Search results for: commercially reasonable efforts

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.”

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.

[By the way, as I write this on New Year’s Eve, I extend best wishes to all my readers for a Happy New Year!]

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

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

Key takeaways:

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

Postscript: See also highlights on these pages of a Delaware Supreme Court decision on the interpretation of the important phrase addressed in this Chancery ruling, as well as related commentary.

A recent Delaware Court of Chancery opinion addressed issues that are of importance to commercial and corporate litigators. In CompoSecure, L.L.C. v. CardUX, LLC f/k/a Affluent Card, LLC, C.A. No. 12524-VCL (Del. Ch. revised Feb. 12, 2018), the court provided a thorough analysis of a contract dispute in a post-trial ruling that primarily relied on New Jersey law, and even though that reliance on non-Delaware law for most issues in this case guarantees cursory treatment on this blog–there are several nuggets of Delaware law which the court cited, for some of its analysis of a marketing agreement for credit cards, that have widespread application in Delaware litigation. For example, the court addressed:

As a postscript for readers who might enjoy trivia, this opinion features as plaintiff’s counsel Delaware’s former Chief Justice, Myron Steele, as well as Arthur Dent, a classmate of mine who was the editor-in-chief of the law review the same year that I was the law review’s internal managing editor. That last bit of data, plus a few dollars, may get you a small coffee at a local coffee shop.

UPDATE: In November 2018, the Delaware Supreme Court had a different perspective on this matter, and affirmed in part and remanded in part.

The Delaware Supreme Court recently analyzed, for the first time, a common contractual standard in business agreements.  The legal meaning of the phrase “commercially reasonable efforts” does not enjoy clarity in the law. Lawyers and jurists alike should be excused if they view the law on this topic as not entirely self-evident.  The split decision of the Delaware Supreme Court in the case styled The Williams Companies, Inc. v. Energy Transfer Equity, L.P., Del. Supr., No. 330, 2016 (Mar. 23, 2017), proves the point. The Delaware high court decision in this matter featured a vigorous dissent from the Chief Justice in opposition to the majority’s affirmance of the Court of Chancery’s decision. The majority opinion was based on different reasoning than the trial court applied.

The background facts were included in the Court of Chancery’s opinion in this matter that was highlighted on these pages previously. The foregoing hyperlink also features links to scholarly commentary on this topic by the esteemed Professor Stephen Bainbridge. (The dissent of the Chief Justice will not be covered in this modest blog post, although those interested in this topic may want to read it, because it may provide ideas for opposing arguments on the topic, and in the future when a new majority exists on the Delaware Supreme Court, perhaps the reasoning in the dissent will garner a majority of votes.)

For now, the majority’s restatement of the latest Delaware law in connection with interpreting the meaning of the phrase “commercially reasonable efforts” includes the following important principles.  

Important Legal Principles Explaining the Legal Meaning of “Commercially Reasonable Efforts”:

Although the Delaware Supreme Court affirmed the post-trial opinion of the Court of Chancery, based on different reasoning, Delaware’s high court explained three errors in the Chancery decision, and in doing so the Supreme Court elucidated the correct principles of law applicable to an understanding of the phrase “commercially reasonable efforts.”

First, the Supreme Court explained that the Court of Chancery took an “unduly narrow view” of the decision in Hexion Specialty Chemicals, Inc. v. Huntsman Corp., 965 A.2d 715 (Del. Ch. 2008).  The Delaware Supreme Court emphasized in this opinion that it agreed with Chancery’s Hexion decision, which was highlighted on these pages. The Supreme Court quoted extensively from the Hexion opinion, and described that the buyer in the Hexion case required financing to complete a transaction.  The Court of Chancery in Hexion held that the agreement required action to the extent that such action was “both commercially reasonable and advisable to enhance the likelihood of consummation of the financing . . ..”  (Hexion, 965 A.2d at 749.) The Supreme Court in Williams quoted with approval the reasoning in the Hexion case even though the Hexion case involved a standard of “reasonable best efforts”–and not commercially reasonable efforts. See footnote 16 and accompanying text in the Williams decision for related analysis.

