in footnote 56–most of which have been highlighted on these pages: Bernstein v. TractManager, Inc., 953 A.2d 1003 (Del. Ch. 2007); Cochran v. Stifel Fin. Corp., 2000 WL 1847676 (Del. Ch. Dec. 13, 2000) (rev’d in part on other grounds, 809 A.2d 555 (Del. 2002)); Lieberman v. Electrolytic Ozone, Inc., 2015 WL 5035460 (Del. Ch. Aug. 31, 2015); Dore v. Sweports, Ltd., 2017 WL 45469 (Del. Ch. Jan. 31, 2015); Charney v. Am. Apparel Inc., 2015 WL 5313769 (Del. Ch. Sept. 11, 2015).
- Regarding whether the “undertaking” provided by the party seeking advancement satisfied the statutory undertaking requirement, the court ruled that the sufficiency of an undertaking is determined by looking at the substance–and not the form alone–of the document containing the undertaking.
Postscript: It was recently reported by The Chancery Daily that the Vice Chancellor who wrote this opinion published it the day after giving birth to a baby boy. Wow. That’s a dedicated jurist. Congratulations to Her Honor and her family on their new addition.
Chancery Finds Usurpation of Corporate Opportunity
Delaware case law is well-established regarding the aspect of the fiduciary duty of loyalty that prohibits a corporate director from usurping a corporate opportunity. A recent decision from the Delaware Court of Chancery applies that well-settled prohibition in a flexible manner to a set of facts that have apparently not been squarely addressed in prior precedent. In Personal Touch Holding Corp. v. Glaubach, C.A. No. 11199-CB (Del. Ch. Feb. 25, 2019), the court awarded damages for the breach of this subset of fiduciary duty, as well as for other breaches of fiduciary duty.
Basic Background Facts:
This case involved a co-founder who also served as a president and director of a New York-based provider of healthcare services. He was removed when the company discovered various transgressions. The former director purchased an office building in his individual capacity–secretly–even though the court found that the former director had been aware that the company was interested for several years in purchasing a similar building for its own use. The former director then offered to lease the building back to the company at what the court found to be above-market rental rates.
Key Principles of Law:
This short blog post assumes that readers are familiar with the basic principles involved with the usurpation of corporate opportunities, and will merely highlight some of the key statements of law and the court’s reasoning in this 84-page opinion.
The well-known elements of a claim based on the corporate opportunity doctrine have been stated frequently in prior Delaware cases. Those familiar with corporate litigation will recognize the following four elements of a claim for usurpation of corporate opportunity:
“ (1) The corporation is financially able to exploit the opportunity;
(2) The opportunity is within the corporation’s line of business;
(3) The corporation has an interest or expectancy in the opportunity;
(4) By taking the opportunity for his own, the corporate fiduciary will thereby be placed in a position inimicable to his duties to the corporation.”
Slip op. at 36-38.
The court explained that Delaware Supreme Court decisions have referred to some of these elements in the disjunctive even though they are often quoted as being conjunctive. Specifically, proof of either the third element or the fourth element would sustain a corporate opportunity claim.
Moreover, the court decides the viability of a corporate opportunity claim by weighing the four factors in a holistic fashion and no one factor is dispositive. Id.
Key Reasoning of the Court:
- The court rejected the argument that the purchase of the office building was not in the line of business of the healthcare company involved, which historically leased office space, because the “line of business factor” was in either inapplicable or was satisfied because the company had a clear “interest and expectancy” in the opportunity. In addition to that factor having a flexible meaning, the court explained that latitude should be allowed for development and expansion of a business, and the Delaware courts have broadly interpreted the nature of the corporation’s business when determining whether a corporation had an interest in a opportunity.
- Regardless, the court found that the line of business test was not relevant where, as here, the company had a clear interest and expectancy in acquiring the building, and the opportunity presented related to an operational decision about how to expand the business as opposed to an opportunity to acquire a new business.
