Zimmerman v. Crothall,  C.A. No. 6001-VCP (Del. Ch. March 5, 2012; revised March 27, 2012).

Issue Presented

The issue presented was whether the directors breached their fiduciary duties by issuing shares that they bought themselves and which were not available to the same extent to all shareholders. 

Result: The Court of Chancery denied defendant’s motion for summary judgment.

Background

The capital structure of the company involved in this matter was presented in four categories:  (1) Class A Common Units; (2) Class B Common Units; (3) Series A Preferred Units; (4) Series B Preferred Units, which participated pari passu with Series A and is Senior to Class A and Class B Common Units.  Venture capital investors controlled a majority of the company’s Series A Preferred Units.

The facts indicated that the company over the last few years, as a start-up, generated revenues of less than $1 million in the prior two years, but suffered losses of approximately $5 million during that same period.  One of the reasons given for the issuance of several million dollars in additional shares was that there was no other source of financing.

The founder and former CEO challenged the issuances of additional shares claiming that they were self-interested transactions designed to benefit the directors of the company and venture capital sponsors by unfairly diluting its common members.  The defendants moved for summary judgment on all counts.  Although the Court granted summary judgment to the defendants on the duty of care claims, the Court denied the motion regarding the duty of loyalty claims and found that the defendants failed to establish that the transactions were not self-interested.

Legal Analysis
After reviewing the familiar standard for summary judgment, the Court also recited the familiar business judgment standard.  The Court reiterated the requirement that the plaintiff establish a genuine issue of material fact as the whether the directors were “independent, disinterested, and informed or acting in good faith.”  In addition, if a plaintiff meets this burden then the challenged transaction must be reviewed for entire fairness.  The fact intensive demands of such review make it difficult for a defendant to prevail on summary judgment.  See footnote 21 (citing Encite LLC v. Soni, 2011 WL 5920986, at *20 (Del. Ch. Nov. 28, 2011)).

The Court also observed that in order to rebut the presumption that is a benefit of the business judgment rule’s deference, the plaintiff must show that “the directors’ decision was either wholly-irrational or motivated by self-interest or bad faith on the part of the directors approving the transaction.”

Duty of Care Claims

The plaintiff claimed that the transactions at issue were approved in violation of the duty of due care because they were without deliberation (being approved by written consent), and did not consider all reasonably available information.  In connection with its analysis, the Court addressed the use of the word “reckless” in the LLC agreement, and equated the term with the more familiar “gross negligence” standard for breach of the duty of care under Delaware corporate law.  See footnotes 29 to 31.  The Court explained why it relied on prior Delaware caselaw as opposed to the contract interpretation doctrine known as noscitur a sociis, which refers to the concept of understanding words (and people) based on their companions.

The Court explained in this 51-page decision why summary judgment was appropriate on the  duty of care claims.  The Court explained that “under the business judgment rule, scrutiny of a board’s actions begins with the presumption that the directors acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interest of the company.”  See footnote 36.  The Court also emphasized that whether or not the board was reasonably informed in making a business decision does not mean that the board must be informed of every fact, but instead the board is responsible for considering only material facts that are reasonably available at the time of the decision.  It is not the office of the Court to second guess the reasonableness and prudence of a business judgment.  In order to avoid the application of the rule, plaintiff must allege that “the process applied by a board in making a business decision was so egregious as to constitute reckless indifference to or a deliberate disregard with the whole body of stockholders for actions which are without the bounds of reason.”  See footnote 39.

Especially noteworthy is the Court’s instruction that:  “where a corporation in financial distress issues stock as a means to raise needed capital, its directors are given considerable latitude in fixing a price for the issuance.”  See footnote 47.  The Court noted in this case that the defendant failed to present any expert opinion on valuation (which did not help his case).

Duty of Loyalty Claims

The plaintiff claimed that the issuance of additional shares and the approval by the board members who participated in the purchase of those shares was a self-dealing transaction of bad faith.  It was also alleged that a majority of the directors stood on both sides of the transaction and received an exclusive benefit at the expense of the common members.

Bad Faith 

In order to prevail on a bad faith claim, the plaintiff “must overcome the general presumption of good faith by showing that the board’s decision was so egregious or irrational that it could not have been based on a valid assessment of the corporation’s best interests.”  See footnote 51.  The Court recognized that there is a third “intermediate category” of fiduciary misconduct between subjective bad faith and gross negligence, which is the “intentional dereliction of a known duty.”  See footnotes 52 and 53.  The Court previously found that the transactions were not grossly negligent or reckless; thus, by necessity it determined that the intermediate standard was not successfully plead. 