The Supreme Court in Williams also observed that in the Hexion case, after the buyer developed a more substantial concern about the solvency of a combined entity after the deal closed, the buyer “was then clearly obligated to approach the seller’s management to discuss the appropriate course to take to mitigate the solvency concerns.” Instead, the buyer in Hexion chose not to approach the seller’s management, and the court in Hexion reasoned that such a “choice alone would be sufficient to find that the buyer had knowingly and intentionally breached its covenants under the merger agreement.”  Hexion, 965 A.2d at 750.

The second error that the Supreme Court determined that the Court of Chancery made in the Williams case was the trial court’s focus on the absence of any evidence to show that Energy Transfer Equity, L.P. (ETE) caused the law firm to withhold the opinion that was a condition precedent to closing.  This is so, explained the Supreme Court, because there was evidence recognized by the Court of Chancery from which it “could have concluded that ETE did breach its covenants,” including evidence that ETE did not direct the law firm to engage more fully with counsel for the opposing party in the transaction in an attempt to negotiate any issues.

The third error the Supreme Court found with the Chancery opinion involved shifting of the burden of proof.  The Supreme Court in Williams ruled that “once a breach of a covenant is established, the burden is on the breaching party to show that the breach did not materially contribute to the failure of a transaction.”  See footnote 54. (Of course, one might note that an adjudication that a party was in breach is not usually made until after trial).  Moreover, the Supreme Court emphasized that a plaintiff “has no obligation to show what steps the breaching party could have taken to consummate the transaction.”

Nonetheless, the Supreme Court affirmed the decision of the Court of Chancery (just barely), because the end result in its post-trial opinion would have been the same even if the Court of Chancery applied the proper burden of proof – – in light of a footnote in the Chancery opinion noting that Williams did not present sufficient facts at trial to prevail even if the burden of proof were correctly applied.

Bottom Line: If you have a case that involves an issue of the meaning or application of the phrase “commercially reasonable efforts,” your first step is to read this opinion.  The next step is to determine how the facts of your case compare to the facts in this decision.

SUPPLEMENT: Scholarly commentary on this decision and the topic of “commercially reasonable efforts” in general, is provided by friend of the blog, Professor Stephen Bainbridge, whose scholarship is often cited in Delaware court opinions.

In an expedited deal litigation matter, in The Williams Companies, Inc. v. Energy Transfer Equity, L.P., C.A. No. 12168-VCG (Del. Ch. June 24, 2016), the Court of Chancery denied a request to enjoin Energy Transfer Equity, L.P. (“ETE”) from evading a deal based on its inability to obtain a tax opinion that was a condition precedent to closing on a deal with The Williams Companies, Inc. Although the facts of this case are somewhat sui generis, the legal principles addressed should have broader application, not only for deal litigation but contract litigation in general.

The court’s discussion of the concept of “commercially reasonably efforts” and “reasonable best efforts” is useful to remember. The court distinguished the two prior Chancery opinions in Hexion, highlighted on these pages previously, and WaveDivision Holdings, highlighted on these pages, in part because, on a factual level, in both of those cases the Court of Chancery found, unlike in the instant case, that a party took affirmative steps, in violation of the relevant cooperation clause, to thwart a condition to closing such as using commercially reasonable efforts, or reasonable best efforts, to obtain financing or to obtain the consent of a third party to the deal.

Short Overview of the Basic Facts

After the merger agreement between the parties was entered into, the energy market, and the value of the assets in the transaction, experienced a precipitous decline. Since a part of the consideration for Williams was $6 billion in cash, which ETE would have to borrow against its devalued assets to obtain, the proposed transaction quickly because financially unattractive to ETE as the buyer. Thus, ETE was looking for an exit from the merger agreement, although initially it had been an ardent suitor of The Williams Companies.