- The court further reasoned that even if the opportunity was not within the existing line of business, it was sufficient that the company had a “clear interest and expectancy” at the time the opportunity arose. Id. at 44-47.
- Regarding the fourth factor, the court instructed that a corporate officer or director was prohibited from taking an opportunity for his own “if the corporate fiduciary will thereby be placed in a position inimicable to his duties to the corporation.”
- The court elaborated by observing that the corporate opportunity doctrine is implicated where the fiduciary’s seizure of an opportunity results in a conflict between the fiduciary’s duties to the corporation and the self-interest of the director as actualized by the exploitation of the opportunity.” Id. at 47-49.
- The court also rejected an argument that the employment agreement of the former director allowed him to pursue other business interests outside of the company, and to devote a material portion of his time to other business interests. The court found that contractual defense to be unavailing in part because that provision did not allow the defendant to compete with the company for opportunities in which the company had an interest or expectancy. In addition, the employment agreement also prohibited the former director and president from engaging in activities which were “competitive with” the business of the company.
- The court applied the entire fairness test because the former director was on both sides of the transaction involving a lease of the building to the company, and also because the director received a personal benefit from the transaction that was not received by the shareholders generally. Id. at 53.
- The court also explained that charging the company an above-market rate for rent was unfair self-dealing and a breach of the duty of loyalty–regardless of whether the former director acted in subjective good faith.
As a side note, the court also found a separate breach of fiduciary duty as a result of the former director engaging in a “letter-writing campaign” over a several month period in which the former director sent harassing and disturbing anonymous letters to board members, employees and the lender of the company which caused harm to the company by hurting morale and causing distraction–in addition to attempting to sabotage the company’s relationship with its primary lender. Slip op. at 76-83.
Chancery Clarifies Director’s Right to Corporate Records
A recent Delaware Court of Chancery decision addressed the important issue of the right of directors to be given access to corporate records. In Schnatter v. Papa John’s International, Inc., C.A. No. 2018-0542-AGB (Del. Ch. Jan. 15, 2019), Delaware’s court of equity considered a claim under Section 220(d) of the Delaware General Corporation Law (DGCL) by the founder and largest stockholder of the Papa John’s pizza chain who was forced out as the CEO but retained his position as a director. He sought to obtain books and records in his capacity as a director to support an investigation that the other directors breached their fiduciary duties by improperly ousting him for unjustified reasons.
Key Bullet Points that Make this Case Noteworthy include the following:
- The court required the Defendant-Directors to produce their text messages and their private emails, that they sent and received, that related to the specific issues in contention. Prior Chancery decisions have required the production of such personal communications that related to corporate business but such a ruling is still notable. For example, a few years ago, in Amalgamated Bank v. Yahoo!, Inc., highlighted on these pages, the Court of Chancery ordered a similar scope of production–and also cited to a law review article that yours truly published in which my co-authors and I explained why electronically stored information (ESI), including text messages and private emails, should often be included within the scope of a DGCL Section 220 demand. See law review article co-authored by yours truly which argued that the court should often include ESI as part of the obligation to produce records under Section 220. See 37 Del. J. Corp. L. 163, 165 (2012), highlighted on these pages here.
- It is well-established that directors have nearly unfettered rights to access to books and records of a corporation in which they serve. Unlike a stockholder, when a director makes a demand for books and records under Section 220(d), the corporation has the burden to establish that the director’s demand for books and records is based an improper purpose.
- Unlike the impact of a stockholder filing a plenary action before a Section 220 case is complete, when a director files a plenary action before a final ruling in a Section 220 case, that will not necessarily bar the continuation of Section 220 claims and it will not otherwise moot the Section 220 claims. See generally CHC Investments, Inc. v. FirstSun Bancorp, C.A. No. 2018-0610-KSJM (Del. Ch. Jan. 24, 2019)(Section 220 stockholder demand case dismissed due to parallel plenary action.)
