BE & K Engineering Company LLC v. Rocktenn CP, LLC, C.A. No 8837-VCL (Del. Ch. Jan 15, 2014)

This useful Court of Chancery opinion addresses the familiar issue of competing forum selection clauses in related agreements and how to decide which forum will prevail for purposes of determine the controlling forum for disputes.

The court’s reasoning in the context of a motion for summary judgment under Rule 56 relied in part on the doctrine of “judicial admissions” in connection with factual statements made to a court in Georgia in a parallel proceeding, including those made in pleadings, depositions, statements of counsel to the court and responses to discovery. Many of those admissions were inconsistent with positions taken by the defendant in Delaware. Such statements are binding upon the parties against whom they operate and serve to limit triable issues of fact.

This 54-page opinion explains in great detail the factual basis for its findings regarding which disputes between the parties are covered by which applicable agreement. The court also explained the standard to convert a preliminary injunction into a permanent anti-suit injunction.

Touch of Italy Salumeria and Pasticceria, LLC v. Bascio, C.A. No. 8602-VCG (Del. Ch. Jan. 13, 2014).

This Court of Chancery opinion rejected a claim by an LLC against a former member for competing against his former LLC after resigning his membership status. In essence, the court reasoned in this gem of an opinion of wide application, that there was nothing in the language of the parties’ LLC agreement that restricted former members from competing against the LLC. The former member competed against his former LLC in close proximity selling speciality Italian foods

Of interest to some “foodies” may be the court’s definition of what a salumeria and a pasticceria are.

Delaware’s Key Corporate and Commercial Cases of 2013

You are invited to a free audio conference for a discussion of the top five decisions of 2013 from Delaware’s Supreme Court and Court of Chancery.

Wednesday, January 29, 2014 at 1:00 p.m. EST

For the last eight years, Francis G.X. Pileggi and Kevin F. Brady have provided an annual review of key Delaware corporate and commercial decisions.  In 2013, we have reviewed and summarized over 200 of the Delaware courts’ decisions on the Delaware Corporate and Commercial Litigation Blog at www.delawarelitigation.com.  Five decisions with the most far-reaching application and importance from 2013 will be highlighted and discussed during an audio conference led by an Eckert Seamans’ team of corporate and commercial attorneys.  Participants can dial-in on Wednesday, January 29, 2014 at 1:00 p.m. EST.  Written summaries of the cases discussed, with links to the full opinions, will be emailed after the audio conference.

To register for this event, please contact Lynn Brinjac at lbrinjac@eckertseamans.com

Speakers:

Francis G.X. Pileggi practices primarily in the areas of corporate and commercial litigation.  He has extensive experience in matters involving fiduciary duties and corporate governance as well as summary proceedings under the Delaware General Corporation Law.  Francis created and maintains the Delaware Corporate and Commercial Litigation Blog at www.delawarelitigation.com.

Kevin F. Brady represents clients in corporate and commercial litigation in the Delaware Court of Chancery, the Delaware Superior Court and the U.S. District Court for the District of Delaware.  He counsels corporations, boards of directors, officers, individual directors and individual shareholders in a wide range of issues involving corporate governance and interpretation of the Delaware General Corporation Law and federal securities matters.

Tara L. Lattomus represents clients in corporate and commercial litigation, bankruptcy and creditors’ rights and labor and employment matters.  She has experience in representing both creditors and debtors in insolvency proceedings and has litigation experience in state and federal courts in commercial litigation matters on behalf of both national and local clients.  She frequently publishes articles and makes presentations on recent Delaware decisions.

 

Professors Davidoff and Cain have published a paper indicating that over 97% of takeovers involving at least $100 million have been the subject of litigation. Professor Davidoff discussed his paper  in a post on DealBook, including reference to the recent comments by members of the Delaware Court of Chancery in response to many of these suits that settle based only on additional disclosures. Also, Kevin LaCroix on The D & O Diary provides an excellent overview of the paper.