One of the key facts of the case was that a condition precedent to consummation of the merger was the issuance of an opinion by the tax attorneys for ETE at the law firm of Latham & Watkins. The firm was specified in the agreement, and in its sole discretion, was to issue an opinion as a prerequisite to closing, to the effect that the transaction “should” be treated as a tax free exchange under Section 721(a) of the Internal Revenue Code. Although Latham initially, at the time the agreement was signed, expected to be able to issue that opinion, after the agreement was signed something changed. Based on the effect of changing market conditions and reduced value of the stock on the tax impact, Latham disclosed that it was no longer able to issue such an opinion. One of the claims that Williams maintained against ETE was that it failed to use “commercially reasonable efforts” to secure the Latham opinion and, therefore, materially breached its contractual obligations.

The court approached the inability of ETE to obtain the Latham opinion with skepticism, amid claims that it was a ruse to allow it to back out of the deal in light of the downturn in the energy market which made the deal financially problematic. Another important fact is that the court found that the person at ETE in charge of tax issues did not accurately read or understand the terms of the deal at the time the agreement was signed, and both he and the Latham firm only realized there was a problem in issuing a the tax opinion after the agreement had been signed. Curiously there were six different tax opinions presented at trial by independent experts and tax experts connected with the deal. Some of those opinions were contradictory.

Money Quote

Notwithstanding the court’s initial skepticism and the motive that ETE had to avoid the closing, a few money quotes from the court have application far beyond this case. For example, the court reasoned that:

“Just as motive alone cannot establish criminal guilt, however, motive to avoid a deal does not demonstrate lack of a contractual right to do so. If a man formerly desperate for cash and without prospects is suddenly flush, that may arouse our suspicions. Nonetheless, even a desperate man can be an honest winner of the lottery.”

Court’s Holding

The court explained in its 58-page post-trial opinion, issued the same week that the trial ended, that Delaware is a contractarian state, and recognizes and respects provisions in contracts that favor specific performance in case of breach. But conditions precedent to a transaction must be enforced as well. The request of Williams to force the court to consummate the deal with ETE would force ETE to accept the risk of substantial tax liability which the parties did not contract for.

Key Issues

Among the key issues the court had to consider was whether the Latham firm determined “in good faith” that it was unable to issue the tax opinion. Williams argued that Latham reached a conclusion that it could not issue the opinion in bad faith and for reasons other than its best legal judgment, in order to please its client. That relates to the argument that ETE persuaded Latham not to issue the necessary opinion, which, if true, would be a breach by ETE of the requirement that it use commercially reasonable efforts to obtain the opinion.

The court articulated the issue as whether Latham determined in “subjective good-faith” that it could issue the necessary opinion which was a condition precedent to closing. The court observed that Latham was a law firm of “national and international repute” and that is was at the very least a blow to the reputation of the firm and its tax partners that they had preliminarily advised that the deal would qualify for certain tax treatment, but had to backtrack in a way that “caused the ‘deal to come a cropper.’”

Among the six different tax experts who testified at trial about the ability to issue the necessary tax opinion that was a condition precedent, one tax law professor testified that “no reasonable tax attorney could agree with Latham’s conclusion,” but another professor testified that the conclusion of Latham that it could not issue the opinion was appropriate. Other law firms argued that although the conclusion of Latham was correct, the reasoning for that conclusion was different.

In its analysis of subjective good-faith, the court observed that it was a “substantial embarrassment to Latham” that it was not able to issue the opinion despite its initial view that it could do so, and that the reputational effects outweighed any benefit of an unethical deference to the interests of its client because “while this deal is, certainly, a lunker, Latham has even bigger fish to fry.” The court also noted a blog post from one of the Wall Street Journal’s blogs that Latham & Watkins had been a clear loser on the deal regardless of who won the litigation. See footnote 122.