- The court observed that a director should not be required to sign a confidentiality agreement as a condition to obtaining records because a director already has a fiduciary duty to keep them confidential—as compared to stockholders who routinely are required to sign a confidentiality agreement as a condition to obtaining records pursuant to a Section 220 demand. See generally Murfey v. WHC Ventures, LLC, C.A. No. 2018-0652-MTZ (Del. Ch., Jan.23, 2019)(proposed confidentiality order rejected by Court as non-compliant with Chancery Rule 5.1 because it did not allow for filing confidential documents with the court–confidentially.)
Advancement for Counterclaims Granted Despite Withdraw of Covered Claim
A recent transcript ruling by the Delaware Court of Chancery in Gasgarth v. TVP Investments, LLC, C.A. No. 2018-0621-JTL, transcript ruling (Del. Ch. Dec. 7, 2018), explained that the right to advancement was not extinguished by an amendment of a counterclaim to specifically withdraw breaches of fiduciary duty counterclaims and remove factual allegations relating to the service of the plaintiffs (counterclaim defendants) as directors and officers.
The court reasoned that it is not bound by the four-corners of a pleading, but rather will view the context of the litigation as a whole to determine if advancement is warranted in light of all the facts and circumstances of the case and the role that the directors and officers played in connection with the claims against them.
Relying on Delaware precedent, the court in this transcript ruling also included as part of the “fees on fees” awarded, a success bonus, which was part of the engagement letter with counsel.
Chancery Addresses “Commercially Reasonable Efforts” Standard
When the phrase “commercially reasonable efforts” appears as a standard of performance in contracts, it seems predetermined to generate litigation, and the recent Court of Chancery decision in Himawan v. Cephalon, Inc., C.A. No. 2018-0075-SG (Del. Ch. Dec. 28, 2018), supports that observation. Although the agreement in this case had a contractual definition for “commercially reasonable efforts”, prior Delaware decisions highlighted on these pages that discuss this phrase should be of relevance to anyone who needs to know what the Delaware cases say about this somewhat amorphous standard, and similarly-phrased “efforts clauses”.
Why this decision is noteworthy: The most notable aspect of this decision is its collection of Delaware cases interpreting various iterations of “efforts clauses”. See footnotes 83 to 85.
Brief overview: This case involved an earn-out dispute and a claim by the seller that it did not receive milestone payments pursuant to an earn-out provision because the buyer did not use commercially reasonable efforts to reach the milestones. The buyer was the pharmaceutical company Cephalon, but Teva Pharmaceuticals later bought Cephalon. The product at issue was an antibody that would allow an organism’s immune system to overcome disease-causing pathogens. As with new drugs, the process to bring antibodies to market is long, difficult and risky.
The earn-out in the merger agreement in this case was payable upon the meeting of certain milestones in the process of obtaining approval by government agencies for the antibody to treat two different conditions. The buyer agreed to use “commercially reasonable efforts” to develop the antibody and achieve those milestones. The seller claims that the buyer did not comply with that efforts clause.
- The Court provides an excellent collection of Delaware decisions that have wrestled with various permutations of “efforts clauses”. See footnotes 83 to 85 and accompanying text. The Court categorizes the collected decisions into the following groups, some of which are overlapping: (i) motions to dismiss (at the pleadings stage); (ii) post-trial decisions; (iii) post-merger decisions (often involving a related earn-out clause); and (iv) pre-merger decisions where the efforts clause applied to the satisfaction of a condition to closing.
- The agreement involved in this case provided a contractual definition for “commercially reasonable efforts” as follows: “the exercise of such efforts and commitment of such resources by a company with substantially the same resources and expertise as [Cepahlon], with due regard to the nature of efforts and cost required for the undertaking at stake.”
- The Court observed that the parties agreed that the foregoing is an “objective standard”, but the Court described the contractual definition as “inartfully” drafted and ambiguous. Also, in the context of denying a Motion to Dismiss this claim, the Court found that neither side offered a reasonable interpretation of this contract provision (as compared to another basis to deny an MTD: when both sides offer reasonable, but differing, interpretations.)