Top Ten 2013 Delaware Corporate and Commercial Decisions

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

This is our ninth annual review of key Delaware corporate and commercial decisions. During 2013, we reviewed and summarized over 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 2013 are the “top ten” that we are highlighting in this short overview. Prior annual summaries are linked in the right margin of this blog.Photo of the Supreme Court Courthouse in Dover (The Supreme Court’s stately building in Dover is featured in the photo from the Court’s website.)

Whenever a “Top Ten” list is prepared, there remains a risk of omitting some opinions that also are noteworthy, so we encourage readers to send us suggestions for additions to this list. Hyperlinks below lead to both a synopsis and each slip opinion. Of course, all the opinions we reviewed in 2013 are available on this blog for those who would like to read all of them and make their own list. In chronological order, the winners are:

Supreme Court Determines that There is No Fiduciary Duty to Structure Executive Compensation to Take Advantage of Corporate Tax Deduction. Freedman v. Adams. This decision is another example of how difficult it remains to challenge compensation decisions on the basis of Delaware corporate law.

Supreme Court Enforces Duty to Negotiate in Good Faith. SIGA Technologies v. PharmAthene. Most lawyers will be surprised to know that an obligation to negotiate can be enforced in Delaware even when a term sheet is not complete or final.

Supreme Court Upholds Presumption of Good Faith in Agreement to Bar Claims. Norton v. K-Sea Transportation. This is one of many recent examples where an LP agreement waived all duties except the non-waivable implied duty of good faith, but the agreement also created a presumption of good faith that made it almost impossible to challenge wrongdoing. N.B. Waivers will be enforced. Read before signing to know what duties and rights are being waived.

Chancery Clarifies Fiduciary Duty of Disclosure Owed by Directors and Majority Shareholders when Purchasing Shares or Selling Shares to Existing Shareholders. In re: Wayport, Inc. Litigation. This opinion provides a textbook-style explanation of the duty of disclosure in general, as well as in the context of selling and buying shares among existing shareholders.

Supreme Court Establishes New Standard for Trial Courts to Determine Appropriate Penalty when Pretrial Deadlines are Not Met. Christian v. Counseling Resource Associates, Inc. This is a must-read for lawyers (and their clients) to understand when court approval is needed to extend pre-trial deadlines and the consequences of missing pre-trial filing deadlines.

Chancery Emphasizes Duty of Oversight Owed by Directors Includes Corporate Operations in Foreign Countries. Rich v. Chong and Puda Coal and In re:  China Agritech, Inc. Shareholder Derivative Litigation. This trio of decisions, all involving operations in China of Delaware corporations, should worry directors of companies with far-flung operations in distant countries unless they make visits to those countries or otherwise make themselves sufficiently aware of those operations.

Business Judgement Rule Announced as Standard Applicable to Controlling Shareholder Transactions with Safeguards.  In Re MFW Shareholders Litigation. This iconic Chancery decision provides a clear standard to practitioners who formerly had less definitive guidance (and multiple conflicting standards) to advise clients on the standard that would apply in Delaware to controlling shareholder freezeouts. This decision was appealed and on December 18, 2013, the Supreme Court heard oral argument en banc. When that decision is published, we will highlight it.

Chancery Addresses Whether Notice Required Before Board Ousts CEO/Controlling Shareholder. Klaassen v. Allegro Dev. Corp. et al.,. This Chancery decision is the subject of an expedited appeal to the Delaware Supreme Court. Among the issues to be addressed by Delaware’s high court is whether the actions of a board to dismiss the CEO, who also had voting power over a controlling percentage of shares, are void — as compared to voidable. The trial court opinion considering a motion for a stay pending appeal provides a mini-treatise on the Delaware law applicable to notice requirements for board meetings and the consequences of ineffective notice. The opinion is also must-reading for anyone interested in the proper approach to contests for control among warring factions of dissident directors and competing shareholder groups.