Self-Dealing

The entire fairness standard will apply where a transaction is approved by a majority of the directors or a controlling stockholder “standing on both sides of the transaction, dictating its terms, and obtaining a benefit not received by all stockholders generally.”  See footnote 53.

In addition to describing those situations in which a shareholder would be deemed controlling, relying on Kahn v. Lynch Communications Systems, Inc., 638 A.2d 1110, 1113 (Del. 1994), the Court found that there was a genuine issue of material fact as to whether or not the venture capital investors together exerted actual control over the company, and therefore the motion for summary judgment on that basis was denied.

The Court found that the majority of the board was either interested or not independent when they approved the challenged transaction.  The Court reviewed each individual director defendant to determine whether they were interested and non-independent.  See footnotes 65 and 66.  After reviewing the definitions as they applied to each member, the Court found that a majority were lacking in independence. 

The Court explained that in order to rebut the presumption of director independence, it does not suffice that the directors “moved in the same social circles, attended the same weddings, developed business relationships before  joining a board, and describe each other as friends.”  Rather, in order to establish lack of independence in considering a corporate transaction, the plaintiff “must make specific allegations of such material connections as financial ties, familial affinity, a particularly close or intimate personal or business affinity, or evidence that in the past the relationship caused the director to act non-independently vis-à-vis an interested director.”  See footnote 72.

The Directors Receive an Exclusive Benefit

In addition to showing that a controlling shareholder or a majority of the board was interested, the plaintiff must also show that “a transaction conferred an exclusive benefit on those interested fiduciaries to prove self-dealing.”  See footnote 73.

Delaware Supreme Court’s Gentile Decision

The Court reviewed the Delaware Supreme Court’s opinion in Gentile that explained that certain claims can be both derivative and direct in the context of an alleged dilution by controlling stockholder.

The money quote by the Court of Chancery is as follows:

“The essential teaching of Gentile is that in situations where a corporation issues successive shares to a controlling shareholder in exchange for an asset of lesser value, minority shareholders can bring both direct and derivative claims.”

That is, Gentile confirms that two types of actions, direct and derivative, can be brought based on the same transaction.

Bottom Line

The Court concluded that the plaintiff properly brought this fiduciary duty claim regarding the alleged overpayments by the company (in connection with the issuance of shares) on at least a derivative basis.  In addition, the plaintiff made a sufficient showing to support a reasonable inference that the transaction conferred an exclusive benefit on defendants, namely the opportunity to buy equity in the company at a price that allegedly is unfair.

The Court also emphasized that to the extent that the transaction was not entirely fair, that issue cannot be decided on a summary judgment motion, based on the factual issues presented.

No Pre-emptive Right

The Court acknowledged that there is no inherent right against dilution under Delaware law.  The court referred to Section 102(b)(3) of the DGCL which provides that no stockholder shall have the pre-emptive right to subscribe to additional issues of stock unless the charter expressly provides.

In this case, the Court found that the director defendants enjoyed an exclusive benefit under the challenged transactions that was not available to everyone generally, and therefore, the transactions were self-dealing and subject to entire fairness.

DGCL Section 144

The Court explained that DGCL Section 144, when its prerequisites are satisfied, fairly removes an interested director cloud so that an agreement cannot be invalidated solely because the director was involved.  However, Section 144, or its analog in the operating agreement in this case, which was based on Section 144, was not intended to address the common law rules for liability or breach of fiduciary duty.  Therefore, even if there was compliance, that would not operate as a safe harbor against the challenge to the transaction under the entire fairness standard.

One final note: the Court explained that “where a breach of fiduciary duty claim overlaps completely” a contractual claim that arises from the same nucleus of operative facts, the contractual claim will control and the courts generally dismiss the fiduciary duty claim.  See footnote 106.

Noteworthy 2011 Corporate and Commercial Decisions from Delaware’s Supreme Court and Court of Chancery.

By:  Francis G.X. Pileggi and Kevin F. Brady.