- Based on Delaware’s version of Rule 12(b)(6)–which is not as stringent as the current Federal standard–the Court found that there was a “reasonably conceivable set of circumstances susceptible of proof” in which (allowing for factual issues at this early stage of the case), it could be shown that companies with similar resources and expertise as Cephalon are currently developing treatments for a similar antibody as the one at issue in this case.
Chancery Rules on Limits of Forum-Selection Clauses in Corporate Documents
A recent seminal decision of the Delaware Court of Chancery must be included in the lexicon of every lawyer who wants to understand the boundaries of Delaware law on forum-selection clauses in corporate documents. In the case of Sciabacucchi v. Salzberg, C.A. No. 2017-0931-JTL (Del. Ch. Dec. 19, 2018), the Court determined that a forum-selection clause in a certificate of incorporation was invalid and ineffective to the extent that it purported to “require any claim under the Securities Act of 1933 to be brought in federal court” (the “Federal Forum Provisions”).
Why this Case is Noteworthy: The court reasoned in its holding that: “The constitutive documents of a Delaware corporation cannot bind a plaintiff to a particular forum when the claim does not involve rights or relationships that were established by or under Delaware’s corporate law. In this case, the Federal Forum Provisions attempt to accomplish that feat. They are therefore ineffective and invalid.
Overview of Key Points:
This opinion is destined to form part of the bedrock of foundational Delaware corporate decisions and could rightly be the subject of a lengthy law review article, but for purposes of this quick blog post, I will merely highlight a few of the more notable excerpts in bullet points.
- A substantial basis for the court’s reasoning was a prior decision from the Court of Chancery which upheld the validity of corporate bylaws that required claims based on the internal affairs doctrine and related claims to be brought exclusively in the Court of Chancery. That decision by the current Chief Justice of Delaware, writing at the time as the Chancellor, was Boilermakers Local 154 Retirement Fund v. Chevron Corp., 73 A.3d 934 (Del. Ch. June 25, 2018).
- Although the Boilermakers case involved bylaws, the Sciabacucchi decision explained why that same reasoning applied to a certificate of incorporation which is governed by similar provisions in the Delaware General Corporation Law (DGCL). The court in Sciabacucchi explained that the reasoning in Boilermakers focused on the ability to enforce forum-selection clauses that related to the internal corporate matters of a Delaware corporation as opposed to external matters, such as claims arising under the Securities Act of 1933.
- The Court buttressed its reasoning by referring to the codification of the Boilermakers decision, shortly after its publication, by means of the adoption of a new Section 115 of the DGCL. In connection with that new DGCL section, the Delaware General Assembly also passed new amendments to Sections 102 and 109 of the DGCL which prohibit fee-shifting provisions in the certificate of incorporation or bylaws particularly in connection with claims related to the internal affairs of a corporation as defined by DGCL Section 115.
- The Court’s reasoning was also supported by reference to what the court referred to as “first principles.” Those first principles included several basic tenets of corporate law such as the following: (i) Although the document filed with the state that gives rise to an artificial entity such as a corporation, and confers powers on it, is a contract, it is not an ordinary private contract among private actors; (ii) The certificate of incorporation is a multi-party contract that includes the State of Delaware. Unlike an ordinary contract, it also includes terms by reference that are imposed by the DGCL; (iii) Unlike an ordinary contract, a charter can only be amended to the extent that it complies with the DGCL; (iv) The DGCL specifies what provisions a charter may or may not include; and (v) Although the courts enforce both types of contracts, when enforcing relationships created by the corporate contract, the courts use an overlay of fiduciary duty. See pages 38 to 42 and footnotes 111 to 125.
- A thorough analysis of the contours and policy behind the internal affairs doctrine is an important feature of this opinion. See, e.g., pages 41-46.
In sum, the court reasoned that the “constitutive documents of a Delaware corporation cannot bind the plaintiff to a particular forum when the claim does not involve rights or relationships that were established by or under Delaware’s corporate law.” The opinion provides extensive citations to substantial scholarship, case law and statutes.