Supreme Court Addresses Business Combination Not Requiring Shareholder Vote. Activision Blizzard Inc. v. Hayes, et al., No. 497-2013, order issued (Del. Oct. 10, 2013). In a rare ruling from the bench, after oral argument, the Delaware Supreme Court reversed an injunction granted by the Court of Chancery in  Hayes v. Activision Blizzard Inc., No. 8885, 2013 WL 5293536 (Del. Ch. Sept. 18, 2013).  The formal written Supreme Court opinion was issued on Nov. 15, 2013. The issue addressed was whether the structure of the deal qualified as the type of business combination that required a vote by public shareholders. In a unanimous ruling, Delaware’s high court ruled that no vote was required. Notably, merely a month or so transpired between the date of the complaint being filed and the Supreme Court’s oral ruling after its review of an injunction that was issued by the trial court. Especially in a major case like this, that remains remarkable celerity.

Chancery Addresses State Insider Trading Claims Twice in Two Weeks (Two cases tied for the last spot in top ten list). In re Primedia, Inc. Shareholders Litigation. In connection with discussing the elements of the claim, this opinion addressed whether equitable tolling of the state insider trading claim applied to extend or suspend the statute of limitations. In Silverberg v. Gold, for the second time in as many weeks, a state insider trading claim, called a Brophy claim in Delaware, was analyzed in a Chancery opinion. This 40-page decision denied a motion to dismiss based on an alleged failure to make pre-suit demand on the board.

UPDATE: The Harvard Law School Corporate Governance Forum published a version of this annual review on their blog.

Grace v. Ashbridge LLC, C.A. No. 8348-VCN (Del. Ch. Dec. 31, 2013).

Issue Addressed:  Whether a successor entity was liable for advancement and indemnification claims based on the operating agreement of a successor entity LLC even though the sole allegations involve a predecessor entity and a related entity. Short Answer:  No.

Brief Overview:  An understanding of this case requires a review of the some of the entities involved for background purposes.  The plaintiff is a co-trustee of a family trust.  The trust owned shares of a company that was renamed Ashbridge Corporation in 1981.  That entity later merged into Ashbridge Partners LLC which was later renamed to Ashbridge LLC, a Delaware entity.  The court refers to another entity named Ashbridge Investment Management LLC (“AIM”) which the complaint did not explain in terms of its affiliation with the other entities.  The plaintiff was a member of Ashbridge LLC (the defendant) and a shareholder of Ashbridge Corporation before its merger.  He also serves on the Board of Managers and is chairman of the defendant.  He was previously chairman and a member of the board of the predecessor Ashbridge Corporation.

Beneficiaries of the trust for which the plaintiff is a co-trustee filed objections to accountings that were filed by the trust in the Court of Common Pleas of Chester County, Pennsylvania.  The objections filed by those beneficiaries merely refer to the actions of the plaintiff in the instant case, whose last name is Grace, as well as Ashbridge Corporation and AIM.  The defendant entity in this case is not mentioned once in the objections of the beneficiaries filed in the Pennsylvania trust matter, which is the pending underlying litigation in Chester County about which Grace seeks advancement and indemnification.

However, the complaint seeks advancement and indemnification under the operating agreement of the defendant Ashbridge LLC.

The defendant seeks to dismiss the claims for advancement because Grace was made a party to the proceedings in Pennsylvania “by reason of a fact” that Grace is a co-trustee of a trust (not a party in this case), and, moreover, the operating agreement of the defendant LLC does not extend advancement or indemnification rights to predecessor entities or affiliates.  Moreover, the underlying suit in Pennsylvania does not allege actions taken by Grace in his official capacity.  Defendant also argues that certain expenses for which Grace seeks advancement have not been adequately described in the amended complaint.

Analysis:  The court describes that the Delaware LLC Act broadly authorizes the grant of indemnification rights in operating agreements.  See 6 Del. C. § 18-108.  When interpreting advancement provisions in an LLC agreement, the court will ordinarily following contract interpretation principles.  See fn. 27.

The objections by the beneficiaries in the underlying Pennsylvania action only involve Ashbridge Corporation and AIM.  Therefore, Grace must demonstrate that the advancement provisions in the LLC Agreement retroactively apply to a predecessor entity or an affiliate.  This he was not able to do.