Legal Principles Discussed

The court observed that the phrase “commercially reasonable efforts” was not defined in the agreement, and that even though the phrase has been addressed in other cases – – “the term is not addressed with particular coherence in our case law”. The phrase has also been articulated as “reasonable best efforts” which has been described as “good-faith in the context of the contract at issue.” Citing Hexion Specialty Chemicals Inc. v. Huntsman Corp., 965 A.2d 715 (Del. 2008), the court found that the phrase “commercially reasonably efforts” in the agreement in this case required the purchaser, ETE, to submit itself to a “objective standard to ‘do those things objectively reasonable to produce the desired’ tax opinion in the context of the agreement reached by the parties.”

The court found that the argument by Williams regarding burden of proof was wrong, and that the buyer, ETE, did not have the burden to “prove a negative.” That is, it did not need to show that its lack of more forceful action, or that a specific action taken, was the reason that Latham did not render a tax opinion. The court similarly distinguished the holding in WaveDivision Holdings, LLC v. Millennium Digital Media Sys., LLC, 2010 WL 3706624 (Del. Ch. Sept. 17, 2010). See footnote 130.

Regarding the court’s reasoning about why ETE did comply with its obligation to use commercially reasonable efforts, the court explained why the arguments of Williams were rejected. Williams argued that ETE:

“. . . generally did not act like an enthusiastic partner in pursuit of consummation of the Proposed Transaction. True. The missing piece of Williams’ syllogism is any demonstration that the Partnership’s activity or lack thereof, caused, or had a materially effect upon, Latham’s current inability to issue the [tax opinion].”

Thus, one may read the above quote as suggesting that “not being enthusiastic about closing a deal” is insufficient to breach a duty to use commercially reasonable efforts. The missing part of Williams’s syllogism described by the court is a key fact that distinguished both the Hexion case and the WaveDivision case because the non-performance allegation and the lack of best efforts allegation – – even if true – – did not contribute materially to the failure of the goal to which the “efforts clause” was directed. See footnotes 122 and 123 and accompanying text.

Postscript: Courtesy of The Chancery Daily, we understand that this decision has been appealed to the Delaware Supreme Court. The Court of Chancery facilitated this option by noting in an Order that accompanied the opinion that pursuant to Rule 54(b), this ruling was appealable although it did not conclude all issues at the trial court level.

Supplement: The venerable Professor Bainbridge provides professorial commentary on the use of the phrase “commercially reasonable efforts” and variants, and observes how common it is to use this phrase, and its variations, without definition and without precision. We are also grateful that the good professor links to yours truly and this post in his discussion.

Second Supplement: In a more recent transcript ruling, in a separate case, another vice chancellor addressed the standard of “commercially reasonable efforts” in the context of a motion to dismiss, as opposed to the post-trial findings in the Williams case. In the matter styled:WP CMI Representative LLC v. Roche Diagnostics Operations Inc.,  C.A. No. 11877-VCL (transcript)(Del. Ch. July 14, 2016), the money quote is found at page 56 of the above-linked transcript ruling when the court explains that a reasonable inference that the parties’ interests are aligned can be defeated when the party with the duty to act in a commercially reasonable manner, does “… something that wasn’t originally contemplated and which has the effect of causing the milestone not to be hit….” In that context, it might be “reasonably conceivable” [under Rule 12(b)(6)] that the change in behavior that was  not originally contemplated or not consistent with past practice, may be a change that was not commercially reasonable.

Several recent Delaware decisions, as noted on these pages earlier this week here, and commented on here, have added to the case law that still only amounts to a relatively modest body of law in Delaware, interpreting the phrase: “reasonable efforts” and various permutations on that phrase, often found in post-closing earn out disputes but prevalent in other contract disputes as well. A Delaware Court of Chancery decision two days ago has added again to the jurisprudence on this topic.