Prof. Ann Lipton provides extensive insights in her blog post about this case with links to her articles on the topic. The good professor’s scholarship on this issue was also cited by the court in the above opinion.
Many cases have been highlighted on this blog regarding forum-selection clauses in private agreements. See, e.g., here and here. In some of the posts on these pages about cases involving forum-selection clauses, a graphic of the Roman Forum adds color as well as an etymological connection.
SUPPLEMENT: Professor Stephen Bainbridge, a prolific corporate law scholar, kindly links to this post on his blog.
For the 14th year, we provide a list of key Delaware corporate and commercial decisions from the prior year. This year, our list is co-authored by Chauna Abner in addition to yours truly, and appeared in the following article published in the Delaware Business Court Insider on January 2, 2019:
For the 14th year, we have created an annual list of important corporate and commercial decisions of the Delaware Supreme Court and the Delaware Court of Chancery. This list is not by any means a complete list of important decisions of the two courts that were rendered this year. Instead, this list includes notable decisions that should be of widespread relevance to those who work in the corporate and commercial litigation field or follow the latest developments in this area of Delaware law. Prior annual reviews are available at this hyperlink. This list focuses on the unsung heroes among the many decisions that have not already been widely discussed by the mainstream press or legal trade publications.
Delaware Supreme Court Decisions
- Aranda v. Phillip Morris USA, 183 A.3d 1245 (Del. 2018).
This Supreme Court decision should be required reading for anyone who has a forum non conveniens issue in Delaware. The opinion provides an overview of the Delaware law on forum non conveniens and clarifies that even if it is a minority view among the 50 states, Delaware only requires that the trial court “consider” whether an alternative forum is available as part of its analysis, and whether an alternative forum is available is not a deciding factor. In its analysis, the court explores three general categories of forum non conveniens cases. A synopsis of the decision and a link to the full opinion is available at this hyperlink.
- Eagle Force Holdings v. Campbell, 187 A.3d 1209 (Del. 2018).
For the first time, the Delaware Supreme Court clarifies the test to determine whether a contract’s terms are sufficiently definite to create an enforceable contract. Before setting forth the test, this opinion discusses the intent necessary for parties to be bound. This opinion also explains the three basic requirements for a valid contract and addresses the ancillary issue of whether the Court of Chancery could impose sanctions for violation of a court order prior to establishing that it had personal jurisdiction over the person who violated the order. A synopsis of the decision and a link to the full opinion is available at this hyperlink.
- Morrison v. Berry, 191 A.3d 268 (Del. 2018).
In this opinion, Delaware’s highest court limits the application of the Corwin doctrine and prohibits the cleansing effect of stockholder approval, in part due to inadequate disclosures. The opinion also explains the various nuances of the board’s duty of disclosure to stockholders, describes the duty of candor owed by directors to each other, and provides a definition of materiality as well as an explanation of when an omitted fact is material. A synopsis of the decision and a link to the full opinion are available at this hyperlink.
- Flood v. Synutra International, 2018 Del. LEXIS 460 (Del. Oct. 9, 2018).
In this opinion with a vigorous dissent, the Supreme Court clarifies the MFW standard that was announced in Kahn v. M&F Worldwide, 88 A.3d 635 (Del. 2014). The court explains whether the prerequisites that must be satisfied for the MFW standard to apply must be imposed as a condition of the deal at the absolute beginning of negotiations. The opinion also discusses whether due care violations were pleaded in the complaint. A synopsis of the decision and a link to the full opinion are available at this hyperlink.
Delaware Court of Chancery Decisions
- KT4 Partners v. Palantir Technologies, 2018 Del. Ch. LEXIS 59 (Del. Ch. Feb. 22, 2018).
The Court of Chancery determined that a stockholder satisfied the prerequisites of Section 220 in this case to obtain certain corporate records. This 50-page decision can serve as a primer for the requirements of Section 220, to which judicial opinions have added prerequisites that are not found in the text of the statute. A synopsis of the decision and a link to the full opinion are available at this hyperlink.