Introduction

This is the seventh year that we are providing an annual review of key Delaware corporate and commercial decisions. During 2011, we reviewed and summarized approximately 200 decisions from Delaware’s Supreme Court and Court of Chancery on corporate and commercial issues.  Among the decisions with the most far-reaching application and importance during 2011 include those that we are highlighting in this short overview.  We are providing links to the more complete blog summaries, and the actual court rulings, for each of the cases that we highlight below. Prior annual summaries are linked in the right margin of this blog.

Top Five Cases from 2011

We begin with the Top Five Cases on corporate and commercial law from Delaware for 2011 and we are glad to see that at least four of them have some support from the bench as these were the cases that four Vice Chancellors highlighted as important decisions in a recent panel presentation that they offered in New York City in early November 2011.  Those cases were the following:  In Re: OPENLANE Shareholders Litigation; In Re: Smurfit Stone Container Corp. Shareholder Litigation; In Re: Southern Peru Copper Corp. Shareholder Litigation and Air Products and Chemicals, Inc. v. Airgas Inc., and Kahn v. Kolberg Kravis Roberts & Co., L.P.

In Re: OPENLANE Shareholders Litigation. In what many commentators referred to as a “sign and consent” transaction, in which the majority shareholders and the board of directors had sufficient control to provide the statutorily required consent, the Court of Chancery determined that the Revlon standard was satisfied and fiduciary duties were not breached notwithstanding the Omnicare case and even without customary safeguards such as a fairness opinion. See fuller summary here.

 In Re: Smurfit Stone Container Corp. Shareholder Litigation. The Court of Chancery denied a motion for preliminary injunction and determined that the Revlon standard applied to a merger for which the consideration was split roughly evenly between cash and stock. See fuller summary here.

In Re: Southern Peru Copper Corp. Shareholder Litigation. In what may be the largest award granted in the Court of Chancery’s venerable history, a judgment was entered for $1.2 billion (later amended to $1.3 billion) for breach of fiduciary duties in connection with an interested transaction. With interest, the total is expected to be $2 billion.  The Court later awarded attorneys’ fees of 15% which amounts to $300 million, in this derivative action. See fuller summary here.

Air Products and Chemicals, Inc. v. Airgas Inc. This magnum opus of over 150-pages in length will be the focus of scholarly analysis for many years to come. For purposes of this short blurb, it ended a year-long takeover battle between two determined companies, with the Court of Chancery ruling, among other things, that the target company was not required to pull its poison pill when the board determined that the offer for the company was too low. See fuller summary here.

Kahn v. Kolberg Kravis Roberts & Co., L.P.  This Delaware Supreme Court decision reversed and remanded an opinion by the Court of Chancery interpreting “a Brophy claim as explained in Pfeiffer.”  The issue before the Court was whether a stockholder had to show that the company had suffered actual harm before  bringing  a breach of loyalty claim that a fiduciary improperly used the company’s material, non-public information (a Brophy claim).  The Supreme Court rejected that part of the Chancery’s decision in Pfeiffer v. Toll which requires a showing of actual harm to the company.  See fuller summary here.

We also selected the following additional noteworthy cases:

Shareholder Litigation

In Re: John Q. Hammons Hotels, Inc. Shareholder Litigation.  Despite the application of the entire fairness standard, the Court concluded that the merger price was entirely fair, the process leading to the transaction was fair, that there was no breach of fiduciary duty, and therefore no claims for aiding and abetting fiduciary duty.  See fuller summary here.

Reis v. Hazelett Strip-Casting Corp.  The Court applied an entire fairness analysis and held that the attempt to cash out minority shareholders via a reverse split was neither the result of a fair process nor did it involve a fair price.  See fuller summary here.

In re: Del Monte Foods Co. Shareholders Litigation. This first of three rulings enjoined a shareholder vote on a premium LBO transaction and the buyers’ deal protection devices.  The Court also held that the advice that the target board received from a financial advisor (who also did work on the deal for the bidder) was so conflicted as to give rise to a likelihood of a breach of fiduciary duty and the Court indicated that the financial advisory firm could face monetary damages due to aiding and abetting the potential breach.  See fuller summary here.

In re: Massey Energy Company Derivative and Class Action Litigation.  The Court declined to enjoin a proposed merger.  The Court noted that the derivative claims that the plaintiffs argued were not being fairly valued as part of the merger, would become assets of the surviving corporation.  The Court reasoned in part that the shareholders should decide for themselves whether to exchange their status as Massey stockholders for a chance to receive value from a third party in an arms-length merger.  See fuller summary here.