In addition to the fact that the allegations in the underlying Pennsylvania case do not mention the defendant entity, it is well settled in Delaware that successor corporate entities are generally not liable for the actions of the corporate officers of predecessor entities or affiliates when a fundamental change in identity has occurred.  For purposes of advancement and indemnification, Delaware law considers a conversion, as here, from a limited liability company to a corporation to be a “fundamental change in identity”.  See fn. 33 (citing Bernstein v. TractManager, Inc., 953 A.2d 1003, 1009 (Del. Ch. 2007).

In The Matter of the Rehabilitation of Indemnity Insurance Company, RRG, C.A. No. 8601-VCL (Del. Ch. Jan. 2, 2014).

This case addresses the standards the Court of Chancery will apply to willful and flagrant violations of a court order, in connection with imposing civil contempt sanctions. Because these types of violations remain a rare occurrence and this decision’s applicability will not be wide, those interested in the topic can download the rather short 24-page opinion.

In Silverberg v. Gold, et al., C.A. 7646-VCP (Dec. 31, 2013), the Court of Chancery denied defendants’ motion to dismiss a derivative action (for failure to make demand) alleging a breach of fiduciary duty based on insider trading against the directors of Dendreon Corporation, a biotechnology company which had only one commercially available drug product, Provenge, a treatment for advanced prostate cancer.  A single treatment of Provenge is administered in three separate infusions that occur approximately two weeks apart and costs $93K.  Provenge was sold using a “buy and bill” policy, whereby physicians prescribing Provenge were required to “purchase” the treatment and then receive reimbursement through Medicare, Medicaid, or private insurance companies.  This “reimbursement risk” became a key factor in the analysis of this case.

On April 29, 2010, after being developed and tested for approximately fifteen years, Provenge received FDA approval for commercial use; it launched immediately afterwards.  Fifteen months later, on August 3, 2011, after the market had closed, the Company halted trading in its securities.  At the following press release and conference calls, the Company acknowledged the significant negative impact of the “reimbursement risk” on the Company’s revenue.  A day after the Company’s August 3 announcement, Dendreon’s stock price dropped 67% and within a year, the Company undertook a restructuring and removed its CEO.  In addition, the SEC commenced a formal investigation of Dendreon.

The plaintiff filed suit alleging that the directors knew of the “reimbursement risk,” yet they failed to disclose this risk to investors, even when that risk manifested itself in the form of lower than expected sales. Instead, the defendants used this nonpublic information impermissibly to sell their shares in the company before the risk became known publicly. 

Insider Trading — a Brophy Claim

Under Delaware law, demand is excused only if plaintiff’s particularized facts “create a reasonable doubt that, as of the time the complaint is filed, the board of directors could not have properly exercised its independent and disinterested business judgment in responding to a demand.”  Here the plaintiffs argued Dendreon’s directors were not disinterested because they faced a substantial likelihood of personal liability for their conduct based on Brophy v. Cities Service Co. 70 A.2d 5 (Del. Ch. 1949) and its progeny.

A Brophy claim is an action for breach of fiduciary duty premised on a fiduciary’s insider trading.  For a plaintiff asserting a Brophy claim, to survive a motion to dismiss, the complaint must plead particularized facts sufficient to support a reasonable inference that: (1) the corporate fiduciary possessed material, nonpublic company information; and (2) the corporate fiduciary used that information improperly by making trades because the fiduciary was motivated, in whole or in part, by the substance of that information.

The Court found that, that the “reimbursement risk” information was significant because prescribing physicians would have to administer a full course of Provenge before they knew if they would be reimbursed, meaning they could not stop the treatment and mitigate their financial risk if a reimbursement problem developed.  The Court also found that the risk would be material to Dendreon’s investors because the commercial success of Provenge depends in large part on how often it is prescribed.  The Court noted that “[a]t least one reasonable inference that can be drawn from these facts is that, as of April 29, 2010 (the date the FDA approved Provenge), the Company and the Board were aware of physician reluctance, or at least the risk of it, and expected it to be an issue.”  Therefore, the Court concluded that the plaintiff had pled particularized facts sufficient to show that it is reasonably conceivable that he will be able to satisfy the first factor of a Brophy claim.