- Feldman v. YIDL Trust, 2018 Del. Ch. LEXIS 75 (Del. Ch. Mar. 5, 2018).
In this opinion, the Court of Chancery adds to the relatively modest body of case law interpreting Section 273 of the DGCL. The court applies Section 273 to dissolve a joint venture with two 50/50 stockholders that was deadlocked. This is analogous to a “no fault business divorce” but the remedy is discretionary and the court will not always grant dissolution. A synopsis of the decision and a link to the full opinion are available at this hyperlink. Shortly after the court issued its decision, the respondent moved for relief from the court’s entry of judgment and the court denied the motion. See Feldman v. YIDL Trust, 2018 Del. Ch. LEXIS 148 (Del. Ch. May 4, 2018).
- PR Acquisitions v. Midland Funding, 2018 Del. Ch. LEXIS 137 (Del. Ch. Apr. 30, 2018).
This Chancery decision is notable for enforcing the provisions in an agreement that provided a procedure and a comparatively short deadline for making claims for funds held in escrow. This decision was in the context of notice being mistakenly sent to the escrow agent when the agreement required that notice be sent to the seller. A synopsis of the decision and a link to the full opinion are available at this hyperlink.
- CBS v. National Amusements, 2018 Del. Ch. LEXIS 157 (Del. Ch. May 17, 2018).
In this high profile case, the Court of Chancery denies the request of CBS, a minority shareholder, for a TRO that sought to prevent the efforts of the Redstone family from exercising its voting control regarding a potential deal with Viacom. A synopsis of the decision and a link to the full opinion is available at this hyperlink.
- Basho Technologies Holdco B v. Georgetown Basho Investors, 2018 Del. Ch. LEXIS 222 (Del. Ch. July 6, 2018).
This 126-page Court of Chancery opinion is a mini-treatise on the capacious capacity of the court to fashion creative and customized remedies when a breach of fiduciary duty is found. The opinion includes many key principles of Delaware corporate law and a description of different types of available remedies. A synopsis of the decision and a link to the full opinion is available at this hyperlink.
- In Re Oxbow Carbon Unitholder Litigation, C.A. No. 12447-VCL (Del. Ch. Aug. 1, 2018).
In this opinion, the Court of Chancery provides the most comprehensive description of the broad and flexible authority of the Court of Chancery to fashion an appropriate customized equitable remedy in several decades. This decision should be treated as an indispensable reference for those involved in corporate or commercial litigation who might need to quote authoritative sources for the voluminous scope of the Court of Chancery’s flexible and customized equitable remedial powers. A synopsis of the decision and a link to the full opinion is available at this hyperlink.
- Applied Energetics v. Farley, 2018 Del. Ch. LEXIS 277 (Del. Ch. Aug. 14, 2018).
This Court of Chancery opinion is a must read for litigators who need to know the finer points of how the amount for a requisite bond is determined for purposes of obtaining an injunction. The court found problems with both parties’ estimates and essentially engaged in an abbreviated analysis of the appropriate measure of potential damages based on the claims in the case. A synopsis of the decision and a link to the full opinion is available at this hyperlink.
- Godden v. Franco, 2018 Del. Ch. LEXIS 283 (Del. Ch. Aug. 21, 2018).
In this opinion, the Court of Chancery explains several important principles that Delaware courts use to analyze issues in the LLC context, and interpretive rules involving LLC agreements. In doing so, the court provides a helpful analysis of the equitable powers of the court to fashion remedies in the context of an LLC—notwithstanding the often exaggerated explanation of LLCs as creatures of contract. In this vein, the court cites several exceptions to the concept of LLCs being purely a product of contract. A synopsis of the decision and a link to the full opinion are available at this hyperlink.