Frank v. Elgamal.  This decision exemplifies the different approach taken by different members of the Court in connection with an application for interim fees in a class action.  (Compare the different approach in the Del Monte case.)  See fuller summary here.

Krieger v. Wesco Financial Corp.  This decision determined that holders of common stock were not entitled to appraisal rights under Section 262 when they had the option of electing to receive consideration in the form of publicly traded shares of the acquiring company.  See fuller summary here.

In re: The Goldman Sachs Group, Inc. Shareholder Litigation.  In this first corporate opinion by Vice Chancellor Glasscock, the Court dismissed a derivative action brought against Goldman’s current and former directors based on a failure to make a pre-suit demand.  At issue was Goldman’s allegedly excessive compensation structure.  See fuller summary here.

Contested Director Elections

Genger v. TR Investors, LLC.  In this opinion, the Delaware Supreme Court addresses electronic discovery issues and contested elections for directors involving DGCL Section 225. See fuller summary here.

Johnston v. Pedersen.  This opinion determined that directors breached their fiduciary duties when issuing additional stock and as a result were not entitled to vote in connection with the removal of the incumbent board and the election of the new directors.  See fuller summary here.

Section 220 Cases

King v. VeriFone Holdings, Inc. This Delaware Supreme Court ruling reversed a Chancery decision that found a lack of proper purpose in a suit by a shareholder seeking books and records pursuant to Section 220.  Delaware’s High Court explained that it remains preferable to file Section 220 suits for books and records prior to filing a derivative suit, but holding that such a chronology is not, per se, a fatal flaw in a Section 220 action.  See fuller summary here.

Espinoza v. Hewlett Packard Co. This affirmance of Chancery’s denial of a §220 claim was based on the requested report to the board being protected by the attorney/client privilege.  (This is one of several decisions in this matter.) See fuller summary here.

Graulich v. Dell., Inc.  This is a Section 220 case in which Chancery denied a request for books and records due to the underlying claims being barred by a previous release and due to the shareholder not owning the shares during the period of time for which he was requesting documents.  See fuller summary here.

Alternative Entity Cases

CML V, LLC v. Bax.  This Delaware Supreme Court decision determined that creditors of an insolvent LLC are not given standing by the Delaware LLC Act to pursue derivative claims unlike the analogous situation in the corporate context.  See fuller summary here.

Sanders v. Ohmite Holding, LLC.  This decision clarified the rights of a member of an LLC that demanded books and records of an LLC.  The Court determined that pursuant to Section 18-305 of the Delaware LLC Act a member may seek records for a period prior to becoming a member of the LLC.  See fuller summary here.

Achaian, Inc. v. Leemon Family LLC.  This opinion addressed the transferability of interests of a member of an LLC and specifically whether one member of a Delaware LLC may assign its entire membership interests, including voting rights, to another existing member, notwithstanding the provision in an agreement that requires the consent of all members upon the admission of a new member.  See fuller summary here.

Jurisdictional or Procedural Issues

Central Mortgage Co. v. Morgan Stanley Mortgage Capital Holdings LLC.  In this decision, a Delaware Supreme Court determined that Delaware would not follow the standards for a motion to dismiss under Rule 12(b)(6) announced by the U.S. Supreme Court in the Twombly or Iqbal opinions.  See fuller summary here.

Hamilton Partners, LP v. Englard.  This decision addressed the issue of personal jurisdiction over directors and interlocking entities, as well as demand futility in the context of a double derivative shareholders suit.  (Although this was decided at the end of 2010, it was important enough to include in this list as it was issued after our deadline for our compilation last year). See fuller summary here.

Encite LLC v. Soni.  This decision rejected a request for an extension of a deadline for submitting expert reports because the Court did not approve an amendment to the Scheduling Order.  See fuller summary here.

Whittington v. Dragon Group.  In this latest iteration of multiple decisions in this long-running saga, the Court examines the doctrine of claim preclusion, issue preclusion and judicial estoppel.  See fuller summary here.

In re: K-Sea Transportation Partners, L.P. Unitholders Litigation.  This decision provides a useful recitation of the standard used in Chancery for deciding whether to grant a motion to expedite proceedings, and it also reviews language in a limited partnership agreement which arguably was an effective waiver of traditional fiduciary duties as allowed by the LP statute.  See fuller summary here.