As to the second element of a Brophy claim, the plaintiff had to allege that the selling defendants, at least in part, “consciously acted to exploit” the fact that they possessed material, nonpublic information.  The Court found that during the relevant period (i.e., April 29, 2010 to July 25, 2011), defendants sold over $78 million worth of the Company’s stock.  Of that amount, over $56 million was sold within one day of the FDA approving Provenge on April 29, 2010.  And defendants large-scale disposal of stock immediately following the FDA’s approval of Provenge was accompanied by alleged facts supporting a reasonable inference that defendants knew when they sold that, at a minimum, there was a significant risk of the physician community being reluctant to prescribe Provenge because of the cost and reimbursement concerns associated with it, and that defendants did not disclose that information to the public.  For purposes of a motion to dismiss, therefore, plaintiff’s allegations were sufficient to support a reasonable inference that defendants intentionally exploited their informational advantage.  Moreover, during this time period, the Company was issuing press releases and holding conference calls with financial analysts and never mentioned the “reimbursement risk,” or that the Company was aware that such a material risk existed.

As a result, the Court found that the complaint supported a reasonable inference that defendants possessed material, nonpublic information when they sold their shares, the facts that they, among other things (1) elected to sell after the stock reached a likely high point; and (2) evidently remained silent when the Company chose not to convey that material, nonpublic information to the market, despite having multiple opportunities to do so.  These facts provided a reasonable inference of purposeful conduct which was sufficient to establish a showing of scienter under the standard applicable at this stage of the proceedings.  Thus, the motion to dismiss was denied.

In In Re Primedia, Inc. Shareholders Litigation Consolidated, C.A. No. 6511-VCL (Dec. 20, 2013), the Court of Chancery addressed defendants’ motion for a judgment on the pleadings in an action brought by minority shareholders of Primedia alleging that defendant directors of Primedia and Kohlberg Kravis Roberts & Co. L.P. (KKR), Primedia’s controlling shareholder, traded on inside information when purchasing shares of preferred stock of Primedia.  At issue were purchases  of  stock  which fell into two categories: (i) purchases made shortly before the public announcement of a sale of Primedia’s assets and (ii) purchases made before Primedia reported earnings that materially exceeded expectations. As to the first category, the Court granted the motion and as to the second, the Court denied the motion.

This opinion contains an excellent discussion about a Rule 12(b)(6) motion to dismiss and a Rule 12(c) motion for judgment on the pleadings and when the court could take judicial notice of information under Delaware Rules of Evidence 201 for purposes of a Rule 12(c) motion.  An earlier post on this decision can be found here.  There is also an excellent discussion on statute of limitations and equitable tolling which also factor prominently in the Court’s decision and are a recommended read for practitioners.  However, due to space limitations, those topics are not discussed in detail in this post.  Rather, the focus of this post is the Court’s discussion of the problems and hurdles stockholders face trying to survive the motion to dismiss stage on a claim for breach of fiduciary claim for insider trading especially in a situation where there is a controlling stockholder.

One of the determinations that the Court had to make concerned when a stockholder plaintiff is on inquiry notice for an insider trading claim that would survive a motion to dismiss.  First, the Court looked to see if there was sufficient information available to arouse a reasonable stockholder’s suspicions. Second, the reasonable stockholder must be able to commence an investigation and discover the facts necessary to plead the claim and survive the motion to dismiss.

A Brophy claim (named after the Delaware Court of Chancery’s decision in Brophy v. Cities Serv. Co., 70 A.2d 5 (Del. Ch. 1949)  is an action for breach of fiduciary duty premised on a fiduciary’s insider trading.  For a plaintiff asserting a Brophy claim, to survive a motion to dismiss, the complaint must plead particularized facts sufficient to support a reasonable inference that: (1) the corporate fiduciary possessed material, nonpublic company information; and (2) the corporate fiduciary used that information improperly by making trades because the fiduciary was motivated, in whole or in part, by the substance of that information.