- Akorn v. Fresenius Kabi AG, 2018 Del. Ch. LEXIS 325 (Oct. 1, 2018), aff’d, 2018 Del. LEXIS 548 (Del. Dec. 7, 2018).
This epic 246-page Court of Chancery opinion serves as a mini-treatise on several topics of importance to corporate and commercial litigators, including: interpretation of material adverse change clauses or material adverse effect clauses in merger agreements; and the meaning and application of the phrase “commercially reasonable efforts” or “reasonable best efforts” often found in merger agreements. A synopsis of the decision and a link to the full opinion are available at this hyperlink. Notably, the Supreme Court affirmed the decision in a three-page order in December.
- Lexington Services v. U.S. Patent No. 8019807 Delegate, 2018 Del. Ch. LEXIS 509 (Del. Ch. Oct. 26, 2018).
In this opinion, the Court of Chancery recognizes that a non-signatory to an agreement may enforce the provisions of a forum-selection clause under certain conditions. In doing so, the court discusses two principles of well-established Delaware law: the general enforceability of forum-selection clauses in Delaware; and the ability of officers and directors of an entity subject to a forum-selection clause to invoke its benefits when they were closely involved in the creation of the entity and were being sued as a result of acts that directly implicated the negotiation of the agreement that led to the entity’s creation. A synopsis of the decision and a link to the full opinion are available at this hyperlink.
- Decco U.S. Post-Harvest v. MirTech, 2018 Del. Ch. LEXIS 545 (Del. Ch. Nov. 28, 2018).
This Court of Chancery opinion adds to the modest body of Delaware case law that addresses whether an LLC should be dissolved based on the statutory standard that it is “not reasonably practicable” to carry on the LLC. The court explains that in determining the purpose for which an LLC was formed, it may not only look at the purpose-clause in the LLC’s operating agreement, but also to “other evidence … as long as the court is not asked to engage in speculation.” A synopsis of the decision and a link to the full opinion are available at this hyperlink.
- Sciabacucchi v. Salzberg, C.A. No. 2017-0931-JTL (Del. Ch. Dec. 19, 2018).
This recent seminal decision of the Court of Chancery must be included in the lexicon of every lawyer who wants to understand the boundaries of Delaware law on forum-selection clauses in corporate documents. The court determined that a forum-selection clause in a certificate of incorporation was invalid and ineffective to the extent that it purported to “require any claim under the Securities Act of 1933 to be brought in federal court” (the “Federal-Forum Provisions”). A synopsis of this decision and a link to the full opinion are available at this hyperlink.
Francis G.X. Pileggi is a litigation partner and vice-chair of the commercial litigation practice group at Eckert Seamans Cherin & Mellott. Contact him at firstname.lastname@example.org. He comments on key corporate and commercial decisions and legal ethics rulings at www.delawarelitigation.com.
Chauna A. Abner is an associate in the firm’s commercial litigation practice group.
The above post originally was published as an article, and is reprinted with permission from the Jan. 2, 2019 edition of the Delaware Business Court Insider(c). 2019 ALM Media Properties, LLC. All rights reserved.
The Delaware Court of Chancery recently issued an epic decision that serves as a mini-treatise on several topics of importance to corporate and commercial litigators including: (1) interpretation of material adverse change clauses or material adverse effect clauses in merger agreements; and (2) the meaning and application of the phrase “commercially reasonable efforts” or “reasonable best efforts” often found in merger agreements.
The opinion in Akorn, Inc. v. Fresenius Kabi AG, C.A. No. 2018-0300-JTL (Del. Ch. Oct. 1, 2018), will be firmly ensconced in the pantheon of the most notable decisions of Delaware courts and could easily be the subject of a full-length law review article. But for purposes of a blog post that merely attempts to highlight the key issues addressed by the court, so that interested readers might review the entire opinion if relevant to their practice, I will focus on several key aspects of the decision only.