Sagarra Inversiones, S.L. v. Cemento Portland Valderrivas, S.A.  This ruling determined that the standard of “irreparable harm” granting injunctive relief was not satisfied based on the financial condition of the defendant which was “not poor enough” to convince the Court that a money judgment would not make the plaintiff whole.  (This is one of several decisions in this matter.) See fuller summary here.

ASDC Holdings LLC v. The Richard J. Malauf 2008 All Smiles Grantor Retained Annuity Trust.  This decision discussed the enforceability of forum selection clauses and in particular when those clauses will be enforced despite a related case being filed first in another forum.  See fuller summary here.

Gerber v. ECE Holdings LLC.  This decision discusses the difference between a motion to supplement and a motion to amend a complaint.  See fuller summary here.

Advancement

Fuhlendorf v. Isilon Systems, Inc.  This decision addresses the advancement of fees incurred by officers and directors sued in connection with their corporate roles.  The specific issue in this case was whether the corporation should pay for all of the costs of a Special Master appointed to review the interim application for fees.  The case also discusses the common procedure employed to review disputed monthly legal bills in advancement cases.  See fuller summary here.

Receiver or Dissolution

Pope Investments LLC v. Benda Pharmaceutical Inc.  This decision rejected the application for the appointment of a receiver on the grounds that while the plaintiff demonstrated that the defendant was insolvent, the plaintiff failed to show that “special circumstances existed which would warrant the appointment of a receiver.”  See fuller summary here.

Stephen Mizel Roth IRA v. Laurus U.S. Fund, L.P.  This decision rejected a request to dissolve a limited partnership and refused to appoint a receiver in the context of an investment fund that was in liquidation mode but was not dissolved, nor was it winding-up as that term is used in the statute.  See fuller summary here.

Legal Ethics

BAE Systems Information and Electronics Systems Integration, Inc. v. Lockheed Martin Corp.  This opinion addresses Delaware Lawyers’ Rule of Professional Conduct 3.4(b) and discusses those situations in which a fact witness may be compensated for the “lost time” away from his “day job” suffered while testifying.  See fuller summary here.

Judy v. Preferred Communications Systems, Inc.  This decision addresses the issue of legal ethics involved in determining whether an attorney may assert a retaining lien over the documents of a former or delinquent client.   See fuller summary here.

Common Law v. Statutory Claims

Overdrive, Inc. v. Baker & Taylor, Inc.  In this last formal decision  by Chancellor Chandler, the Court discussed how the Delaware Uniform Trade Secrets Act displaces conflicting tort and other common law claims that are grounded in the same facts which would support the statutory misappropriation of trade secret claims.  See fuller summary here.

Damages for Breach of Agreement to Negotiate in Good Faith

PharmAthene, Inc. v. SIGA Technologies, Inc. This Court of Chancery decision awarded damages for breach of a contractual obligation to negotiate in good faith and fashioned an equitable remedy that required the sharing of profits from the production of a product that the defendant failed to negotiate the license of in good faith. There are several decisions involving contract law by the Court of Chancery in this matter, the most recent ruling denying a motion for reargument. See fuller summary of the most recent decision here.

Postscript

On a final note, the last week of 2011 saw the sudden and sad passing of one of the nation’s foremost experts on alternative entities, Professor Larry Ribstein, who was often cited in opinions of the Delaware Courts. He coined the word “uncorporations” to refer to alternative entities and was the author of many treatises, law review articles and other publications on uncorporations, jurisdictional competition, the business of law firms and related topics involving the intersections of law and business. He was an iconic figure in the law, and the legal profession is better because of his many contributions.

——————————————————————————

UPDATE: The Harvard Law School Corporate Governance Blog published this post here. The NACD’s Directorship.com site kindly published this article as a lead story on Jan. 5, 2012, available here. Professor Stephen Bainbridge graciously commented on this summary in his post available here. Professor Joshua Fershee on the Business Law Prof  Blog linked to this summary with kind references here.

Encite LLC v. Soni, et al., Del. Ch., C.A. No. 2476-VCG (Dec. 13, 2011). The prior decision by the Court of Chancery in this case, that this ruling refused to modify, was highlighted on this blog here. Another Chancery decision in this matter was summarized here.

This summary was prepared by a former associate of Eckert Seamans.

Background

The Court’s previous decisions in this case denied plaintiff’s requests to (i) extend an already expired deadline, and (ii) permit expert evidence on damages despite submitting its expert report months after it was due. The position that the Court took in this matter was an eye-opener for litigators who frequently request and grant extensions to scheduling orders without seeking Court approval.