The Court discussed the burden on stockholders and the level of due diligence they must exercise when monitoring corporate filings for potential claims.  The Court noted that stockholders are entitled to rely on the competence and good faith of a fiduciary but they are not entitled to ignore red flags. The Court said:

[T]he trusting plaintiff still must be reasonably attentive to his interests. Beneficiaries should not put on blinders to such obvious signals as publicly filed documents, annual and quarterly reports, proxy statements, and SEC filings.  Once a plaintiff is on notice of facts that ought to make her suspect wrongdoing, she is obliged to diligently investigate.

 With respect to the first category regarding purchases made before the public announcement of a material sale of assets, the Court identified several red flags.  First, KKR was Primedia‘s controlling stockholder, and several KKR representatives served on Primedia‘s board. Second, the KKR Form 4s showed that KKR was purchasing large quantities of preferred stock just weeks before the public announcement of a material sale of assets. Third, in response to the public disclosure of the asset sale, the trading price of Primedia’s common stock increased by double digits, and the trading price of one of the series of preferred stock increased by a much greater amount.  Based on those events, the Court found that a reasonable stockholder would have been suspicious, satisfying the first step of the test for inquiry notice.

The Court then focused its discussion on whether a reasonably suspicious stockholder could have conducted an investigation that would have uncovered the information necessary to file a complaint. A Primedia stockholder could have used Section 220 of the Delaware General Corporation Law to request board minutes concerning the sale which would have shown that the KKR directors were present at the meeting when the board approved the sale of assets subject to liabilities for approximately $115 million in cash. A reasonable investor reviewing those minutes would have focused on the fact that a KKR affiliate paid $8.5 million for preferred stock with a face value of $22.9 million on the same day that KKR representatives approved the sale.  A reasonable investor also would have noted that, less than two weeks later, an entity formed by KKR as a vehicle for purchasing stock, paid an additional $30.7 million for preferred stock with a face value of $84.9 million, before the sale was announced publicly.  A court may also infer scienter when a trade is sufficiently unusual in timing and amount.  Under the circumstances, a stockholder plaintiff would be entitled to an inference that defendants acted with scienter.  Thus, the Court found that a reasonable stockholder could have pled a Brophy claim that would have survived a motion to dismiss.

With respect to the second category regarding purchases made before Primedia reported earnings, the Court noted that a reasonable investor could have used Section 220 to request books and records showing what the KKR directors knew about Primedia‘s second quarter earnings and when they knew it.  If an investor had made such a demand, Primedia could have provided the documents that would have confirmed what the public filings showed: KKR was interested in purchasing, and then in fact purchased, preferred stock during July. But these documents would not have revealed anything about the reasons for KKR’s purchases or suggested that KKR made its decision to acquire preferred stock based on inside information.  The missing link would be an internal KKR memo, which Primedia did not have in its possession and therefore could not produce in response to a Section 220 demand.  Without that memo, the Court noted that it is “perhaps possible, but unlikely, that a stockholder could have pled a viable Brophy claim relating to the July purchases.”   Nothing in the Section 220 documents would have shed light on when the KKR representatives or the board learned of Primedia‘s better-than-expected earnings results.  Nor would KKR’s purchases necessarily have given rise to an inference of scienter.  KKR owned nearly 60% of Primedia’s common stock and purchased the entire Series J Preferred Stock issuance for $125 million in August 2001. Purchasing $30.5 million of another series of preferred stock might not be deemed sufficiently unusual in timing or amount to support a claim. Moreover, KKR purchased another $5 million of preferred stock on August 8, after the earnings release, which was an amount larger than the purchases on July 12, 15, and 26.  Thus, without the internal KKR memo, a court might well think that it was unreasonable to draw the inferences necessary to support a Brophy claim.

Two weeks after this opinion, Chancery against addressed another state insider trading claim, highlighted on these pages.

The procedural background and factual details about this case were highlighted on these pages in connection with several prior decisions by the Court of Chancery and the Delaware Supreme Court.