The procedural context in which this decision was written, was expedited proceedings in which two parties to a merger agreement sought competing rulings on the meaning of the agreement. On the one hand, the seller argued that the merger agreement should be specifically enforced. The buyer, however, filed a counterclaim that sought a ruling that it properly terminated the merger agreement based in part on the occurrence of a material adverse effect or a material adverse change, as defined in the agreement. The purchaser prevailed in its argument that it properly terminated the agreement.
Notably, a 5-day trial was held with nearly 2,000 exhibits. A total of 16 witnesses testified, and 54 depositions were lodged. The trial was held less than 3 months after the complaint was filed. This 246-page opinion was issued less than one week after the final post-trial briefs and oral argument were completed.
The detailed facts on which the court’s reasoning and conclusion are based are described in the first 110 pages of this decision. It would be a challenge to do the facts justice in a brief overview, but for purposes of providing the highlights of the legal principles in the case, suffice it to say that the court provided exhaustive detail about each of the factual aspects of the parties’ dispute and why one party sought to enforce the merger agreement and one party successfully argued that it was justified in terminating the merger agreement prior to closing.
Highlights of Legal Principles and Analysis by the Court:
Material Adverse Change Clauses:
- In a comprehensive and scholarly analysis, the court surveys the law on Material Adverse Change (“MAC”) provisions or Material Adverse Effect (“MAE”) provisions in merger agreements, including prior cases that discuss them and copious footnotes are provided with reference to specific percentages, for example, that are necessary in determining whether a MAC clause or a MAE clause should be triggered. See pages 117 to 204. The court refers to a MAC clause and a MAE clause as synonymous.
- This decision is thought to be the first Delaware opinion upholding the termination of a merger agreement due to the occurrence of a MAC/MAE.
Key Treatise Cited:
- Notable is the court’s reference in footnote 558 to the many Delaware decisions that cite to the Kling and Nugent treatise on M&A agreements and M&A practice as an authoritative source for issues relating to merger agreements, such as MAC/MAE clauses and post-closing indemnification provisions.
Is Delaware Pro-Sandbagging—or Not?
- Importantly, the court discusses whether Delaware should be considered a “pro-sandbagging” state as it relates to the enforcement of representations in contracts when one party might know prior to closing that the adverse party’s representations are not accurate. See footnote 756 to 767 and accompanying text. But cf. Eagle Force Holdings LLC v. Campbell, in which the Delaware Supreme Court declined to affirmatively decide the issue, but questioned whether Delaware was a pro-sandbagging state. 187 A.3d 1209, 1236, n. 185 (Del. 2018); id. at 1247 (Strine, C. J. & Vaughn, J., concurring in part, dissenting in part). This case was previously highlighted on these pages.
- Also noteworthy is a robust explanation, with citations to many authorities, that describe the factors that must be considered to determine when the breach of a contract is material. See pages 208 to 211.
Commercially Reasonable Efforts and Reasonable Best Efforts:
- In what may be the most comprehensive analysis in a Delaware decision of the meaning of the phrase “commercially reasonable efforts” and similar phrases such as “reasonable best efforts,” the court discussed the meaning of these contractual standards and their variations, as well as how they should be interpreted and applied. See pages 212 to 220.
- The court compares the differences, if any, between these similar standards, with citations to treatises, cases and articles that discuss them. See pages 213 and 214, as well as footnotes 788 to 800.
- See generally Professor Bainbridge’s analysis of this topic with citations to many authorities. (The corporate law scholarship of Professor Stephen Bainbridge is often cited by Delaware courts.) See also several Delaware decisions highlighted on these pages that also discuss the topic.
- In its analysis of this topic, the Court of Chancery cites to the Delaware Supreme Court opinion in Williams Companies v. Energy Transfer Equity, L.P., highlighted on these pages. The Delaware high court explained in that decision that it: “did not distinguish between” the two phrases, “commercially reasonable efforts,” and “reasonable best efforts,” but rather the court described those phrases as both imposing “obligations to take all reasonable steps to solve problems and consummate the transaction.” (quoting Williams, 159 A.3d at 272). See also footnote 808, and accompanying text.