Analysis

In this most recent ruling, Encite moved the Court to set aside the prior orders of the Court (which were made by then-Chancellor Chandler), and to allow the plaintiff to proffer expert testimony at trial. The Court denied the plaintiff’s invitation and found that then-Chancellor Chandler’s decisions were the “law of the case,” which controls subsequent litigation unless:

(1) the prior ruling was clearly wrong; (2) there has been an important change of circumstances; or (3) equitable concerns render application of the law of the case doctrine inappropriate.

Encite argued that circumstances had changed because the trial date was moved. Plaintiff argued that since the trial date was no longer looming, defendants wouldn’t be prejudiced by allowing plaintiff to submit expert testimony. The Court disagreed and reminded Encite that then-Chancellor Chandler cited six separate reasons that plaintiff’s behavior warranted the exclusion of expert testimony—the looming trial date being only one reason. Since plaintiff did not (and could not) argue that the remaining five circumstances cited by then-Chancellor Chandler had changed, the Court upheld the law of the case and denied plaintiff’s motion.

 

Encite LLC v. Soni, C.A. No. 2476-VCG (Del. Ch. Nov. 28, 2011), read 80-page opinion here. Prior Delaware decisions in this matter have been highlighted on these pages here.

Issues Addressed

One of the  issues addressed in this ruling on two motions for summary judgment was whether “a person can purchase a claim for breach of fiduciary duty in a bankruptcy proceeding.”  The Court did not condemn that concept.  The more specific issue was whether or not the defendant directors satisfied the entire fairness standard, which they conceded was applicable.  See footnote 156.

The sub-issue was whether, for purposes of the entire fairness review, the director defendants used a fair process in seeking and negotiating bids for the assets of the company that were being sold or whether they breached their duty of loyalty by favoring one particular bidder in such a way that other, higher bids were discouraged or precluded, thus causing the company to lose its chance to secure the highest value for its assets.

Short Overview

This opinion includes a helpful summary of the entire fairness standard.  The Court noted that due to the fact-intensive nature of Delaware’s most onerous enhanced scrutiny standard, directors face a difficult road in satisfying that standard in the context of a summary judgment motion. 

By contrast, when the application of the business judgment rule is appropriate, a motion for summary judgment by defendant board members makes sense because a successful application of that rule often resolves the case.  See footnote 155. 

The Court explained that the entire fairness standard places the burden on the director defendants to establish “to the Court’s satisfaction that the transaction was the product of both fair dealing and fair price.”  Although fair dealing and fair price concern separate lines of inquiry, the determination of entire fairness is not a bifurcated analysis.  Citing to recent cases, the Court acknowledged that “at least in non-fraudulent transactions, price may be the preponderant consideration.  That is, although evidence of fair dealing may help demonstrate the fairness of the price obtained, what ultimately matters most is that the price was a fair one.”  See footnotes 160 through 162. 

The Court further explained that the entire fairness analysis requires a transaction to be objectively fair and that “the board’s honest belief that the deal was fair is insufficient to satisfy the test.”  The Court noted that due to insufficient evidence in the record, its analysis was mostly limited to “fair process.”  The evidence regarding the price and value of the company purchased through the bankruptcy proceeding was odd at best.  For example, the argument was that the company should have been worth more and that the actions of the directors depressed the sale price.  The plaintiff purchased the company in bankruptcy and he sought to buy at the lowest price possible.  In other words, the less the plaintiff paid for the company, according to the argument of the plaintiff, the higher the damages that the defendant directors would be liable for in the pending suit.

Several other key points about the entire fairness standard were made in the opinion.  For example, the Court emphasized that fair dealing cannot be established simply by reliance on expert counsel.  That is, although “reasonable reliance on expert counsel is a pertinent factor in evaluating whether corporate directors have met a standard of fairness in their dealings with respect to corporate powers, its existence is not outcome determinative of entire fairness.”  See footnote 169.  Moreover, the Court emphasized that a “defendant may not rely on expert counsel to opine as the actual substantive fairness of a transaction.  Rather, the advice given by counsel is relevant to the issue of fair dealing, a question of process.  Relevant advice for an entire fairness analysis might therefore include whether counsel advised the defendant that the business judgment rule would apply or that the bidding process was thorough and fair.”  See footnotes 170 and 171.