In the opinion styled In Re Oxbow Carbon LLC Unitholder Litigation, C.A. No. 12447-VCL (Del. Ch. Feb. 12, 2018), Delaware’s equity court published a 178-page magnum opus that has already been the subject of articles in Bloomberg and other legal publications. Prior Chancery decisions during the course of this hotly litigated case have been highlighted on these pages, and those rulings also provide background color. The opinion provides a comprehensive analysis of a factually complex dispute involving the billionaire William Koch and contractual rights of a minority member of an LLC in which Koch owned a majority. The post-trial tome deserves a robust synopsis, but in this short post I will only focus on the small aspect of the titular topic.

The following bullet points should entice readers to consult the full opinion if they need to know the latest iteration of Delaware law on these issues:

  • The court relied on Delaware Supreme Court precedent (n. 602) applying “commercially reasonable efforts” to “impose an affirmative obligation on the parties to take all reasonable steps to complete a transaction.”
  • Koch testified at trial that the Reasonable Efforts Clause involved required each party to “act in good faith to do what it takes….”
  • The court found support in the record to conclude that Koch spent resources and energy to thwart the sale instead of using reasonable efforts. See Chancery opinion in WaveDivision cited at note 614 and accompanying text.
  • This decision is also notable for its exemplary explanation and application of the following key Delaware concepts often involved in corporate and commercial litigation:
  • (i) the implied covenant of good faith and fair dealing;
  • (ii) unclean hands; and
  • (iii) interpreting an LLC Agreement in a manner that avoids an inequitable result.

 

A recent Delaware Court of Chancery opinion is useful for commercial litigators who encounter the frequent situation where one party is required to use some variation on the standard of “best efforts” to either sell a product or reach certain revenue milestones, for example, in connection with a joint venture or a post-closing earn-out. In BTG International, Inc. v. Wellstat Therapeutics Corporation, C.A. No. 12562-VCL (Del. Ch. Sept. 19, 2017), the court applied the contractually defined standard of “diligent efforts” to the promotion of a pharmaceutical product, in a post-trial opinion.  This discussion of the contractually defined standard of diligent efforts is at least generally analogous to other cases highlighted on these pages that address the standard of “reasonable best efforts” or “commercially best efforts” or the like, to perform certain tasks or to reach certain goals.  Due to the relative paucity of cases thoroughly analyzing these types of standards, this case will likely be useful to many readers.

Background: This case involved a distribution agreement between two pharmaceutical companies. BTG was the larger company and agreed to promote, distribute and sell a drug called Vistogard, that the smaller Wellstat did not have the resources to promote, distribute and sell.  After extensive negotiations, the parties agreed to a contractual definition of “diligent efforts” which BTG was required to employ in order to reach various sales goals for Vistogard.  In addition, the parties were required to work together to formulate and finalize a business plan that would describe the details for promoting, distributing and selling Vistogard.

Key Findings: The court found that BTG failed to hire a sufficient number of sales representatives and failed to devote other resources to sell Vistogard, but instead focused most of its efforts and resources on a completely different product in a different division of the company – – with instructions from the CEO to keep the costs flat related to Vistogard and not to increase the resources that were necessary to implement the business plan.

The court found that BTG failed to comply with the contractually defined standard of “diligent efforts” and also breached the agreement by not complying with the business plan that required certain resources, including a sufficient number of sales representatives, to be devoted to the sale of Vistogard.

Legal Analysis: The court provides a useful discussion of the elements of a claim for breach of contract and for awarding damages. The court also took the rare step of shifting fees due to bad faith litigation tactics, and explained its reason for doing so.

The court recited the familiar elements for breach of contract: (1) the existence of a contract, whether expressed or implied; (2) the breach of an obligation imposed by that contract; and (3) the resultant damage to the plaintiff.

BTG took the aggressive approach of filing a declaratory judgment action seeking a declaration that it had not breached the contract. In response, Wellstat asserted a counterclaim for breach of contract. In sum, the court treated the DJ action as a defensive tactic, which failed, in part because Wellstat did not breach the agreement such that it would have excused a performance of BTG.