Although Delaware law imposes no specific procedural requirements for the sale of assets or the change of control, “if the Defendant Directors seek to establish fair dealing in regards to an interested transaction, they nonetheless must demonstrate that they used procedural safeguards sufficient to convince the Court that the negotiations provided the equivalent of arm’s length bargaining.  Based on the record before me, I cannot make this finding.”

Other important principles in corporate and commercial litigation were also addressed.  For example: 

(1)        The doctrine of unclean hands was discussed at page 67. 

(2)        The flexible and capacious law of damages and equitable remedies available to the Court of Chancery in connection with breaches of fiduciary duties was discussed at page 71. 

(3)        In addition, the law of “contribution” among defendants was discussed at footnote 196.

Dishmon v. Fucci, No. 784, 2010 (Del. Supr., Nov. 10, 2011) (en banc), read Delaware Supreme Court decision here.

A former associate of Eckert Seamans prepared the overview of this case.

Although tangential to the substantive topic of commercial and corporate litigation, this negligence case is relevant to corporate and business litigators because it establishes an important rule applicable to procedural aspects of all cases before the Delaware courts. The gist of this opinion is that procedural defects caused by excusable neglect should not prevent a litigant from having her day in court for an adjudication of her case.

Background

In December 2006, plaintiff filed a complaint alleging that medical negligence caused the death of his father. In medical negligence cases, Delaware statute requires a plaintiff to submit an Affidavit of Merit with a complaint. An Affidavit of Merit is a statement signed by an expert witness supporting the plaintiff’s assertion that there are reasonable grounds to support a medical negligence claim. Affidavits of Merit are not discoverable by defendants, and must be submitted to the court in a sealed envelope marked “CONFIDENTIAL.”

Procedural History

With his complaint, plaintiff filed a motion for extension of time to file his Affidavit of Merit. That motion was granted, and the plaintiff thereafter submitted Affidavit of Merit to the court within the newly prescribed deadline. Four months later, the court dismissed plaintiff’s complaint (it is unclear from the Delaware Supreme Court’s written decision whether a motion to dismiss was pending) for failure to comply with the statutory requirements governing the submission of an Affidavit of Merit. In dismissing the case, the court found that plaintiff failed to submit his expert’s curriculum vitae with the Affidavit of Merit. Plaintiff moved for relief from judgment in a timely fashion.

More than three years passed before the court denied plaintiff’s motion (without explanation–i.e., no explanation for the delay or for denying the motion).

On appeal, the Delaware Supreme Court reversed and held that a procedural defect that does not prejudice the defendants in any way should not bar a litigant from receiving his day in court:

[W]e conclude, as a matter of law, that trial courts must give weight to Delaware’s well known public policy that favors permitting a litigant to have his day in court. In these circumstances, the absent curriculum vitae should have been viewed as a procedural defect, but not an independent basis for dismissal.

The court further admonished the trial court for the inexplicable and regrettable delay in ruling on the motion for relief from judgment.

Comparison to Recent Chancery Decision Refusing to Extend Pre-Trial Deadline, in:  Encite LLC v. Soni, 2011 Del. Ch. LEXIS 58 (Apr. 15, 2011). See highlights of that opinion here.

In one of Chancellor Chandler’s final decisions, summarized at the link above, the Court of Chancery declined to allow counsel to submit an expert report after the court-ordered discovery deadline had passed. The overarching holding of Dishmon—that procedural defects should not deny a plaintiff his right to his day in court—was a peripheral issue in Encite. The starkly different decisions in these cases are noted and compared briefly as practice points:

The decision in Encite was not dispositive of the merits. Disallowing a party to file an expert report is not the equivalent of dismissing a plaintiff’s case in its entirety, as happened in Dishmon. In Encite, the plaintiff still was allowed its day in court.

The procedural defect in Encite was not due to excusable neglect. In Encite, plaintiff’s counsel proffered to the court that the parties had reached an agreement to extend the deadline to submit expert reports, but defendants’ counsel did not concur. Further, plaintiff’s counsel only moved the court to extend the applicable deadlines after the deadline had passed, and only days before dispositive motions were set to be filed.

In contrast, in Dishmon, the Delaware Supreme Court found that counsel’s failure to confirm that the expert’s curriculum vitae was included in the sealed envelope was excusable because administerial tasks like sealing an expert report and accompanying documents in an envelope are not typically completed by an attorney.

The defendant in Dishmon was not prejudiced. Unlike the clearly prejudicial effect of submitting an expert report to opposing counsel within days of the dispositive motion deadline (and where expert reports were intended to be submitted simultaneously by all parties), there was no prejudice in Dishmon since Affidavits of Merit are not submitted to, or discoverable by, defendants.

Conclusion

Procedural defects can result in myriad outcomes; but they should never result in denying a litigant of his day in court.

Encite LLC v. Soni, et al., C.A. No. 2476-CC (Del. Ch. April 15, 2011), read letter decision here.

Holding

Court of Chancery rejected a request for the extension of a deadline for submitting expert reports.

Brief Overview

 

This 7-page letter ruling is a useful tool for the toolbox of Chancery practitioners who deal with the issue of extending deadlines imposed by a Scheduling Order.

 

Court of Chancery Rule 6(b) applies to motions to extend deadlines after the expiration of the prescribed period, during which the Court may grant an extension “if the failure to act was the result of excusable neglect.” Excusable neglect has been defined in other circumstances by the Delaware Supreme Court as “neglect which might have been the act of a reasonably prudent person under the circumstances.” (citing Dolan v. Williams, 707 A.2d 34, 36 (Del. 1998)). The Court reasoned in this decision that the foregoing standard was not met.

 

I love it when the Court uses Latin. In this decision the Court explained that: “Informal agreements among counsel do not operate, ex proprio vigore, to modify a Court’s Order.” 

 

The salient background facts of this case involve a conversation with counsel in which one of the attorneys thought that there was an oral agreement to extend the deadline for submitting expert reports. That oral understanding was not confirmed in writing and one of the attorneys denied having that understanding.

 

The bottom line “takeaways” from this ruling are at least three-fold: 

 

(1) No modifications of the deadlines in a Scheduling Order will be effective, regardless of written confirmation among counsel, unless and until the Court approves such modifications of the Scheduling Order;

 

(2) Even if all counsel agree in writing to a modification of the Scheduling Order, and even if they are deadlines that do not impact dispositive motions or trial dates, those modifications must be submitted to the Court for approval prior to the expiration of the applicable deadlines; and

 

(3) Requests for modification after the expiration of the deadlines in the Scheduling Order are subject to the “excusable neglect” standard under Court of Chancery Rule 6(b). Because that standard was not met here, the Court determined that the plaintiff’s “thirteenth-hour attempt to modify the Scheduling Order is denied.” The Court relied on a recent Delaware Supreme Court decision upholding a trial court’s refusal to include an expert report that was submitted after the deadline in the Scheduling Order. See Jackson v. Hopkins Trucking Company, Inc., 2010 WL 3397478, at * 3 (Del. Aug. 30, 2010).

 

Parenthetically, in closing, although the Court did not address it and did not rule on it, the Court mentioned “in passing” but did not condemn the position of one party who required that a discovery request made during a deposition be submitted in writing afterwards.

 

UPDATE: A motion for reconsideration was denied in a letter ruling on April 26, 2011, available here.

Christiana Care Health Services, Inc. v. Connor, et al., (Del. Ch., Aug. 4, 2008), read opinion here,  and Encite LLC v. Soni, (Del. Ch., Aug. 1, 2008), read opinion here, are recent opinions of the Delaware Supreme Court and Delaware Chancery Court, respectively, that deal with procedural and substantive aspects of imposing liability on joint defendants.

In Christina Care, Delaware’s High Court interpreted Section 2301(d) of Title 6 of the Delaware Code that relates to pre-judgment interest when a settlement demand is made in an amount less than the amount of damages awarded in a judgment. In this Supreme Court case, a pre-trial settlement offer was made to each defendant in the amount of $1.25 million each (which was not accepted) but the jury award was $2 million jointly for both defendants. Consistent with its recent ruling in Cahall v. Thomas (see summary here), regarding Rule 68 and pre-trial offers of judgment, the Supreme Court reasoned that because the $2 million judgment was a common liability of both defendants which the plaintiff could collect in full from either one, regardless of how the jury apportioned the fault, the entitlement to pre-judgment interest would apply.

 In the Encite LLC case, the Chancery Court addressed the right to contribution between joint tortfeasors, and at footnote 76 refers to cases that confirmed the right to contribution as being governed by the Contribution Among Tortfeasors Law that has as an inherent requirement that the parties are jointly or severally liable in tort for the same injury to person or property. See Section 6301 of Title 10 of the Delaware Code.