This 60-page decision provides extensive detailed factual background which is necessary to fully appreciate the court’s thorough analysis. For purposes of this relatively short overview however, the key points in the analysis are based on the court’s finding that BTG failed to devote the necessary resources for Vistogard – – and instead prioritized the sale and promotion of other products of BTG other than Vistogard.  In addition to failing to comply with the contractual definition of diligent efforts, BTG also breached the agreement by failing to comply with the business plan that required a minimum amount of resources to be devoted to the sale and promotion of Vistogard.

The court also discussed principles applicable to claims for breach of contract damages. The basic remedy for breach of contract should give the non-breaching party “the benefit of its bargain by putting the party in the position it would have been but for the breach.” See footnote 170.  Expectation damages require the breaching party to compensate for the reasonable expectation of the value of the breached contract.  These damages are to be measured “as of the time of the breach.” See footnote 172.

Although expectation damages should not act as a windfall, the “injured party need not establish the amount of damages with precise certainty when a wrong has been proven and injury established. Doubts about the extent of damages are generally resolved against the breaching party.” See footnotes 173 through 175.

Moreover the court noted that: “Public policy has led Delaware courts to show a general willingness to make a wrongdoer bear the risk of uncertainty of a damages calculation where the calculation cannot be mathematically proven.” See footnote 175.

The court concluded by taking the unusual step of shifting fees due to bad faith litigation conduct, which included the need during the litigation for Wellstat to file a motion to compel before BTG complied with its discovery obligations, as well as BTG presenting a misleading demonstrative exhibit at trial. See footnotes 216 through 218.

SUPPLEMENT: The Delaware Supreme Court, by Order dated June 11, 2018, affirmed this decision with the exception of one minor point regarding the start date when pre-judgment interest will accrue.

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 Holdings, Del. 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, 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.

On the same day I completed the highlights for the above case, 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.

POSTSCRIPT:

Professor Stephen Bainbridge, a nationally-prominent corporate law professor whose voluminous scholarship is often cited in Delaware corporate law decisions, was kind enough to share this annual review via Twitter with the following high praise while referring to a subscription-only publication called The Chancery Daily which reports on decisions from Delaware’s Court of Chancery and Supreme Court:

@PrawfBainbridge

With all due deference to @chancery_daily, which is considerable, this is the single most indispensable event of the corporate law year. A must read.

Annual Review of Key Delaware Corporate Decisions https://delawarelitigation.com/2023/01/articles/annual-review-of-key-delaware-cases/18th-annual-review-of-key-delaware-corporate-and-commercial-decisions/

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*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

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.
  • Nor did the covenant 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.

Postscript: We are grateful to Prof. Bainbridge for sharing this post on LinkedIn. 

In the case of Snow Phipps Group LLC v. KCAKE Acquisition, Inc., C.A. No. 2020-0282-KSJM (Del. Ch. April 30, 2021, modified  June  2021), the court reviewed a topic of importance in deal litigation and one that has been the subject of many blog posts on these pages: an analysis of when reasonable best efforts or commercially reasonable efforts, which are deemed equivalent standards, have been satisfied.  This decision found that reasonable best efforts were satisfied in the context of obtaining financing–and found no MAE in the context of the pandemic. Also notable in this decision is the discussion of the “prevention doctrine.”

This 125-page decision, authored by newly-appointed Chancellor Kathaleen St. J. McCormick while she was still a Vice Chancellor, has already been the subject of much commentary by practitioners and others. See, e.g., the overview that appeared on Harvard Law School’s Corporate Governance Blog (on which yours truly has published multiple articles in the past.)  In part because I prefer not to duplicate extensive existing commentary, I simply want to highlight a few key issues addressed in the opinion that have widespread applicability to corporate and commercial litigators.

A prior Chancery decision in AB Stable VIII LLC v. Maps Hotels and Resorts One LLC (Del. Ch. Nov. 30, 2020), was another magnum opus of epic length that addressed similar issues, such as reasonable best efforts, and similarly did not find an MAE in the context of the pandemic.